Being properly insured is part of having your finances in order. Insurance will protect you and your family far better than an emergency fund in the event of a disability, critical illness, or death.
Nevertheless, it’s something many young people neglect.
In recent weeks, a handful of readers have approached me with questions about cash-value life insurance. I’m not sure if it’s increasing in popularity, or you simply don’t become a target of insurance salespeople until your late-20’s and early-30’s. Regardless, there seems to be an increasing trend of insurance policies being pushed on millennials.
As you might already know, I’m highly mistrustful of financial salespeople and products. I am wary of financial advisors that push high-fee investments. I loathe mortgage brokers that get people into debt in order to come up with their down-payments. And I deeply dislike insurance agents that wrangle people into expensive policies. If you want to know what all of the above have in common, it’s commissions.
Beware anyone that stands to gain a percentage of your investment when you purchase a financial product because it is in their best interest to get you to pay as much as possible, not ensure you get what you need.
Spoiler alert for those who do not want to read the entire post below: buy term life insurance, avoid cash-value life insurance at all costs.
The difference between Term Life Insurance and Cash-Value Life Insurance
Here is the difference between Term Life and Cash Value or Whole Life insurance:
Term Life Insurance
Term life insurance provides coverage over a certain term for a fixed monthly payment. In the event of your death, a beneficiary you designate will be paid out the value of your policy.
You are covered for a term, typically 1 to 30 years, and when the term ends, your coverage expires and you have to renew or start a new term plan. The price of your monthly premium is constant for the term, but typically increases with your age when you renew.
Term Life Insurance is a must-have for everyone, especially if you have a spouse or dependents. You can explore and compare affordable term life insurance policies here.
Cash-Value Life Insurance
Cash value or whole life insurance is a blended savings and insurance plan. Like Term Life Insurance, your beneficiary will be paid out the value of the plan in the event of your death. However, there’s an added investment aspect.
The policyholder pays into the plan, and in addition to being covered for life insurance, a portion of the premiums accumulate as a cash asset. This cash grows tax-free within the policy, allowing the policyholder to borrow against to meet other financial obligations, such as clearing debts or making other investments.
Both types of life insurance will provide a financial payout to your designated beneficiary in the event of your death, but term life insurance is reasonable for almost everyone andwhole life insurance is virtually useless.
Cash-value life insurance is not a not a scam, but it isn’t a great financial product
Cash-value life insurance is sold as a tax-free investment vehicle. Usually the salesperson will try to position it as a secret product only the wealthy know about.
Heads up: you’re not wealthy enough to make it useful.
You do not need the tax-sheltering advantage of a cash-value life insurance policy because if you’re earning anything measurable in the five-figures or low six-figures, you’re not paying a whack of income tax in the first place. (I know you think you are, but you’re not)
Cash-value life insurance is ridiculously more expensive than term life insurance
It’s not uncommon to see premiums for a cash-value life insurance policy as high as $700 or $800 per month. Even with a good income, this is a hefty bill and will likely prevent you from being able to save in more traditional savings vehicles, like your retirement accounts.
Your cash-value life insurance is not as liquid or as useful as other savings accounts, so if this is the only place you can afford to save, you’re going to run into trouble when you need to access your savings.
The biggest problems with the high premiums of a cash-value life insurance policy are that many young people cannot keep up with the payments. Often they will simply give up paying into the plan, losing both their investment and their insurance coverage, but relieving themselves of the burden of paying hundreds of dollars per month. Talk about no-win!
In some instances, even missing a payment just once in your life, can void the policy so your loved ones can’t collect if, god forbid, something happens to you. You know insurance companies: they don’t like to pay out claims.
Signing up for a cash-value life insurance plan is a more serious commitment than your job or marriage — and you never get a sick day! You must pay every month until your plan is paid up, or you risk voiding the plan entirely.
The incredible returns are not guaranteed, and the fees suck
Your insurance agent will brag about the amazing returns of your cash-value life insurance but, like everything else, it is absolutely not guaranteed (even if they say it is).
Those projections are estimates, just like everything else. It’s true that the money will grow tax-free, but it’s also true your salesperson will make a killing on commissions & fees from you first. Life insurance agents typically make 80% to 100% in commissions of the first year’s policy premiums.
Remember that next time they tell you about how this will be such a great wealth-building tool for you.
Stay away from Cash-Value Life Insurance, and stick with Term Life Insurance
20- and 30-somethings can get term life insurance at great prices ($20/mo or less usually!) or receive plans from their employers. If you need life insurance, just get an affordable term life insurance plan, and reinvest the hundreds of dollars you’re not putting into a cash value plan into the stock market instead.
And if you really want to get rich, become an insurance agent.