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Outliving Your Need for Life Insurance

Untitled1“You need to protect yourself and your family with life insurance that you won’t outlive.”

This is one of the common selling points for whole life or universal life rather than term life insurance. At first glance, it seems to make a lot of sense. Of course you don’t want to outlive your life insurance. Having it pay benefits upon your death is the reason you buy it.

This statement, however, misses one essential fact. Many people don’t need to worry about outliving their life insurance, because they outlive their need for life insurance.

We don’t all need life insurance throughout our entire lives, any more than we do auto or homeowners’ insurance. If you no longer drive a car, you don’t need auto insurance. If you no longer own a home, you don’t need homeowners’ insurance.

In circumstances like the following, you may no longer need life insurance: First, when you and your spouse have accumulated enough assets and income streams to independently care for yourselves. Second, when your children are self-sufficient adults. Third, when your estate is too small to owe estate taxes or liquid enough to pay the estate taxes.

The primary purpose of life insurance is to replace the future income of a primary breadwinner. Two groups most likely to need it are middle-aged couples saving for retirement and parents of minor children. Ideally, most young families should have over $1 million in life insurance to provide for the children if either parent should die prematurely. Yet many of them are unable to afford the higher premiums for this much “permanent” insurance. Their choices are to underfund their needs with a smaller permanent policy or purchase an affordable 30-year term policy.

As we age, the probability of dying becomes greater. Therefore, a $1 million life policy costs much less for a 25-year-old than a 75-year-old. It doesn’t matter if the policy is cash value, whole life, universal life, or level term, the cost of providing the life insurance component increases every year.

Yet most human brains have a psychological aversion to price increases. In order to please their customers with life insurance premiums that didn’t increase every year, insurance companies came out with level term policies. Essentially, the premiums are averaged out by overcharging in the early years of the policy and undercharging in the later years.

Whole life and universal life insurance policies don’t have that same averaging. To be “permanent,” the premiums must be much higher in order to fund a savings account that grows over time and is often used to offset a significant portion of the death benefit in the later years of the insured’s life. Usually, if the insured cancels the policy, a portion of the premiums will be refunded.

A cash value policy may occasionally be a good estate planning tool, generally for those with substantial wealth. It might be used to fund an irrevocable life insurance trust upon the second spouse’s death, perhaps to pay taxes on an illiquid estate like a family farm or other property. It also can be used for those wanting to leave the bulk of an estate to charity and still provide income to their children. These strategies rarely apply to those whose primary goal is basic income replacement for their families.

One of the ironies of insurance in general is that we all know it’s essential and we all hope never to need it. For most people, life insurance is not really an exception to this. Its primary purpose is not to provide us with investment income, but to provide our families with income if we aren’t there.

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