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What kind of life insurance policies are the cheapest? what are the features of different kinds of policies out there? What should I be looking for?

21

Term is the way to go. Whole/universal are basically a combo of term and savings, so buy term life insurance and invest the difference in cost yourself. You should make a lot more that way (as far as savings go) than by buying whole life. By the time term life gets too expensive to be worth (when you're a lot older) you will have enough saved to become "self-insured". Just don't touch the savings :)

You really only need insurance when there is income to replace and debts to cover - house/mortgage, kids/school, job income, etc.

9

Whole life in most instances is a very bad plan. It's marketed as a life insurance policy wrapped in an investment but it does neither very well. The hidden caveat of whole life is that the investment goes away if you die.

Say for example I have a $100,000 whole life insurance policy and over the years I have paid in enough to have a $15,000 cash value on the policy. If I die, my family gets $100,000 and the cash value is lost.

With term life you can get a substantially higher amount of coverage for a smaller payment. If you invest the difference you end up not only with better coverage, but a better cash value from the difference if you don't die (which is what we all hope for anyways). As JackiYo said, your insurance should be designed around replacing lost income/value.

You should get 10x your annual income in term life insurance.

  • If income replacement is the goal, wouldn't 10x your annual income imply you'd need to earn 10%/yr on the proceeds to replace the income? Or, are you assuming some principal is used as well? – Chris W. Rea Oct 9 '09 at 21:55
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    Properly invested a 10% per year rate of return in a normal market isn't incredibly difficult. In fact, getting higher than a 10% is realistic which will help compensate for when down markets do end up hitting (and they will). It's incredibly important though to work out the details with your financial adviser especially so that when a down market does hit that it doesn't screw up plans too much. The target is to live off of the gains as you stated, but you have to be careful with how you manage investing and withdrawing the money. – Phillip Benages Oct 12 '09 at 13:18
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    Somebody has been listening to Dave Ramsey. – Jared Aug 7 '14 at 19:08
  • You only have to make 10% per year if you never want the principal to go down. You can spend more than your investments earn if you are willing to spend it down before death. Also, presumably your dependents will be able to earn money (kids grow up and get jobs, spouses get social security, etc.). Not arguing for or against the 10x rule, just against the assertion that it implies a required 10% annual return, which is likely to not be achieved. – farnsy Mar 30 '16 at 19:21
5

Wow, very amused by some of the answers. I will comment on those later.

To directly answer your question, here is a link to a brochure that explains the three basic typs and is written in straightforward language.

link text

That is step one.

Step 2 is a question, cheapest when, initially or for long term?

Without a doubt term initially is the cheapest. However every 10 years or 20 years it increases in price. As the name term implies it is temporary. Coverage will end at some point, 75, or 80 depending upon plan design chosen. It is possible that if you choose Term you can outlive your coverage and all you have are a bunch of cancelled cheques.

Young people with a mortgage, children and other debts should buy a lot of term as the mortgage will be paid off, the kids will no longer be dependent. These needs are temporary.

However some needs are permanent. What about leaving a Legacy at Death to a Charity? Insurance is a good solution and can provide a tax deduction too. Term isn't a good fit.

Or a business owner wishing to transfer his/her business at death to their children. Taxes will be due and permanent insurance such as Whole Life and Universal Life can be arranged to provide cash to pay tax whenever this happens.

Let me ask you who received 10% in the last ten years on their equity portfolio. Almost zero people did.

However a Whole Plan would have generated a guaranteed return of 3.0% plus a non-guaranteed return via dividends that the combined internal rate of return on a combined basis would be about 5.6% AFTER TAXES. Life a bond portfolio yield. (Internal rate of return is dependent on age at buying, years of investing. All insurance comany software can show you the internal rate of return.) IRR is essesntially: what is the return after tax that you must get to equal the equity or death benefit from a permanent insurance plan.

Someone mentioned by Term and Invest the difference. That is what universal life is, Term and Invest the difference except the difference is growing tax sheltered.Outside investments with comparable risk are taxable!

There is no easy answer for what type is right, often a combination is. The key question you should ask is How Much Is Enough? Then consider types based upon your needs and budget.

Here is a link where you can calculate how much you need.

I hope this helps a bit.

