Do Most People Need Life Insurance?
March 20, 2018 by Ted Jenkin and Samuel Rad
The rationale for life insurance is simple: It’s a way to protect family members financially in case a provider dies unexpectedly.
Yet fewer and fewer people are opting to invest in a policy, across a wide spectrum of the population.
According to a 2017 report by the Federal Reserve Bank of Chicago, 60% of households had life insurance in 2013, off from 77% in 1989.
What’s driving the ownership numbers down? The study explains that a large part of the decline is a puzzle and can’t be explained by shifts in demographics, family structure, income or education. The authors say that a number of factors could be driving the numbers down, including rising life expectancy, altered tax rules that make buying insurance less appealing and the ease of finding and buying attractive alternative investments for saving.
All of which raises the question: Do most people actually need life insurance?
Some experts think it’s a necessity because most families don’t have the resources to cover themselves if tragedy occurs. Others think most families will be fine—the chance of needing coverage is remote.
Ted Jenkin, co-CEO and founder of oXYGen Financial, makes the case that life insurance is essential for most families. Samuel Rad, a certified financial planner at Affluencer Financial and an instructor at UCLA, argues that life insurance is oversold and purchased by many who don’t need it.
Click HERE to view the original story via WSJ.
YES: Families need to protect themselves, just in case
By Ted Jenkin (see oXYGenFinancial.com)
Life insurance isn’t sexy. And death isn’t something any family wants to talk about. But risk management is an important part of anybody’s financial plan—and that makes life insurance a crucial purchase for most families.
In my 27 years of giving financial advice, I have never had a person tell me that they bought too much life insurance after a spouse passes away. And I’ve never gotten a call from someone to tell me that they regret purchasing a policy.
Two years ago, I received a phone call that financial planners dread. It was from a client whose husband had vigorously opposed the idea of getting life insurance. His argument: The family had plenty of money, he said, and the wife could always work if something happened to him.
Something did. His wife now had to manage the affairs of the family business and maintain their standard of living as the family’s cash reserves ran lower and lower—a tremendous financial and emotional strain.
As this tragic example shows, life insurance is essential for most families, even those that have considerable financial resources. The reality is that with an unexpected death of a breadwinner, family income will drop immediately and remain lower, very likely for an extended period.
Life insurance provides immediately liquidity to help cover expenses. And there are more expenses than most people realize: paying for funerals, eliminating credit-card debt, covering mortgage and school payments.
And in the long term, of course, insurance helps make sure that a spouse or partner has enough resources to maintain the family’s standard of living. In addition, if people own a business, insurance can be an invaluable tool to ensure that the operation keeps running.
Some contrarians will argue that most people don’t need life insurance because most people don’t die before their life expectancy. That means that they will pay premiums without ever collecting a death benefit.
Moreover, critics may say, people’s life situation will change enough over the years that they will stop needing insurance. Their children will begin working, for instance, and be able to take care of themselves. Or the family will build up enough resources to cover any eventuality. So they’ll probably end up canceling a policy anyway instead of collecting.
But those arguments don’t hold water. For one thing, the fact that most people live to their life expectancy doesn’t remove the risk of unexpected death. Most people never really build up as many assets as they ought to if a breadwinner dies unexpectedly. And if they don’t, they’re out in the cold.
For that reason, people should carry a mix of term insurance to provide short-term coverage and permanent insurance for protection over the long haul. If someone would prefer whole life or universal life—but worry that those types of policies are too expensive—there are lower-cost versions available.
Another argument critics may make against getting life insurance: People frequently buy a policy to help their family take care of estate taxes, and now that the estate-tax exemption has been raised, there is not a need for coverage. But that argument misunderstands the point of insurance. You buy a policy to provide liquidity for a number of things, not just one particular tax, so that your family doesn’t have to scramble to sell assets at an already-difficult time.
What’s more, people should not assume that the insurance they get through work will be enough. Most group life insurance has a cap on how much life insurance you can buy, but the bigger challenge is that the policy may not be portable, which means you cannot take it with you if you leave your job.
For many people, there is an initial stigma attached to products like life insurance. We may feel that we are being pushed into a buying a product, so we naturally put up a wall of resistance. Sure, insurance policies can be complicated, and you don’t want to get burned by making a wrong decision. However, indecision could be the worst decision of all, and leave a family to deal with a financial mess.
Mr. Jenkin is co-CEO and founder of oXYGen Financial. Email reports@wsj.com.
Why Have It
Reasons cited for owning life insurance, by age
Source: Limra 2016 Insurance Barometer Study
NO: Most people don’t need it—and will never use it
By Samuel Rad (see SamuelRad.com)
Life insurance is one of the most misconstrued and poorly utilized concepts the financial industry has ever devised.
The right insurance policy, used in the correct circumstances, can be an asset to a family. But it is way oversold and relied upon by many who don’t need it or possibly even understand how it works. Many agents make the blanket claim that life insurance is good for everyone.
I don’t agree. Most people don’t need it, and those who do need it only for a short time. Yet many end up buying it and sticking with it for years. There’s a reason insurance companies have done so well.
The fact is, most people are very likely to outlive their coverage, which makes their rate of return on the policy zero. In fact, they will be getting a negative rate of return, due to all of the money that they spent on being insured over their life before the policy ended.
New circumstances
Another reason most people don’t need insurance is that their circumstances are always changing. Couples build up assets and fixed income so a survivor doesn’t need help from insurance to stay afloat. Similarly, children get jobs and don’t need help.
If I no longer drive a vehicle, I no longer need car insurance. If I no longer own a house, it wouldn’t make sense for me to have homeowners insurance. Yet when we sign up for a life policy we are expected to keep paying the insurance company—regardless of what changes we see in our lives.
Many people, of course, do end up canceling their coverage at some point—but then they lose the death benefit they paid for all those years, and were constantly assured that they needed. Others pay for insurance forever even though they no longer need it due to a change in lifestyle.
The deal can even get worse when we consider whole life insurance and universal life insurance, which are designed to accumulate a cash value using internal investments along with providing coverage.
These are considerably more expensive than term life, and come with the same basic problem—most people end up dropping the policy due to life changes. But the basic promise of cash value also vanishes when you consider that the policies have high built-in costs that erode the true rate of return on cash values over the long term, usually leaving you with a minimal rate of return if you live to your life expectancy.
In short, with these policies, the longer you live, the lower your internal rate of return. So why not just invest the money in a high-performing index fund instead?
There’s another consideration here, too: Many people were sold large life-insurance policies with the promise that the policies would pay off their estate tax when they passed away.
However, with the new tax law, the estate-tax exemption has doubled—to nearly $11.2 million per individual or $22.4 million per married couple—which means people can now pass along double the amount of estate to their children without triggering any taxes. That means the insurance policy that people purchased and paid into for all of these years may now be considered obsolete.
A remote chance
Obviously, in the rare case that someone does die unexpectedly, insurance will prove itself to be a good bet. If someone is concerned about that possibility, a mixture of term and permanent insurance might be a worthwhile option.
However, it’s a gamble with very slim odds. Would you go to Vegas if you knew that you would win only one out of every 99 hands? Probably not.
Remember that many families have enough assets to rely on in case of a premature death, much more than they are led to believe by insurance agents. It’s all too easy for insurance to become a liability and cause financial damage if used without extreme caution. It’s something I see all too often with clients.
My advice? Like any tool, make sure that you only buy coverage if you absolutely need it. Once you have it, reconsider keeping it every five years.
