Maybe I just don’t understand what they’re doing. BUt it seems to me if I take out a 10 year policy that costs $100 per month, I’m betting that I’m going to die within that period of time and the company is betting that I won’t or that they won’t have to pay out. If I get to the end of that 10 year term, then I’m just out $12,000. What am I missing?
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It’s exactly like car insurance. You pay for a month, three months, six months, whatever, and if the giant bad thing happens (death/accident) you have financial protection. If the bad thing does not happen you are out the money. You are trading a small bad thing (the premium) to reduce the severity of an unlikely big bad thing.
The reason the policy has a 10 year term is that they are promising not to raise the premium for that period. Your car insurance company will not do that. Get the life insurance policy, then get diagnosed with diabetes, your premium stays the same until the term is up. Get a car insurance policy, get six speeding tickets, up goes your premium. That’s the only real meaning of the term part of the policy.
Because of laws and regulations of boundless complexity there are all kinds of life insurance policies with all kinds of features attached. Sometimes they are a very good way to handle your money, sometimes not. Talk to a professional.
For most people, life insurance is more important in case you or your partner dies young. If you die when your old, insurance will likely be cool as a perk for your kids/family, but not “life saving”. Consider these two:
Guy is 30, has a wife, 3 kids, 2 cars he has payments on owes a few hundred K on his house. Kids will be in college in a few years. His net worth is likely negative. His only source of income is his job. If he dies…it’s a major problem for the family. They can’t pay for the house, cars, school…maybe even just food on the table. So he gets a say 10 or 20 year term plan to take care of that. Well, what if he dies when he is 65?
At this point his house is paid for, kids are through school. HIs 401 and Roth have some real$$ in them, and he gets money from that monthly. He may be retired. He may be taking social security. His assets are higher, and his spend is lower. If he dies, the family has money coming in and has a nest egg that he didn’t have when he was 30. His wife can easily stay in the house and put food on the table. So for the family it is a very different picture if Guy dies when he’s 30, compared to 50, 60 or 70. Insurance can fill that gap and be a win for him and the insurance company.
So many people look at insurance like that: I need $$ for my wife or family in case I die at a time when debts and cost of living are high, and people are dependant on the income.
I am a 25yr financial planner and have two 30yr term policies, taken out when each of my kids were born. They are there to replace my income through getting my kids out of college and as my wife reaches retirement age. Term insurance is like car or homeowners insurance. Just because your house didn’t burn down while you owned it doesn’t mean having homeowners insurance wasn’t worth it. I built a house 10 years ago and for the first time ever, I made a homeowners claim last February. Had a dishwasher leak which resulted in insurance basically renovating my entire kitchen.
Good tip is to buy term insurance and invest the difference from a whole life policy on your own. It’s easy with auto withdrawal.
I’ll try to break this down in math terms.
You are 30 years old, with a kid. You want to make sure your kid’s life is not completely thrown off course by you dying. In order for you to do this, you need to have money available to them to help with housing, college, food, etc.
You can do this by investing the money. Let’s say you invest $1000 a month. If you got a modest 5% interest rate, after 5 years you will have saved $53,000, after ten years you’ll have saved $95,000. That’s a good chunk of change that if you were to die exactly 10 years after you started to save, would be given to your kid (hopefully not spent on yolo outs with WSB friends, this has really happened, sadly).
So let’s set that 95k as the minimum goal to be giving your kid at the end of ten years. What if you die within that timeframe? They would get whatever you have accumulated until that point. Could be 92k, could be 8k, nobody knows when you will die. This is where insurance comes in.
The tables I have aren’t totally accurate, but if you are 30, you have a .004% chance of dying within the next 10 years. When you do the math (too complicated for ELI5), the insurance company figures out that 95,000 paid out at the time of death if it happens within the next ten years is is worth .00295 * 95000 = 280.25
If you paid a yearly premium, it would be calculated to be about $35 dollars a year. So, instead of invest $1000 a month to get $95k at the end of ten years, you can pay a $35 yearly premium and give your kid $95k if you die within the next ten years.
So for roughly $3 a month, you can guarantee the money to your kid in 10 years, which is a good deal if you ask me. That’s how term life insurance policies work. You can scale the up to be whatever benefit amount that you want, the math stays the same. It’s essentially an investment product just in case your unfortunately die at a time you haven’t established yourself you pass on what you would pass on. Whole life insurance is similar, but the chance of you dying at some point in your life is 100%, so the premium is much higher because you don’t have that .004% chance of dying within the term to bring the premium down.
