Call me old-fashioned, but I believe as a husband and father it’s my responsibility to provide for my wife and children should I die prematurely. Life insurance is the best way to meet this need, but many people get confused, Term versus Universal Life. A recent email from a reader will help clear up this confusion.
Richard is 26 years old and in his email he tells me, “I was getting ready to pull the trigger on a $200,000 universal life policy for myself. I have 2 children and I think not preparing for a pre-mature death is irresponsible planning. I just read your article and I have a few questions for you.” He goes on to provide the details of the cost between term insurance and the cost of a universal life policy.
Based on his calculations, it will actually cost more to buy term insurance over the next 60 years than buying universal life. He wonders why the universal life policy wouldn’t be a more logical choice. To Richard’s credit, he has taken the time to research this decision. But there are a few issues that he is missing. Here’s my response.
“There are several things for you to keep in mind as you make your decision.
“First, why are you getting life insurance? If it’s for income replacement (pre-mature death) then you need to take a look at the amount. $200,000 wouldn’t be enough to cover the costs of housing, education, etc. for your children. You may find that $1,000,000 is more realistic based on your earnings, etc. Consider 10-15 times your salary.
“If your wife is the primary caregiver then you should consider picking up some insurance on her to help cover child care costs in the event of her death, perhaps $200,000 worth.
“As for you, the difference in cost between term and universal life on a $200,000 policy for a 26 year old isn’t that great. When the death benefit is $1,000,000, the difference in premium can be significant. If it’s a matter of cost, I would suggest using the difference in cost on the $200,000 policy to buy more term death benefit.”
Richard further discussed the difference in cost assuming he lived to age 76. Based on the minimum guaranteed return with the universal policy compared to the cost of the term insurance over the same time period, it was clear to him that the universal was a better deal. Why shouldn’t he do it?
My response continued, “Second, if you want to compare apples to apples then you have to take into account investing that difference in premiums over that same time period. Otherwise you are assuming growth in the universal policy scenario but not in the term scenario. When you do, the numbers look entirely different.” In Richard’s example, the $70 a month he’d save with the term policy may not seem like much. But over 50 years, assuming an annual interest rate of 3%, it amounts to over $90,000. That’s much more than the cash value of the universal life policy after 50 years. Plus, he has complete control over that money.
I continued, “Third, it depends on whether you anticipate keeping the policy till age 100. This comes back to the point about life insurance being primarily used for income replacement. As people near retirement and their children are grown and their wealth has increased, they no longer need life insurance for that purpose.
“Fourth, you should take into account inflation. $200,000 won’t buy much in another 40 years. And since the underlying cost of insurance in the universal policy increases just like term, the growth of the cash value will slow considerably.
“Lastly, the only value associated with the cash value in a universal life policy is that you can use it. The problem is that when you borrow it from the insurance company (it’s really not your money), it will dramatically affect the policy’s performance. The ‘target’ premium may no longer be enough to keep the policy in-force.
“By the way, Richard, I don’t sell either universal or term life insurance so I don’t have any financial incentive to recommend one over the other. All things considered, I still prefer term life insurance over universal. It’s what I use. Thanks for the question!”