14 Apr Term Life Insurance Strategies
When term life insurance is the recommended solution for a person’s life insurance needs, there are a number of strategies that can be implemented, depending on a client’s personal financial situation.
Starting with Term Insurance
Many individuals and families, particularly families raising young children, have so many needs to meet that satisfying those day-to-day needs consumes almost all of their available income. Often in these situations, clients have minimal liquidity that would be available to meet financial emergencies should they arise. Life insurance planning for these clients could involve the recommendation of term life insurance, even if their death benefit needs are permanent, coupled with a basic financial plan that will enable the client to save enough of an emergency fund to meet three to six months of bills if they are suddenly jobless, become ill, or need to pay for a costly repair. When that liquidity level is reached, the client can begin converting some or all of the term life insurance to another, more permanent type of coverage, if the need for permanent protection exists at that time. This strategy enables a policyowner to start building permanent coverage while still meeting their current protection needs.
Combining Term and Permanent Coverage
Some clients who cannot afford to fully insure their needs through permanent life insurance alone will often purchase both permanent and term policies. For example, assume a client determines that he needs $600,000 of life insurance coverage but can only afford to purchase a $300,000 whole life insurance policy. He could then purchase a $300,000 term life insurance policy to obtain the desired amount of total coverage at a lower, more affordable premium cost.
A client with both short- and long-term insurance needs could also use a combination strategy that utilizes both types of policies. For example, a client could purchase a certain amount of term insurance as his or her baseline amount, and then purchase a small face amount permanent policy to provide permanent protection. Such a strategy utilizes term insurance to meet financial obligations that may be temporary—such as paying off a mortgage or for children’s college expenses—as well as ensuring that lifelong protection is in place. A term-permanent combination strategy again can help a person fully insure their needs at a lower overall cost.
A client who wants permanent life insurance protection but lacks the financial resources to purchase the required level of coverage could also purchase a smaller permanent policy with a decreasing term life insurance rider to create a combination of death benefits and living benefits. Dividends paid by the permanent policy can then be used to buy paid-up additions that eventually replace the term coverage as it decreases over time.
Purchasing Term and Investing the Difference
The advice to “buy term and invest the difference” is a common strategy that’s recommended by some financial professionals. According to this strategy, a client should purchase term rather than permanent life insurance due to the significant cost savings. The client would then take the money he or she saves and invest it in stocks, bonds, mutual funds, or other investment products. Such an approach attempts to provide clients with both death benefits (from the term insurance) and living benefits (from the investment fund)—somewhat similar to the benefits provided under a permanent life insurance policy.
In addition, by purchasing low-cost term life insurance, a client will have more disposable income that can be invested and potentially earn a higher rate of return than the cash value growth in permanent life insurance policies. Advantages to investing such money outside of a permanent insurance policy include:
maintaining complete control over the investments in a person’s portfolio
not being limited to the investments offered by an insurance company
avoiding the fees and commissions associated with permanent life insurance
not having investment performance tied to an insurer’s financial performance
For example, assume a client is deciding between a 20-year term policy that costs $300 annually and a whole life policy that has an annual premium of $1,500. If the client purchased the term policy and invested the $1,200 savings each year, he would have $39,679 at the end of 20 years, assuming a 5 percent annual rate of return on the investment. Depending on the investment vehicle, however, taxes would likely decrease the rate of return.
Note that the buy term and invest the difference strategy assumes that people will actually invest rather than spend the savings each month. In other words, this strategy requires discipline and attention to investment matters—traits that some clients may not have.
This strategy also overlooks the important benefits a cash value policy offers that are not available with other types of investments, such as:
creditor protection
a minimum rate guarantee
waiver of premiums in case of disability
policy loan provisions
a variety of nonforfeiture and settlement options
Layering Term Policies and Group Coverage
Some clients may benefit from layering policies—that is, by using both group and individual term life insurance to build a protection plan that’s right for them.
