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A CPA Talks About Buying Life Insurance
By: Stephen Nelson
Not everyone needs life insurance. The first thing to do is make sure you need
it. Life insurance is really meant for your family members or other dependents
who rely on your earnings.
Why You Buy Life Insurance
You buy life insurance so that, if you die, your dependents can live the same
kind of life they live now. Strictly speaking, then, life insurance is only a
means of replacing your earnings in your absence. If you don’t have dependents
(say, because you’re single) or you don’t have earnings (say, because you’re
retired), you don’t need life insurance. Note that children rarely need life
insurance because they almost never have dependents and other people don’t rely
on their earnings.
Life Insurance Comes in Two Flavors
If you do need life insurance, you should know that it comes in two basic
flavors: term insurance and cash-value insurance (also called “whole life”
insurance). Ninety-nine times out of 100, what you want is term insurance.
Term Life is Simple to Buy and Understand
Term life insurance is simple, straightforward life insurance. You pay an annual
premium, and if you die, a lump sum is paid to your beneficiaries. Term life
insurance gets its name because you buy the insurance for a specific term, such
as 5, 10, or 15 years (and sometimes longer). At the end of the term, you can
renew your policy or get a different one. The big benefits of term insurance are
that it’s cheap and it’s simple.
Cash Value is Trickier
The other flavor of life insurance is cash-value insurance. Many people are
attracted to cash-value insurance because it supposedly lets them keep some of
the premiums they pay over the years. After all, the reasoning goes, you pay for
life insurance for 20, 30, or 40 years, so you might as well get some of the
money back.
With cash-value insurance, some of the premium money is kept in an account that
is yours to keep or borrow against. This sounds great. The only problem is that
cash-value insurance usually isn’t a very good investment, even if you hold the
policy for years and years. And it’s a terrible investment if you keep the
policy for only a year or two. What’s more, to really analyze a cash-value
insurance policy, you need to perform a very sophisticated financial analysis.
And this is, in fact, the major problem with cash-value life insurance.
While perhaps a handful of good cash-value insurance policies are available,
many— perhaps most—are terrible investments. And to tell the good from the bad,
you need a computer and the financial skills to perform something called
discounted cash-flow analysis. If you do think you need cash-value insurance, it
probably makes sense to have a financial planner perform this analysis for you.
Obviously, this financial planner should be a different person from the
insurance agent selling you the policy.
What’s the bottom line? Cash-value insurance is much too complex a financial
product for most people to deal with. Note, too, that any investment option
that’s tax-deductible—such as a 401(k), a 401(b), a deductible IRA, a SEP/IRA,
or a Keogh plan—is always a better investment than the investment portion of a
cash-value policy. For these two reasons, I strongly encourage you to simplify
your financial affairs and increase your net worth by sticking with
tax-deductible investments.
If you do decide to follow my advice and choose a term life insurance policy, be
sure that your policy is non-cancelable and renewable. You want a policy that
cannot be canceled under any circumstances, including poor health. (You have no
way of knowing what your health will be like ten years from now.) And you want
to be able to renew the policy even if your health deteriorates. (You don’t want
to go through a medical review each time a term is up and you need to renew.)
About the Author:
Seattle certified public accountant & author Stephen L. Nelson CPA has written
more than 150 books. His web site is http://www.stephenlnelson.com
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