The desire to take care of our kids is powerful. As parents, we often err on the side of caution. Mix that instinct with a topic that can be uncomfortable (who wants to think about their own death?), life insurance products that can be confusing, and it’s unsurprising that many parents get taken advantage of.
The systemic over-selling of permanent life insurance is a big problem. Families get locked into expensive policies that make no sense for them.
Permanent life insurance = more expensive annual premium payments, pays a benefit WHEN you die. Comes in many “flavors” that have different names, including “whole life”, “universal life”, “variable life” among others.
You often see “permanent” and “whole” used interchangeably, but “whole life” is actually a type of permanent life policy, just like “universal life” is a type of permanent life.
Term life insurance = less expensive annual premium payments, pays a benefit IF you die. The alternative to permanent.
The facts are clear: even the industry’s own data shows that 40-50% of people give up on* the policy within 10 years; after 20 years, that percentage climbs to 60-75%.
Think about that for a moment: “buyer’s remorse” is so strong that 40-50% of people would rather lose a bunch of money than keep the insurance (you almost always lose money when you give up on permanent life insurance in the first 10 years). An additional 20-25% of people stick around for another 10 years, and then bail out (usually either still losing money, or getting back only a bit more than they put in). That means this product disappoints at least 60-75% of people who buy it.
People in their 20s-40s are hit hardest: people in their 20s, 30s & 40s have the highest rates of giving up on their policies, meaning they are basically flushing money away. Money that, for many of them, could have gone to retirement savings, kids’ college savings, or even a much-needed vacation.
This is dysfunctional.
So what’s going on? People getting paid.
The commissions on permanent life policies are much bigger than on term life, often to the tune of ~7-20 times more. Unsurprisingly, big paydays for selling permanent have spawned a bunch of well-honed sales lines.
There are a number of ethical, expert insurance professionals who handle this potential conflict of interest well, and suggest what’s truly right for the client, rather than what’s most lucrative for themselves. Unfortunately, there’s a host of professionals who don’t fit that description.
Not everyone who buys permanent is getting ripped off, and it’s entirely possible it’s right for you. Our interactive Parents’ Financial Guide to Life Insurance, walks you through a clear, efficient way to think about whether it’s worth considering in your situation.
“BS vs. Truth” scale
Let’s rate some of the most popular permanent life insurance sales lines on a “BS vs. truth scale”
= total BS, really doesn’t make sense
= mostly BS, has some grains of truth
= true in some situations, BS in others
= true, but can be misleading
= true and sensible (but watch out for “misuse!”)
A Quick Bit of Background
Unlike term policies (where you hope your loved ones never receive a check from the insurance company) you’d buy a permanent life insurance policy because you want to pay money to the insurance company in exchange for your heirs getting the death benefit when you die.
Any permanent life insurance policy is an investment of sorts: you put money in (premiums) and your heirs get money out (the death benefit).
This concept of life insurance as an investment underlies a number of the sales lines we’ll explore.
“Now that you’re a baller / wealthy / high earning …”
So your insurance agent probably didn’t use the term “baller” but if they did, (a) that’s cool (b) that in no way enhances the credibility of their arguments.
So let’s analyze what they’re saying on the basis of relevant facts.
Being high earning and wealthy is necessary but not sufficient: permanent life insurance should be considered when you’re ready to carve out a chunk of your wealth for future generations to use after you’re gone.
It’s also entirely reasonable to conclude that – despite being high-earning and wealthy – you wish to plan to use the bulk of your wealth during your lifetime, assuming you enjoy a typical lifespan.
If you’re worried about being above the estate size that the Federal government allows to pass without estate tax (called the “basic exclusion amount”, in 2017 it’s $10.98mm for a couple married filing jointly or $5.49mm for an individual), you can buy a term policy through an irrevocable life insurance trust - we go into the details in the AboveBoard Parents’ Financial Guide. There’s no requirement that you buy permanent insurance in a trust.
“You’re throwing money away on term”
I can assure you the insurance companies are not confused – they didn’t fail to understand there’s a 100% probability that all humans die at some point. The insurance company "gets" that the odds of paying you are much higher with a permanent life insurance policy.
Term is much cheaper than permanent precisely because it is unlikely you will receive a payout, and that’s awesome because you really don’t want one! The odds are greatly in your favor that you will survive the entire term and thus never receive a payout.
Sometimes an analogy helps illustrate why an argument really doesn’t make sense. Imagine someone said: “you’re throwing days of your life away by taking time to buckle your seatbelt”. You’d probably think that is ludicrous, and you would be right.
Consider this analogy:
By buckling your seatbelt, you're incurring a small cost (time) to ensure a better outcome (less likely to die or incur severe injury) on the unlikelihood of a severe negative event (car accident).
With term insurance, your small cost (money) ensures a better outcome (your family having adequate financial support) on the unlikelihood of your premature death.
"Think about your future self"
This is great advice generally -- getting a dog, eating a burrito, considering permanent life insurance...any decision, really. As people age and enter a life stage where than can name more than one or two friends who have passed away, "leaving a legacy" often starts to matter more.
And buying permanent life insurance while you're young is indeed less expensive than when you're old. But the dream of "leaving a legacy" - if it matters to you or you think it might someday - can be achieved with or without permanent life insurance (e.g. having money left over in your 401k or a vacation home for your heirs). If you are financially on track for the life you want (including retirement), then it's worth putting permanent life insurance on the list of things to consider, but it should be considered in the context of multiple options, some of which don't involve permanent life insurance.
