Monday, December 1, 2014

Term Life Insurance VS Whole Life Insurance

Term Life Insurance VS Whole Life Insurance

Let’s say I am forty years old. I am married, I have two children and I am the main incomer in my family. I earn most of the income for my family. We also have mortgage. I am hoping that my kids go to college. I need to pay for their college and I also want to make sure that my spouse, If anything were to ever happen, can retire, because maybe my spouse does not have income generating ability or if she does she can generate at large degree because she have to take care of the children if anything were happen to me. So because of all of these things that I want to make sure get paid off or get funded in the event that I die, I think about getting life insurance. I think most of us understand the general idea about life insurance. You pay certain amount on a regular basis, and in the event you are die. Your relations, whoever you put as the beneficiaries of your life insurance policy, or your estate, those people will get some money. But life insurance isn’t quite simple. One version of life insurance is the other one is less simple.
There’s two types of life insurance.

• Term life insurance
• Whole life insurance

I will talk about term because frankly, term life insurance is simpler, so I go to the insurance agent. Agent say “Look, if you pay a premium every year of $500”. The word “premium” literally just meant the amount that you would pay every year. If you pay a premium of $500 every year for 10 years. If you were to die at any point over those 10 years, “we will give you $500, 00.” I guess more exact, “we will give your family because you will be no more at that time  ” Or we will give $500, 00 to beneficiary of the policy. The beneficiaries are the people who would benefit from your policy, who would get the payout if in the event that you were die. Over the next 10 years you will pay about $5, 00. If you will die your family get the premium money. The reason why this works out for the insurance company is that the insurance company figures out, OK, if you don’t smoke, you have good health, it’s unlikely that you are going to die in the next 10 years, and so if they average it over many, many thousands of people, they are going to make money. Some people are going to randomly die, but they are going to get the premium from everyone else. That’s going to more than offset the payoffs that they need to give for the people. Who are randomly, accidently or who die for whatever reason.

The reason why this is called term life is that if you don’t die after those 10 years. You have to then get a new insurance policy. If you don’t get a new insurance policy. After those 10 years you didn’t die nothing really happens. You just keep on living. All of this money that you had put in goes away. It just goes to the insurance company. You gave to them in the event that you might have died in those 10 years. All is gone simply. What’s unfortunate, and this was probably good enough for you because 10 years was, from when you are 40 to 50 years old, maybe that’s the time that your kids started go to college. That gave you enough time to save more money for retirement. It gave you time to pay off more the mortgage and maybe save up some more money for college. You just say “Hey 10 years was perfect for me.” If you think when you are 40 years old that, you think I want more time to pay off the mortgage. Save money for college save money for retirement then you could make this a 20-years policy. If you buy a 20 years policy then your premium is little bit higher. You are going to pay it every year. Reason why the premium is going to be a little bit higher is that you have a higher chance of dying from ages 50 to 60 than you did from ages 40 to 50. So the insurance company will figure out those probabilities and charge you a slightly larger amount. But regardless any way you look at it. In a term policy, you pay a fixed premium for a fixed term. If you pass away over that term, your family gets the payoff. If you don’t, then the policy just expires. You have to get another term life policy. At some point maybe by the time that you are 70 years old. If you haven’t passed away and hopefully you haven’t.
It’s actually very hard to get a term life policy when you are 70. The insurance company would say you have a high probability of passing away between the age of 70 and 80. We don’t want to take that risk. Term life is really good if you feel that there is just a set amount in your life where you just want to make sure. I am around for the next 10 or 20 years to take care of a lot of obligations. If anything were to happen then my family can use the payoff from the policy to take care of these obligations for themselves. This is what I have because I am 31 year old. I have mortgage. I have young child. I have to make sure that if anything happen to me over the next 20 years my family easily pay the mortgage and else.
The other type of policy is whole life. The motivation for whole life policies comes from the idea that people did not like this notion that you pay money in a term life policy year after year after year. But if you don’t die which is frankly a good thing. All that money just went for nothing. You don’t get it back. You didn’t save it any way or anything like that. The other issue is that a term life is only valid for a certain terms like 10 years, 20 years whatever it might be. Some people want the idea that, Hey, I want to keep paying a premium my entire life and when I die for all we know, all of us will die. When I die there will be a payoff. If I am 40 years old. I might be paying that premium for the next 40 years. But when I’m 80 and if I passed away at 80. My family will still get something. For all of this insurance that I paid.
Whole life can appeal to all of these notions. That you are saving some of this premium. That your family definitely will get a payoff but the insurance companies are not silly people. They will scrutinize their probabilities and they want to make sure that it’s a profitable thing for them. So really what they do in a whole life policy is that they just charge you more so that you get a lot of what’s in the term life policy, a lot of the insurance aspects of it, and you also get a saving part but they charge you a lot for that so that it comes out to be a god deal for them. In a whole life policy for the same 40-year old, and I am just making up the number. You should contact an insurance agent. If you want more accurate numbers. Your premium let’s say it’s also $500,000 payoff. Your premium in this situation could be a lot higher than the term life policy. So it could be maybe it is $5,000. It is $5,000 per year and it is your whole life. If you will die at any point. You will just keep paying this policy until you die and then your family will get the payoff. So upon your death beneficiaries will get $500,000. You might be saying, wait this is a complete rip-off. I am paying ten time more but it’s the same death benefit.
There are couple of thing to think about. Why it’s not quite that much of rip-off. Although it tends to be always a little bit less financially savvy than the term life. One day you will die and if you will pay the premium for your whole life. It’s guaranty that you will get the premium. But on the other hand if you are 32 year old and get the whole life policy and you die at the age of 70 you pay more than you policy. Other thing that whole life policy does for you is that the insurance company is implicitly setting aside some of this money to just purely insure your life, but they are also setting aside some of your money as cash. That cash built up over time. Not all of your premium goes into this cash but some of your premium does. Early on in the first year of premium usually that just goes to the insurance company. Then every year a fraction of your premium does go into a saving account within the insurance company, and you get cash savings and it can get interest while it is with the insurance company.
It’s getting interest on a tax-deferred basis. Someone trying to sell you a whole life. Will say Hey look this is a good deal. You pay a premium. You are guaranteed this payment your whole life. Your family will eventually get the death benefit as long as you continue to pay the premium. And we building up this cash savings for you. If some point you decide all of these risks are not there for my family anymore. I don’t want to pay premium anymore. Maybe you are 65 years old. You have paid off your mortgage. You have saved up a bunch of money. You say I am going to stop paying this when I am 65. Then you can get cash payouts. All of extra cash and interest which insurance company was saving. On the other hand they are taking huge fee on this cash savings.
Now one fact which is clearly visible. If you get term life policy and its premium is $500 on the other hand whole life policy premium is $5000. So if you buy term life policy you will save $4500 per year. If you put them in saving account and generate interest on them. You will also get the very good amount in next 10 or 20 years as long your term life policy run. So what is the conclusion if you die you get the money on the other hand if you don’t die you will also get the money from your savings. That’s it this is the main and major difference between term life policy and whole life policy. Hope you will understand the whole phenomenon.