We continue our Q&A series with money personality Terry Savage. (Part 2 of 6)

Part 2: Term vs Cash Value

TIAA-CREF (TC): Why do you think people are reluctant to talk about life insurance?

Savage: People don’t want to think about life insurance for several reasons. First, we all hate to face our own mortality. Second, the perception is that life insurance is very expensive, complicated, and boring. Third, we know that we’re being asked to spend money on something for which we will never personally get the benefits!

Those seem like three good reasons to avoid thinking about life insurance. But you’re only fooling yourself if you procrastinate. Next time the question comes up you’ll be older, so the policy will be more expensive. And health changes could make you uninsurable at any price.

So if you’re young and healthy and have people depending on you, take the first step and buy some simple, inexpensive term life insurance. After you’ve covered your basic, immediate need for life insurance, you can move on to more complex products that cost more, last longer, and involve investment growth inside the policy.

TC: We often hear about term and perm – or permanent – insurance. What is the difference?

Term insurance is coverage on an annual basis that will pay out if you die within the term of the policy. It’s that simple. Obviously, the older you are when you buy insurance, the greater the risk to the insurance company – and the higher the annual premium.

You’ll want a permanent policy if you need insurance far into the future - either to provide for loved ones, or to pay estate taxes, or to leave money to a charity or cause. It’s likely a more costly option, but one that will last far into your future, potentially covering you in your old age.

TC: What should insurance shoppers know about term policies?

Savage: Insurance companies recognize that you don’t want to pay a rising premium every year, so they designed policies with a guaranteed premium for a fixed number of years: 10, 15, 20, and even 30 years. That way you can plan for the annual cost. As long as you pay the premium on time every year, your coverage will continue for that year – no matter what your health status.

With term insurance, the most important questions you must ask are: How much, and how long?

Let’s say you’ve already decided that you want to provide security for your loved ones in case of your untimely death. In Part 1 of this series, we went through the tough calculation of how much coverage you need to provide. Don’t be intimidated by the number, since term insurance will keep the cost at a relatively low price.

Next, ask yourself these questions:

  • How long will the coverage be needed?
  • Will your spouse need money to pay off the mortgage?
  • Is the need going to end when your children graduate from college?
  • Do you have a family member with special needs child who might need care for a longer period than you are likely to live?

TC: What would you say to someone who says they can’t afford insurance?

Savage: In the world of life insurance, time is money. If you can limit the period for which you need coverage, you can pay significantly less for your life insurance. Simple term insurance fits the bill.

For example, today a 40 year old, non-smoking male in good health could get $500,000 of level term coverage for about $460 a year. For a woman, the same policy would cost only $400 a year. Since women tend to live longer, they pay less for life insurance.

Guaranteed level term insurance is the easiest and least expensive way to cover your insurance needs. But when thinking about how long you’ll need the insurance coverage, you must remember that when the term of the policy ends, your insurance is finished –and you have nothing to show for your payments except the peace of mind you received.

TC: Okay, so that’s term insurance. Talk a little about permanent insurance.

Savage: They are often called whole life or cash value policies because they have various ways to accumulate extra cash inside the policy. You can use the money in the future either to pay the premiums or to borrow in case of need. Insurance policies have a special tax provision that allows extra money in the policy – above the amount needed to pay the actual mortality costs of the insurance – to grow on a tax-deferred basis.

Sometimes this additional money will grow at a fixed rate promised by the insurance company, or you may have a choice of investment sub-accounts that will give you a variable return, depending on your investment success inside the policy.

The premiums for this type of policy depend on your willingness to add extra money, which might grow enough so that you can pay less each year in your old age. But be warned that if the money does not grow as projected, you could be forced to pay higher premiums later on, or cut the value of your insurance.

Each of these policies has its own terms and conditions, which you must consider. Just remember that all the illustrations of the best things that could happen in terms of growing cash in the policy are just that: illustrations. They are not guarantees that there will be enough money in the policy to pay future premiums. Start with the idea that the only guarantee is a minimum interest rate you will earn to build value.

TC: Any final thoughts?

Savage: Some term policies come with a guaranteed right to convert to a whole life policy, without evidence of insurability, before your term policy expires. But as you grow older, the premium to be paid after you do a conversion will be significantly higher, reflecting the value of this open-ended opportunity. That may be your only choice to prolong your coverage, if your health has deteriorated in the intervening years.

So think far into the future. If you want to maintain your insurance into your old age, do consider the various forms of cash value insurance that are designed to last your whole life.
And, once again, this important reminder applies: Don’t Procrastinate. Every day you wait means the insurance will cost more – if you remain healthy enough to qualify. That’s the Savage Truth!

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