“The tax advantages are AMAZING…”
Life insurance death benefits are generally free from income tax if you take the death benefit in a lump sum. This is indeed a benefit but other factors, such as fees and investment performance, can overshadow such tax advantages.
Any permanent life insurance policy is an investment of sorts -- some “look” more like investments than others (i.e. a “this tracks the S&P 500” feature), but even the ones that don’t “look” as much like investments are still a type of investment: you put money in (premiums) and your heirs get money out (the death benefit).
The insurance company takes your premiums and invests them. They will also charge expenses, including the cost of providing the insurance and administrative & sales costs. Some policies make these components easier to “see” than others, but it all boils down to two relationships:
* How much you pay in premiums vs. the death benefit (what your heirs are paid when you die)
* How much you pay in premiums vs. the “cash value” (most, but not all, permanent policies have cash value, the investment balance that you can access during your lifetime...it’s less - a lot less - than the death benefit up until you're quite old)
Taxes, fees and poor investment performance all mean the same thing for you: less money to keep for yourself and your loved ones.
So when an insurance salesperson sings the praises of life insurance’s tax advantages, know that you also need to understand the “real deal” with fees and investment performance. Tax advantages often get (more than) gobbled up by fees and poor investment performance.
When I’ve run these analyses myself, I’ve often found that by the time you’re done counting fees and investment performance, you’re better off forgoing the permanent life insurance.
To be clear, you can find reasonably structured permanent life policies: some policies are well-constructed and charge reasonable fees for the product offered. Some come with guaranteed minimum returns, which are indeed “worth something” (but not "worth anything”). The bigger question is if you actually need permanent life policies, which most people don’t.
Know that life insurance proceeds are exempt from Federal income taxes, but NOT from estate taxes. If you want to move your life insurance proceeds out of your taxable estate, our Parents’ Financial Guide walks you through what you need to know.
“Why rent when you can buy?”
This line illustrates a tactic for manipulation: speak to an emotional inclination or bias, regardless of whether it’s factually accurate or relevant.
The real question is: do you want to insure only the risk that you die early, or do you want to blend insurance and investing? That is a valid question, but there is nothing that – by definition - makes blending insurance and investing better than keeping them separate.
“Protect your family forever”
Another emotional argument that doesn’t really make sense. Sure, everyone wants to protect their family forever. But you don’t need permanent life insurance to do it.
You do need to protect your family from the risk that the financial support or unpaid care you provide suddenly “disappears” prematurely – a breadwinner dies when the family still relies on that breadwinner’s income, or a care provider dies when the family would need to hire paid caregivers to help out. Term insurance will usually achieve this for you.
However, if you’re looking for protection longer than 30 years, you can encounter a limitation with term . There are some 35 year term or “until age 75” policies on the market, but there are few and the pricing is often not great. Check those out, but you should also consider permanent if you definitely need insurance for more than 30 years.
Our Parents’ Financial Guide helps you figure out the right term, and whether you should consider permanent.
“You can borrow from yourself”
It is technically true you can borrow against the cash value life insurance policies. It’s usually at a cheaper-than-credit-cards-and-consumer-loans rate.
But guess what? You can save money in a brokerage account and borrow from yourself for free at any time. No paperwork, no expenses. Yes, you bear the risk that the value of your money could go up or down, but know that that same risk exists with some permanent life policies, too. Additionally, the “cash value” of a permanent life policy if often less than the total amount of money you paid in for 10-20 years.
You can also withdraw your contributions to a Roth IRA at any time and without penalty (penalties happen in most cases if you take out gains before age 59 ½).
If your financial resources are such that you feel it’s highly likely that you might need a consumer loan, then you should not be considering permanent life insurance at this time. Permanent life insurance is best-used as a vehicle for passing wealth to future generations after you pass – and even then, you should work with a competent attorney to consider your full range of options, some of which involve insurance, some don’t.
“You stop paying after  years!”
It’s true that many permanent life policies have specific payment periods where you stop “cutting a check” after a defined period.
What continues on – and is often poorly disclosed or glossed over – is that the insurance company continues to debit your account for an amount related to administrative and mortality expenses.
Think of it this way: if I said “I’m going to link up to your bank account, and pull money out each month”, would you say that you’re paying me?
Yes! You are definitely paying me in that scenario. If I am removing money from your account and not giving it back, you are paying me, regardless of whether you had to proactively send a payment (vs. authorizing me to pull money out of your account).
Be mindful of these expenses. A good question is, “I understand that I will need to make payments of [insert your understanding of the payments]. Can you please walk me through anything in addition to those payments that will result in a decrease in value to my account, including debits to my account for any fees and expenses.”
“There’s a guaranteed rate of return!”
For many permanent life insurance policies, this is entirely correct. And the right way to think about this is always: a guaranteed rate of return is worth something, it is not worth anything.
If the sales pitch crosses into “…and therefore we don’t need to compare this policy to buying term and investing the difference” then the rating would flip to You always need to run the comparison, and make an informed choice from there.
What are the life insurance sales lines you’ve heard? Drop me a line at firstname.lastname@example.org
*When we say “giving up on” a permanent life insurance policy, we’re referring to when a consumer allows a permanent life insurance policy to “lapse”, which basically means the consumer decided they are either no longer willing or able to pay for the policy they initially bought. To get technical, the US Individual Life Insurance Persistency Study (released 2012) by the Society of Actuaries and Life Insurance Market Research Association, defines “lapse” as:
For purposes of this report, lapse includes termination for nonpayment of premium, insufficient cash value or full surrender of a policy, transfer to reduced paid- up or extended term status, and terminations for unknown reason. This is consistent with the definition of lapse applied to other LIMRA and the Society of Actuaries experience studies.