3

All life insurance is pretty much the same when it comes to cost. You can run the numbers over certain time period and the actual cost of insurance is about the same. A simplified way to explain life insurance and the differences between them below:

The 3 characteristics of life insurance:

  1. All life insurance is a variation of annual renewable term insurance (ART).
  2. Life insurance typically gets more expensive as your age, and it is very expensive when you reach a very old age.
  3. The major differences between them are: how long it will lasts, if it has cash value, and how is that cash value credited.

There are 5 popular types of life insurance and they are:

  1. Term

  2. Whole Life

  3. Universal Life

  4. Variable Universal Life

  5. Indexed Universal Life

But first, one must understand the most basic life insurance which is called Annual Renewable Term:

Annual Renewable Term (ART):

Annual Renewable Term Simplified Illustration

This is a policy that covers 1 year and is renewable every year after. The cost of insurance typically increases each year as the insured ages. So for every year of coverage, your premium increases like in the simplified illustration above.

This is the building block of all life insurance, term or permanent. There is no cash value; all premium goes to the cost of insurance.

Term:

15 Year Term Simplified Illustration

This is an ART that spans over a longer time period than 1 year (say 5, 10, 15, 20 or 30 years). All the cost is added together then divided by the number of years of coverage to give a level premium payment for the duration of the policy. The longest coverage offered these days is 30 years.

There is no cash value; all premium goes to the cost of insurance. The premium is fixed (level) for the term specified. If the policy comes to an end and the owner wishes to renew it, it will be at higher premium. This can be seen in the simplified illustration above for a 15-year term policy.

Permanent Insurance

Permanent Life Insurance Simplified Illustration

Because life insurance gets very expensive as you reach old age, life insurance companies came up with a way to make it affordable for the consumer wishing to have coverage for their entire lifespan. They allow you to have interest rate crediting on the cash value account inside the policy.

To have cash value in the first place, you must pay premiums that are more than the cost of insurance. The idea is: your cash value grows over time to help pay for the cost of insurance in the later stages of the policy, where the cost of insurance is typically higher. This is illustrated above in an overly simplified way.

Whole Life WL

This is a permanent life insurance policy that is designed to cover the lifespan of the insured. There is cash value that is credited on a fixed interest rate specified by the insurance company (typically 3-5%). The premium is fixed for the life of the policy. It was designed for insuring the entire lifespan of the insured.

Universal Life UL

This is variation of Whole Life. There is cash value; it is credited on a fixed interest rate specified by the insurance company, but it does fluctuate year to year depending on the economy (typically 3-6%). The premium is flexible; you can increase/decrease the premium.

Variable Universal Life VUL

This is basically a universal life policy, but the cash value sits in an account that is invested in the market, normally mutual funds. Your interest that is being credited (to your account with your cash value from investments) is subjected to risk in the market, rise/fall with the market depending on the portfolio of your choosing, hence the word "Variable". You take on the risk instead of the insurance company. It can be a very good product if the owner knows how to manage it (just like any other investment products).

Indexed Universal Life IUL

This is a hybrid of the UL and the VUL. The interest rate depends on the performance of a market index or a set of market indices. The insurance company states a maximum interest rate (or cap) you can earn up to and a guaranteed minimum floor on your cash value interest that will be credited (typically 0% floor and 12% cap). It is purely a method to credit you interest rate. It takes the market risk out of the equation but still retains some of the growth potential of the market.

Summary

Term policy is designed for temporary coverage. There is no cash value accumulation. Permanent policies such as whole life, universal life, variable universal life and indexed universal life have a cash value accumulation component that was originally designed to help pay for the cost of insurance in the later stages of the policy when the insured is at an advanced age, so it can cover the entire lifespan of the insured. People do take advantage of that cash value component and its tax advantages for retirement income supplement and maximize the premium contribution.

Always remember that life insurance is a life insurance product, and not an investment vehicle. There is a cost of insurance that you are paying for. But if you have life insurance needs, you might as well take advantage of the cash value accumulation, deferred tax growth, and tax-free access that these permanent policies offer.

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    Is your advice in the last targeted towards everybody, or just a subset of people? (Nice answer by the way. Very complete.) – MrChrister Aug 6 '14 at 20:48
  • I hope to target everyone, I have seen life insurance being mis-represented by agents and misunderstood by consumers. Thanks for the comment. – Thevin S Aug 7 '14 at 22:10
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TL;DR:

Only term is pure insurance and is the cheapest. The rest are mixtures of insurance and savings/investment. Typically the mixtures are not as efficient as doing it yourself, except that there can be tax advantages as well as the ability to borrow from your policy in some cases.

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