December 10, 2007
Part two of a guest post by The Finance Buff.
First published Sep. 13, 2007
My last post about life insurance was on how to buy life insurance. This time I’m going to talk about what to buy.
1. Permanent vs. Term. The best approach on the permanent aka cash value vs. term discussion is tuning out. Just buy term. Very few people have permanent need for life insurance. The vast majority of people are better off buying term. So don’t even worry about the other kinds of life insurance. Some agents and web sites will try to steer you into permanent insurance. They put up all kinds of false arguments like “permanent is like owning; term is like renting.” Just ignore them. For entertainment value or if you’d like immunize yourself from the false arguments, you can see how an insurance salesperson twisted the logic and how the members on the Bogleheads forum rebutted.
2. Level Premium Term or Annually Renewable Term. Level Premium Term guarantees fixed premium for the entire term. You pick how many years you want to insure for. The premium stays the same throughout the entire term. Because the odds of a person dying increases with age, the cost of insurance also increases with age. So while your premium stays the same, you will be paying more than the cost in the earlier years and less than the cost in the later years. Annually Renewable Term is pay as you go. Your premium is lower in the earlier years and higher in the later years. See sample premiums for a $500,000 policy for a 35-year old in the chart below:
I chose Level Premium Term for myself because I like the certainty of knowing my premium won’t change. I also think it’s more economical. More companies offer Level Premium Term than Annually Renewable Term. More competition drives down the cost.
3. For how long? With Level Premium Term, you choose a number of years you’d like to have the premium fixed. The longer the period, the higher the premium because the higher cost of insurance for the later years has to be averaged out to the earlier years. People usually choose to buy coverage through the year when their kids are out of college, when their mortgage is paid off, or when they retire. I chose 15 years for myself. That’s when my mortgage will be paid off.
With annually renewable term, you don’t have to pick a specific term up front. When you don’t need insurance any more, just stop paying.
4. For how much? This will involve a bit of math. This post is already getting long. I will cover it in the next post. Stay tuned.
InsuranceYak Editors note: Annual renewable term (ART) is still sold by a few companies but is getting increasingly rare. Most level term policies will convert to ART at the end of the guaranteed period, but you may not like the premiums.
Some insurance companies offer a ’conversion’ period at the end of a level term that allows the purchase of a permanent policy at current age (and that cost) without proof of insurability.
When determining which Level Term policy to buy, I usually do some arithmetic:
- How many years until the kids are out of the house?
- How many years until my investments get to the point where I don’t need insurance payouts?
- How old will I be when the level term period expires? Will I be insurable or will I not care?
I picked 20 year level term policies that will expire when I’m in my early 60s.
For other discussions about permanent life insurance check here or here.
