I talk about a lot of different things on this blog, from motivation to the markets to personal finance. There are always blind spots in terms of our expertise though and one thing I have left out which is very basic and comes up with almost all financial advisors is life insurance.

I haven’t talked about life insurance for a simple reason: it’s boring. Although I have it, I like to think about the things I can control within my life and in reaction to what is going on, not a fixed amount that will appear when I die. It’s a necessary expense if you have a family though, or at least just want to ensure that your funeral costs are taken care of so your family doesn’t have to worry.

The world of insurance can be just as confusing as investments. It offers tailored options and no one really gives you guidance on how much you need or don’t need, what type you should get and if a particular type is right for you. I hope to tackle the basics of this in this post to be of more assistance to those who have asked me about life insurance.

Why Get Life Insurance?

First and most basic, why get life insurance at all? The modern argument for life insurance centers around the concept of human capital. You can think of human capital as potential energy when it comes to money. It’s an estimate of how much money you can make over your working life. When you are young, your human capital is high (you have the potential to earn over many years) while your financial capital is low. It’s the opposite if you are older and have saved a good nest egg. You human capital is low (you don’t have many years left of productive earning potential) and your financial capital is high. The idea of life insurance is to protect that human capital should something go wrong on your journey from young poor person to rich old person.

In technical terms, we can say that human capital is the present value of an investors future labor income. In the dark, depressing and cold evil view of the financial world, life is about turning your human capital into financial capital, so get to work!

In all seriousness though, you will likely start to think of life insurance when you have a spouse or children and they will be depending on things like staying in a home or going to college on that future income you have coming, so you want to protect that for their sake should anything happen to you.

Term vs Whole

So now we have the theoretical background as to why you may want or need life insurance and now we can talk about the two main types. These are term, for which you pay an amount to have a defined insurance benefit upon your death if you die within a particular span of time, say 10, 20 or 30 years. The other us whole life insurance, which pays out something upon your death, no matter when that is.

The main difference that will jump out to you initially is the cost. For a 40 year old married man in relatively good health, a 25 year $1 million policy can cost around $93 a month. A whole life insurance policy could cost 10-12 times that. I got my estimates for these figures here.

Again, keep in mind why you are getting life insurance: you haven’t realized your full earnings potential and want to pass that on to your descendants or others you care about should you die before your time. In the case of a policy which covers you until your death at any time, a big pay out when you are 90 often doesn’t make much sense. At that point you will likely have saved up a ton of other money and children tend to be grown, why not focus on building these to pass on to your descendants?

For this reason, whole life insurance doesn’t make sense for most people.

The Counter Arguments

Insurance salespeople will counter that this should be looked at as an investment. You can invest the premiums and access them tax free through borrowing down the road. They contend there are tax advantages to this along with a range of investment options.

Fair enough, but let’s dive into insurance investment options versus regular brokerage account options of what to do with your money.

When you invest through the policy, you will be limited to the investment options that the insurer offers, this limits you in terms of scope. They may offer some counter points to this that they can guarantee a return but guarantees are just code for lower returns in my view. They will offer you a guarantee and then go and put the money in riskier assets so they can make the difference.

In addition, both the policy and your regular brokerage account are funded by after tax money. If you want a retirement vehicle, you could easily divert funds to a 401k or IRA and avoid paying taxes on that money until you retire. Roth whole plans are offered but so are Roth 401k plans and in a 401k plan you won’t need to borrow against the funds to access it when you are older.

While we are on the topic of borrowing against the savings in a policy, that can be done with a regular ol’ brokerage account too. That also avoids taxes. With interest rates so low, you can likely borrow against your securities from any large brokerage firm that offers lending for less than the tax rate. If your investments are long term and gains much greater than the initial principal, it may not even make sense to borrow at all since capital gains tax rates are around 15% for most people. The argument for the whole life insurance policy as an investment vehicle really starts to look flimsy when stacked up against this case.

Finally, there has been momentum towards transparency in fees for investment products and that has been anything but the case for whole life insurance plans. The salesperson will likely not be able to tell you the annual fund fees charged for those market investments and what goes towards fees and what goes towards principal in the first few years usually isn’t transparent. If you want transparency in your costs, while life insurance has big hurdles while those you invest in through a brokerage account are straightforward.

I haven’t even touched on the fact that whole life locks you into expensive payments for life. Life is not always going to offer us the opportunity to pay hundreds or even thousands of dollars every month. Don’t discount the flexibility of private savings, which you can forgo when you go through times such as a job loss.

So Why Does Anyone Sell Whole Life?

In a word: commissions. There are very high fees associated with this product and salespeople can expect a hefty check if they manage to close a whole policy. Add to that the fact that the fees aren’t transparent and you are setting yourself up for getting hosed.

Keep in mind that chart of human capital and financial capital. A whole policy builds into old age and can provide a big payout upon your death. If you manage to save any money though, you will likely have something to leave behind in old age anyway, life insurance isn’t really that necessary in old age for most people.

Any assets you want to leave behind can be left to a trust, to which you can grant the funds tax free or can be left through your estate, to which the government doesn’t even start to tax it until it is greater than $11.18 million for singles and $22.36 million for married couples.

The question I ask myself is should anyone buy whole life insurance? The only way I can see it making sense is if you have no discipline in terms of saving and don’t expect to have any money in retirement so you need a forced savings vehicle which can leave something to your descendants. You also would need an extremely stable, government like job that doesn’t risk you getting let go so you can always make the payments. If you can’t save at all, is getting locked into requires payments for life really a thing you want to commit to anyway?

Personally I don’t see a way that whole life makes much sense for anyone other than the insurance agent trying to sell it to you and the insurance company which extracts fees from your money for their own bottom line. In summary, skip the whole life insurance and get term if you really feel you need it.

The information provided by www.cashchronicles.com is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs. www.cashchronicles.com does not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any tax or investment decision without first consulting his or her own financial advisor or accountant and conducting his or her own research and due diligence. To the maximum extent permitted by law, www.cashchronicles.com disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Content contained on or made available through the website is not intended to and does not constitute legal advice or investment advice and no attorney-client relationship is formed. Your use of the information on the website or materials linked from the Web is at your own risk.