Thursday, July 2, 2009

Another look at life insurance

Its a fact that any life insurance that builds cash value is a ripoff and should be a scam. Generally how cash value life insurance works is that your premiums are paid for two parts in the policy, which is the insurance and the cash value. The fact that these types of life insurance have more than one parts to it should be a red flag to you. After all, look at the other types of insurance out there such as auto insurance or homeowner's insurance. Why is that only life insurance builds cash value and the other types of insurance don't?

Cash value life insurance policies are very expensive. If you own it, you will realize that you have pay lots of money for a very low coverage. An average 30 year old with $100,000 coverage will pay about $1000/year.

Many life insurance agents or financial advisors may tell you that life insurance is a great way to save for your kid's education or a great way to save for retirement. If you keep the policy long enough, you can take out the cash value. But did you know that when you take money out, that you are borrowing your own money? Did you also know that the company has the right to deferred you loan up to 6-9 months? That means, they put a hold on your loan request. When you get the money from the cash value, the insurance company will charge you a loan interest of anywhere between 5-8%! And when you pay the loan back, the interest portion of the payment does not go back into the cash value. It is kept by the insurance company as profits. If there is insufficient cash value in the policy, your policy is in high risk of being lapsed. If this happens, all that loan you have taken out will now have to be reported to the IRS and you will pay income tax on that loan. If you die while there's a loan balance due, the loan balance plus interest plus and missed premiums will be deducted from the death benefit. For example, if you had $100,000 coverage and there's a $20,000 loan and you die, your beneficiary will receive less than $80,000.

People selling this garbage may also say its a great way to build tax-deferred savings! FACT: There is no life insurance policy out there that has done better than a 5% rate of return. FACT: It only grows tax-deferred because the total amount of premiums you paid is always greater than the value of the cash value. How do you pay income tax on a loss of return? You don't! But if somehow the cash value is greater than the total amount you paid, your life insurance policy will be considered a "Modified Endowment." This means that any growth on the cash value will be subjected to income tax and that the death benefit will also be subjected to income tax to the beneficiary.

Let's say you paid all your premiums on time and never taken a loan out and then someday, you die. All the cash value in the life insurance policy will be kept by the insurance company while your beneficiary will only receive the death benefit.

You are probably wondering why anyone would want to own a cash value life insurance? The main reason is that they don't understand how it works and the person selling it makes this type of life insurance very attractive to the buyer. When the client receives the policy, majority of them never read it.

The solution: Buy pure life insurance that doesn't build cash value, which is Term Insurance. Term insurance can provide you lots of coverage for a low amount of premium. An average 30 year old with $100,000 coverage will pay about $600/year (compare to the $1000/year for a cash value life insurance).

Since it doesn't build cash value, you have the opportunity to save your money wherever you want. Whether its in a safe , inside your home, at the bank, or at any financial institution, you have easy access to your money. There's no such thing as "borrowing" (unless you have a 401(k) and you want to borrow from that. But at least the interest portion you pay goes into your investments, not to the investment company).

If you do the smart thing with your money by investing it in the right mutual funds, you will achieve a higher rate of return than any cash value life insurance policy. There's many mutual funds out there that has done a 10% or greater return in the past 10 years, even during all the tough times in the economy in some of those years.

If you die during the term, your beneficiary will get the death benefit. All the savings you built up will be paid to your spouse or family members. (Its always a good idea to have a Will setup for yourself so that your assets is properly distributed to the right person(s)).

If you live to the end of the term, you have options on what to do next. If you believe you still need life insurance, then you can renew the term for another one to 5 years, regardless of your current health conditions. You may be able to do a policy exchange into another term policy, but proof of insurability maybe required (depending on how much coverage you are asking for). Or you can cancel the term policy and save the money for retirement.

If you die after the term is up, at least your family will receive your savings. If you buy term and invested your money since the start, that could be lots of money for your family. If you invested $400/month for the next 30 years and the average rate of return was 10%, you will have $911,730.

Keeping life insurance and investments separate just makes sense, doesn't it?

1 comment:

Ed Brenner said...

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