We get a ton of questions about term insurance. It’s a popular subject in the personal finance space.
“Should I keep my term insurance?”
“Should I buy some term?”
And my answer is, “That depends.”
Term insurance is a great life insurance policy.
Many of our clients and even our agents have term. But a lot of people don’t use term insurance for the proper purpose. “Buy term, invest the difference,” leaves out something very important. First you need to understand what term insurance is. It’s buying life insurance on your life for a specified period of time, or a “term.” So if I buy a house and I have a 30-year mortgage, it would only make sense to buy a 30-year term policy to cover my life for that mortgage term of 30 years.
That’s how you should use term insurance. It should always be used for something that has a stated term. College loans are another perfect example. If you have college loans for 10 years, you can take out a 10-year term policy to protect yourself and your family for those 10 years.
Term insurance has a necessary place in the average person’s life. In fact, investors will find massive value in term insurance to protect something that has a stated amount of time they need protection for.
Now, here’s the problem with term.
It’s not going to work for an ongoing long-term need. If someone takes out a term policy with the intention to have it cover funeral expenses, that’s a big mistake. You, the insured person, are more than likely going to outlive that term policy.
There’s no secret why insurance companies love term. It’s a cash cow. Over 90% of all term policies go unpaid. So, if you were an insurance company, would you want to sell a policy that 9 times out of 10 will not get paid out, or would you rather sell a policy that lasts a lifetime that certainly will pay out no matter how old the insured person gets? The life insurance company wants to sell the term policy, right?
Most people buy term because it’s inexpensive. But cost is only an issue in the absence of value. What is the value when you outlive your term policy? There is no value. As a matter of fact, you just wasted a whole lot of money to have a policy that you just outlived and you’ve just made the insurance company a whole lot richer on premiums for a policy they never had to pay out.
Let’s talk about term insurance in the case of IBC.
When we’re designing a whole life policy for banking, one of the things we want is the lowest death benefit and the highest amount of cash value. The death benefit is what costs money, which is one reason why we want less of it. But remember, I said there is a cheap way to get death benefit. And that’s through term insurance. So we use term riders inside the whole life policies to increase the death benefit for a select period of time, or a “term.” And that term fits within the MEC 7 Pay Rule. 7-Pay means seven years. So if we were trying to avoid a MEC status on a policy (taxation), we would put a term rider on the policy for a term of 7 years. Or we would put a 1-year increasing term rider on so that every year it gets a little more expensive. Then, in the 8th year when we don’t need the term insurance anymore, we drop it, which means we no longer have the cost of the term policy, and we were able to stuff a ton of money into that specially designed and engineered whole life.
Term insurance can be used in more ways that you may have been aware of.
When you’re looking at term insurance, try not to look at it as a “one size fits all” approach because it’s the cheapest. This would be a major flaw of the touted “Buy term, invest the difference” approach to term. Which is the reason it has failed more often than not. Just because it’s cheaper doesn’t mean it’s better. Analyze your financial needs, see where you may need protection for a stated amount of time, and determine whether term might fit the bill.
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