Sunday, October 18, 2009

Financial Myths pt 1-Term Insurance is Cheaper the Permanent Insurance

I want to discuss or cover some myths that are very prevelant in the financial services arena. These myths are causing great confusion and indecision with many clients,Financial Services Professionals, etc. Let's list them out, as I will begin to dispel these myths in a series of blogs. It is dishartening to hear people repeat these myths over and over again, and could possibly receive benefit if these myths were not a part of their belief system. Here are the some of the myths listed here, and we will add more as I continue this blog:

1.Term is cheaper than Permanant Insurance

2.401k plan is the best plan for Retirement

3. Mutual Funds are safe Investments

I will add more "myths" as I continue, but will start off with these three.

Term vs. Cash Value Insurance

Term Insurance is NOT cheaper than Whole Life Insurance.Its ONLY cheaper during the term period!

Term Insurance is cheaper than Whole Life insurance(during the term period) for this simple reason:the probability of death is very low during the term period. The life insurance company calculates the average price of insurance over the term period(10,20, 30 years). The shorter the term period, the lower the price. For example, price out a 10 year term life policy as compared to a 20 or 30 yr term life insurance policy. The price is cheaper, why?The probability of a individual dying in this term period is very low. This is why insurance companies only pay around 2% on death benefit for Term Insurance. After the term period is over, then the price of insurance goes up each year. Term Insurance is designed for a Temporary need, not a permanent need.

Permanent Insurance(Cash Value)
If all life insurance is Term Insurance,then permanent insurance is really term insurance until age 120. The probability of you dying in this term is close to fact it is! Since you dont know when you are going to die, then the premiums are averaged throughout the period till age 120. So it may appear that the premiums for Whole life are more expensive, but the premiums are not if you sum the total premiums paid up to age 120.Now the other side of the argument is this, I dont think I will live to age 120, so why am I paying a higher premium? This is where the Cash Value comes into play. In case you live to be 120, the premiums are level so that you will NOT have to pay a higher premium after age 65,since the probability of death increases exponentially.In your younger years, the premiums are higher so the extra cost goes into the Cash reserve account for future premiums and future benefits.This allows the price of insurance to the consumer to be the same throughout his/her whole life. The Cash Value really is not an investment account since it really is for future benefits and future premium payments!This is why Insurance Companies must provide GUARANTEES on the Cash Value or Terminal Reserve Account since it is for Death Benefits. This is also why they require you to BORROW the money out of this terminal reserve aka Cash Value. This is also why you don't get BOTH death benefit and Cash Value at death since this accumulation is really for future benefits on the policy.

If you look at numbers below, I have the term policy for a 30 year old and compared to a Whole Life policy.Same age, same gender etc. I have totalled out the premium payments up to age 70. The reason why I did this assumption since no one knows when they are going to die, we will assume age 70 is when we will die. As you can see, the amount of premium paid is different if you compare both premium payment totals.

Term Life
Age 30-Annual Premium $327
Total Premiums paid up to Age 70:$68,747

Whole Life
Age 30-Annual Premium: $1,143
Total Premiums Paid up to Age 70:$46,863
Cash Value Total(Guaranteed):$57,838

If the policyholder wanted with the Whole Life policy, they could stop making payments for several years! The Term Policy if they continued it, the Annual Premiums would continue to increase exponentially each year!

In conclusion, both types of insurance are excellent depending on the person's situation.This is not an indictment of Term Insurance. In Fact,many people may start off with Term insurance, and convert that policy into a more permanent type policy. One is NOT better per se than the other, but it is prudent for a working individual to carry life insurance. The point of the matter is this, if Term fundamentally was cheaper OVERALL in comparison to Whole Life, then no one would buy Whole Life or permanent insurance. In my opinion, the best kind of insurance is the one that pays benefits to the loved ones at the time of need. There is no price for that service. The next entry I will discuss the next myth: 401k plan.

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