Life Insurance Is Not a Financial Plan
These days, life insurance is often improperly sold as a complete financial plan. Life insurance salespeople are generally concerned with the amount of insurance a person has the capacity to pay for rather than the amount of coverage they actually need. As a result, the sales conversation often focuses on the death benefit of the policy as well as its ability to build up cash value.
A life insurance policy is a contract that is established with a financial institution designed to provide the insured’s beneficiaries with some level of financial security upon their death. In exchange for premium payments, the insurance company provides a lump-sum payment, known as a death benefit, to any named beneficiaries. The contract’s cash value is a feature only available in whole life insurance policies that earns interest and is made up of the excess premium payments collected each year.
Whole life or permanent life insurance policies are designed to be carried or in place for the rest of a person’s life, whereas term insurance is intended to be temporary and provide coverage only for a specified period. The term may be set for any period, but they typically extend 5, 10, 20, or 30 years. The death benefit and premium amount remain the same throughout the life of the policy, making it the more straightforward of the two.
Term insurance tends to be significantly cheaper than whole life and does not charge any excess premiums to build up a cash value. Consequently, term insurance policies pay considerably less commissions and are less likely to be recommended by insurance salespeople.
Whole life insurance policies are often incorrectly positioned as a catchall for multiple circumstances. Whether you are concerned about saving for retirement or about leaving a legacy to your heirs, and even if you have a hard time managing cash flow and saving for a rainy day, the concerns are all met with the same solution – whole life. Buyers are told that their ability to accumulate a cash value inside of the policy, and borrow from it if necessary, will serve as a means to tackle all of their other long-term financial needs.
A true financial plan, however, is a comprehensive document containing an individual's short- and long-term objectives for achieving financial success and well-being. A financial plan may be created independently or with the help of a professional financial planner. In either case, preparation begins with a thorough evaluation of the individual's current financial state and future fiscal expectations.
The elements of a financial plan include the development of a cash flow analysis and budget, a retirement income plan, tax minimization strategies, a diversified investment portfolio, the review of estate planning documents, and the determination of the most suitable level of life insurance coverage. Much of financial planning involves thinking through what-if scenarios and, in the case of life insurance, planning for the conceivable worst-case.
If the worst should occur, term life insurance would provide a person with the coverage necessary to replace their income and to settle any large debts, like a mortgage, in a cost-effective way. There are certainly a few scenarios where purchasing whole life insurance can make sense, but in most cases, it is sold to people who do not actually need it. Aside from business owners looking for larger contributions than traditional retirement plans allow, and those with large enough estates that the Federal or state estate tax are a concern, term life insurance would likely be sufficient.
Considering that the difference in premiums for a whole life versus term life policy on an insured person can sometimes be ten times greater, it is reasonable to assume that that same person could afford to hire a fiduciary financial planner who is trained to help address all of the other financial challenges that life insurance does not reach and realize a much better outcome.
Want more on this topic? Read these:
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Malcolm Ethridge, CFP® is the Managing Partner of Capital Area Planning Group based in Washington, DC. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
Disclosures:
The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
Investments in securities and insurance products are:
NOT FDIC-INSURED | NOT BANK-GUARANTEED | MAY LOSE VALUE