Term policies are a great idea when you know that your financial needs will diminish at a certain point. For example, I have a 10-year-old child right now. A 10-year term policy would be cheaper than a whole policy, and it would provide coverage if I died while I still had my child under my care. The idea here is that, if I die in 11 years, my son will already be an adult and will be able to support himself.
It’s also important to note that some term policies have the option to convert to whole policies at the end of the term, too.
There are also variants on the concept like decreasing term policies, which decrease the payout over time. These are often tied to things like a mortgage, so if you die before your mortgage is paid off, the insurance will pay it off. And some people will just get a term policy for long enough to cover their mortgage.
I’ve seen people get term policies to cover the five years after the birth of a child. Mom had decided to stay at home with the baby for two years, then only work part-time until the child was in school. Since they were now relying on just a single breadwinner, they got a term policy for him to cover that period. Once Mom returned to work full-time, they had a backup, but if something had happened to the only breadwinner while Mom was out of work, they would’ve been in a pickle.
Are you comparing a term life insurance policy to not having a life insurance policy, or to a whole life insurance policy?
Well, I guess I’ll answer for both.
Life and death can be pretty uncertain. Life insurance is a system where if you die someone (usually spouse or a kid) get money. The idea here is that they get money because you are not there to provide support anymore. So having a life insurance policy means that they are “protected” against financial loss because of your death.
Ultimately some folks will resort to a smaller life insurance policy once their kids are grown or there is hopefully sufficient reserves for a spouse’s retirement etc. In other words, if nobody is dependent on your anymore for support the necessity of a life insurance policy may be diminished, just at time as health is getting worse.
Anyways. A whole life insurance policy is both insurance and an investment vehicle. The premiums are much higher, and the commission to the salesperson is also much higher. There can be some long term security involved, in that the money built up in the investment can be accessible even before death. The details vary by insurance policy. With your $100 premium for a term insurance policy example, a whole life policy might be like $500. And yes, it doesn’t run out after a certain number of years.
The very generic run of the mill financial advice is to get term life insurance and invest the difference (in this case $400 per month) into mutual funds or something and then the end result would be similar, except you would pay less in administrative fees than you would with the whole life insurance policy.
I know several people who heard this advice, went and got the term insurance policy, and then never invested the difference.
Which ever method you choose will probably work out just fine, as long as you are covering your bases.
Cheers
If you’re taking out a term policy that costs that much, you should change insurance companies. My husband and I have twenty year term policies, and pay less for both. The point of a term policy is that it costs less, and covers a specified period of time – for example, right now is the “riskiest” time for one of us to die, because we have debt on our house, and kids. We have a policy that covers the riskiest time – by the time the policy expires, the kids will be out of the house, the mortgage will be paid off, and it will hurt far less financially if one of us dies.
Typically a term life insurance policy is the better value. Think about it this way: Pretend A term policy costs 100 per month. In that caase a similar whole life policy would probably cost north of $200 per month. The hook they get you with is that at the end you don’t lose the money, it just stays there and you no longer have to keep paying in.
The way the whole life policy can do that is because your payments have created a ‘lump sum’ that has become large enough to earn enough investment income to effectively become profitable for the insurance company. So you no longer need to pay in, the investment profit on that money is now covering your contribution. The kicker is that the lump sum stops growing. The insurance company is now collecting all the investment profit on that lump sum to pay the management fees as long as you remain alive. (Check your fine print because it’s also likely that if there is some sort of shortfall in the market you may still be responsible for ‘topping up’.)
Now circle back to the term policy. Buy the term policy so that you’re covered in the case of untimely, premature death, but also take the difference between the term policy and the whole life policy and YOU invest that difference. At a certain point your investment will grow beyond what the lump sum the whole life will stop at… and it will continue to grow. It doesn’t really matter if the term goes POOF because your savings is still further ahead. Remember, you don’t pay any management fees or finders fees on YOUR INVESTMENT.
Now, all this is dependant on how long you live but generally speaking a disciplined investor will be better off with term, and this difference will only widen the longer you can invest.
Lots of good answers here, but maybe this will help your understanding:
It’s not for you, it’s for people who depend on you if you die.
Some companies push “whole life” or “permanent” plans that pay out whenever you die. In that case, it can essentially be an investment, albeit typically a poor one.
Term, like a 10 year plan when you are young, is relatively cheap. The idea is that you only have people depending on your income for a portion of your life, like when you have kids and a mortgage. If all goes well, by the time you near retirement age, your kids are grown and independent, and you have savings. If you die now, your dependents are fine. That’s why term is nice to have.
Your 100 is also pretty high. That would be a typical premium for like a multi million dollar plan or so, so 12k might be reasonable to know your family would have what they need.
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