Using this approach, a person would first assess his or her group life insurance options, which could serve as the base layer of protection. As noted earlier, group life insurance plans typically offer coverage to employees at no cost as part of their benefits package or as a voluntary benefit at a group rate. Most insurers provide a baseline level of coverage—such as $50,000—that is available to all employees. Employees can then evaluate the other voluntary life insurance coverage options offered by the employer and decide whether to purchase such coverage. Usually, the amount of coverage available under a supplemental group term life insurance plan is restricted to some multiple of the employee’s salary—typically from one to five times salary. However, such coverage would end if the employee quits his or her job, unless the policy allows portability or has a conversion option.
After assessing the amount of group coverage available—which likely will not cover all of a person’s life insurance needs—a client would then determine the additional amount of insurance needed. Many individuals choose term life insurance to fill this need, given its lower cost. A term policy might also be appropriate if a person is concerned about providing extra protection to family members during his or her working years but doesn’t need death benefit protection during retirement.
Laddering Term Policies
Another option is for clients to layer several different term policies to meet long-term term needs. In other words, instead of purchasing one large term policy, a client could purchase several smaller policies totaling the same amount but that will expire at different times, thereby reducing a client’s insurance costs over time.
Example
Consider the following example of how this strategy might work.
Your client Mia is married, has two teenage children, and is about to turn 50 years old. She and her husband have a mortgage on their house that they plan to pay off in 15 years. Mia also plans to retire in 20 years once she turns 70.
Because Mia is the family breadwinner, she wants to purchase enough insurance to accomplish the following in case she dies prematurely: pay for her children’s college education, pay off her mortgage, and ensure that her husband, Abe, has sufficient income to live on until he can access their retirement savings. Once she retires—and these concerns are no longer at issue—Mia feels she won’t need life insurance.
Mia’s insurance needs over the next 20 years are as follows:
In ten years, Mia’s children will have finished college. Her coverage needs will therefore decrease at this point. Until this occurs, she wants to have a total of $250,000 in life insurance (or $125,000 for each child’s college expenses).
In 15 years, Mia’s mortgage will be paid off. In the meantime, Mia still has $250,000 outstanding on her mortgage.
In 20 years, Mia will be ready to retire, at which point her insurance needs will end. Until she retires, Mia wants to ensure that Abe has $250,000 in insurance that he could use to pay for his living expenses.
How much term life insurance should Mia purchase? Mia would first add together her needs at each of these stages to determine that she needs a total of $750,000. She could simply purchase a 20-year level term policy with a $750,000 death benefit. However, this might be more expensive than purchasing three separate term policies for different time periods, as follows:
one $250,000 term policy for ten years to cover her children’s college expenses
one $250,000 term policy for 15 years to insure her declining mortgage balance
one $250,000 term policy for 20 years that will provide replacement income for her husband until reaching retirement age
Using three separate policies, Mia will still carry $750,000 in total coverage. However, in ten years, the first policy will expire, thereby reducing the total cost of her insurance coverage. Five years later, Mia’s mortgage will be paid off and the 15-year term policy will expire, which will further decrease the cost of her life insurance.
At this point, Mia will only own one term policy: the 20-year term policy that provides $250,000 of coverage until she reaches age 70 and retires. A breakdown of Mia’s insurance costs using a single-policy approach versus three separate policies is shown in the following chart.5 As this example shows, by layering Mia’s insurance coverage and purchasing three term policies rather than one, she will save over $6,000 in premiums during the next 20 years.
Single Term Policy: $750,000, 20 years
Initial Monthly Cost: $85.58
Monthly Cost After 10 Years: $85.58
Monthly Cost After 15 Years: $85.58
Total Cost Over 20 Years:$20,540
Three Layered Policies:
$250,000 each, 10-, 15-, and 20- year policies
Initial Monthly Cost:
$76.17
Monthly Cost After 10 Years:
$55.71
Monthly Cost After 15 Years:
$31.65
Total Cost Over 20 Years:
$14,382
30% Savings
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