My friend Brandon is a very big advocate of Permanent Life Insurance. Him and I have gone the rounds on many occasions about permanent versus term. I decided that to be fair, I would present his argument in a series of posts here in Rabbit Funds. The series begins with this post. You can find links to the other posts in the series at the bottom.
Buy term and invest the difference is one of the most common pieces of financial advice out there. It is promoted in books, on TV, on the radio and just about every place where you might find financial information. But is it really the best thing for everyone to do?
For people with financial responsibilities that will remain even after they are gone, buying life insurance is an important moral consideration. But the kind of insurance you buy is an economical decision.
In the end, everyone wants to have as much wealth as possible and the greatest opportunities to enjoy it; no one would turn down any financial strategy if they knew it would be beneficial for them in the end.
With that in mind, here are some things that you probably haven’t been told by everyone that is promoting buy term and invest the difference. I put this out there not to convince you that one way is better than another but because I have seen too many people make poor financial decisions because they were not well informed. And making the buy term and invest the difference choice early on can really set the tone, for better or worse, for the rest of your financial future.
Make sure you understand your choices.
First is the actual life insurance component. Everyone that promotes buy term and invest the difference also says that you should plan to self insure. You really can’t use one of the strategies without the other.
The idea is that you can save and invest enough money that your savings will be great enough to support your financial responsibilities even if you die. It sounds pretty good too. I mean, wouldn’t all of us like to get rid of a life insurance bill and have hundreds of thousands of dollars in the bank?
It’s strange to me that this self insurance idea is so popular
Think of the most valuable asset you have. You’re probably thinking of your home or your car, right? Wrong! Your most valuable asset is your ability to earn an income. Most people don’t realize that an insurance company will only offer you about as much life insurance as they think you are worth. And that is the greater of either your net assets, or your average annual income multiplied by the average number of years someone your age has left in the workforce.
For instance, the average 30 year old could only get a policy equal to 30 times his annual income. So life insurance is actually insuring your ability to earn an income. Like any other insurance, it is designed to replace something that is lost.
If you had your home completely paid for, and some money in the bank as a cushion, would you drop your homeowners insurance? You would save around $1,000 a year on average if you did. But I have yet to meet a single person who would drop their coverage because the risk of loss is too great. They don’t want to have to replace their home and all of their possessions if something happens, even if they have the money to do so.
So if someone doesn’t want to be out a few hundred thousand dollars to potentially replace a lost home, why in the world are people comfortable with their survivors being out much more due to lost future income?
It sounds absurd to say, “Well, we have enough money in the bank, we don’t need any more.” But that is essentially what people are saying by giving up life insurance.
Even more ironically, life insurance is the only kind of insurance that is guaranteed to eventually have a claim. No one is guaranteed to get sick, or have a car wreck, or have flooding in a home, but everyone will eventually die.
The issue is not that people don’t want insurance
If insurance were offered for free you’d take as much as you could get. The issue is that people don’t want to pay for it, at least until a claim is made. Then people wish they had more.
Did you know that over 50% of all new universal life policies are issued to people that are over age 65? Why? Because once someone gets to that age, they realize they want permanent life insurance.
Here are all of the posts in this series:
- Challenging Pre-conceptions
- How Term Life Insurance Works
- Is 12% Realistic when “Investing the Difference”
- Returns, taxes, death benefit and debt
- Achieving Financial and Spending Freedom
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