Life insurance, an investment? Despite what you hear, it's rarely a good choice - includes related article on two non-commission life insurance companies and where to get information on life insurance - Tutorial

Home Office Computing, June, 1994 by Linda Stern

Despite What You May Hear, It's Rarely A Good Choice

LISTEN TO AN INSURANCE SALESPERSON FOR EVEN A few minutes and you'll come away convinced of one thing: Life insurance is so insanely complicated you couldn't possibly understand it, so you better just buy some quick. Self-employed people, in particular, are targeted by an industry that would have us believe that its policies are the tax-favored ticket to comfortable retirement, college funds, and the orderly transition of family businesses. They'd like to sell you a policy without even mentioning the words death benefit.

But don't invest in life insurance unless you need that death benefit. Life insurance carries commissions, fees, and charges (including the so-called mortality charges that pay for the death benefit) that most mainstream investments do not.

Still, death benefits are what life insurance is all about for any worker, self-employed or not. If you have a family that depends on you for money, you need life insurance. That's not so complicated, is it? If you already know you need life insurance and want to add a few investment wrinkles, there are products that do that. Here's your orientation to the world of life insurance.

How Much Insurance? Well, you can figure your family's expenses and then inflate that amount into the future to determine how much moneyh you will need. Subtract the amount of money that would be available if you weren't around (such as your spouse's income and your Social Security death benefits) from the total needed, and buy insurance to cover the difference.

Or you can do what James Hunt, an actuary and the former state insurance commissioner of Vermont, suggests in Taking the Bite Out of Insurance, the book he wrote for the National Insurance Consumer Organization. Multiply your annual net income by five, and buy that amount of insurance. Adjust that rule of thumb for your own situation: If your spouse earns good money, or could earn substantially more than he or she does now, buy less. If you are a work-at-home person who runs a business and manages a home at the same time, up the factor to realistically reflect the cost of replacing all the services you provide.

Five Insurance Choices There are two basic types of life insurance--term and permanent, or cash value, which is, in turn, divided into four subgroups.

Term policy. The quickest, cheapest, and easiest way to buy life insurance is to buy a term policy. Term insurance works like car insurance, with annual premiums for a set amount of coverage. Every year you pay, but if you stop paying, the policy lapses and nobody owes anybody anything. If you buy term insurance, make sure it's renewable. Premiums may rise (typically on an annual or five-year schedule), but you won't be dropped. Term insurance makes the most sense if you don't expect to need life insurance into your 60s and 70s, when it starts to get expensive. That's because term insurance helps you protect those people who depend on you, but by that age most folks have retirement savings and any children are typically grown and independent.

If you expect you will need life insurance no matter how old you are--say you will be supporting a handicapped child through adulthood, or your business is worth so much (more than $600,000 in non-liquid assets) that your heirs will face a substantial tax burden when it passes to them--compare term rates with those of a so-called permanent or cash-value policy. This policy couples the insurance part of a term plan with a tax-deferred investment capability.

The four subgroups of cash-value life insurance policies are as follows.

Whole life. Whole life is the old-fashioned kind--guaranteed premiums, cash values, and death benefits. The insurance company invests the cash value where it sees the best mix of growth and safety and uses dividends earned to reduce future premiums. USAA Insurance, for example, offers $250,000 death benefit coverage in a whole life policy for a 40-year-old at a fixed $3,657 annual or $310.88 monthly premium (monthly premiums include service charges). At current dividend projections, premiums may disappear altogether by the time the policyholder has paid in for about 10 years; the cash value also should be $237,342 by the time the insured person is 65 years old, according to company spokesman Richard Erickson. But USAA guarantees only a cash value of $101,930 when the insured man is 65. That's less than a 5 percent annual return, though the policyholder also would be getting death benefit coverage from the first day the policy was in effect.

The same policy would cost $1,872 a year (or $159.16 a month) for a 25-year-old, who would be guaranteed a cash value of $119,310 at age 65, says USAA. A 60-year-old buying that policy could expect to spend $10,500 a year ($892.50 a month) for a guaranteed cash value of $35,552 in five years.

Universal life. Universal life insurance lets the policyholder raise or lower the death benefit and vary the amount or timing of the premiums that feed into the cashvalue part of the policy. This helps you invest more through your insurance policy when you're flush and spread payments out when you haven't much to spend. The same $250,000 coverage on the same 40-year-old nonsmoking guy in the previous example could be bought for only $151.60 a month, says Erickson, though at estimated rates of return that stretch payments out until the policyholder is 95. (In real life, interest earned on the policy's cash value would likely end the payments before then. And, as with any other form of life insurance, the policyholder would be covered with the $250,000 death benefit from the day the policy was put in force.) As time goes on, the policyholder could speed up payments into the policy.