For the last couple of weeks, we’ve been examining the two primary forms of life insurance—“term” and “whole life” (or “permanent”). More specifically, we’ve been evaluating the commonly repeated advice: “Buy term and invest the rest.”
It seems so obvious. When you’re young and healthy, term insurance is shockingly inexpensive. Doesn’t it make sense to pay less, get the coverage you need, and put all the money you’re saving into the market where it can grow?
But here’s a truth many forget: as you age, term insurance gets more and more expensive. It can eventually become unaffordable to all but the wealthy.
Conversely, adequate permanent insurance coverage is often too expensive for younger wage earners with lower incomes. The fact that whole life insurance builds cash value for the future is nice, but that’s not much help when you’re trying to live within your budget and pay your bills now.
Here’s my recommendation: Let’s stop arguing about which form of insurance is better or worse and, instead, exploit the strengths of both. Consider this approach…
Paul and Pam are 32 years-old and want $1,000,000 of life insurance coverage on Pam. (She’s a CPA; he’s an aspiring writer…and stay at home dad).
Assuming Pam’s a non-smoker in good health, she could get covered for only about $550 per year for 20-year level term insurance. That’s the good news.
The bad news is if she wanted to keep her insurance, in year 21 her premium would be about $5,100 annually. By age 60, her premium would rise to $10,000. By age 65, that million-dollar policy would cost her $15,000 a year in premium payments. No thanks.
However, there’s a solution Pam might not be aware of. She doesn’t have to sit still and do nothing for 20 years. She could begin a conversion process (and no, I’m not talking about a religious conversion).
Many term life insurance policies contain a contractual provision allowing the owner to “convert” a portion (or all) of the policy into a permanent policy at any time…up to age 65…without having to pass another physical. This provision isn’t universal, and it does involve an increase in premiums, so make sure you work with an experienced agent who knows how to set this up.
In short, Pam could “convert” 5% to 10% of her policy each year from term to permanent insurance. By the end of the 20-year period, her term policy could be converted into whole life insurance. And she gets to keep it her “whole life.”
Okay, but where would the money come from to pay for those rising premiums?
My experience is that workers can use a portion of their increases in income (i.e., their raises) to pay the higher premiums that go along with the term conversion process. For example, it might cost a 30-something worker earning $75,000 annually about a fourth of each year’s raise to convert 10% of her term insurance. What if he or she didn’t get a raise one year? They simply wouldn’t do a conversion that year.
What’s the takeaway here? Extreme, all-or-nothing opinions like “Buy term and invest the rest” are wildly popular in personal finance (and in politics—and most other areas of life). They can make for pithy slogans.
But sometimes, the right answer for you lies somewhere in the middle.
Meanwhile, as you consider your insurance options, if you are also wondering about your best options for turning your retirement nest egg into regular retirement income, I have a FREE gift for you.
It’s a short quiz called the RISA (which stands for Retirement Income Strategy Assessment). Just as one kind of insurance strategy isn’t a great fit for everyone, so your retirement needs will differ from your neighbor’s. The RISA can help you figure out the strategy you should adopt. Email me (bmoore@argentadvisors.com) to request your link to take this free quiz.
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