NEWSWEEK: OK, what is the biggest mistake consumers make?
HUNTER: The most massive confusion seems to be over cash-value life insurance, which is any policy that builds up a cash value over the years-whole life, universal or variable. One of the things people don’t understand is that the vast majority of people-95 percent–who need insurance should buy term insurance. Cash value only makes sense when your tax adviser suggests it for estate planning. It’s very easy to compare term policies. You don’t have to think about the interest rate you’re getting, how fast your cash value is building and all those projections.
So why do people buy cash-value life?
Because it’s sold to them. Agents get very high commissions from these policies, as high as 75 percent to 100 percent of the first year’s premium. I think the average commission on all whole-life policies is around 65 percent. In contrast, term insurance pays agents very little-about $5 percent of a much lower premium. People also buy insurance when they don’t need any. Here’s the fundamental question to ask: do you need protection from the economic consequence of a premature death? A little infant doesn’t really need life insurance. I can’t imagine anything more devastating, but there are no negative economic consequences from the death of a child. Now the child graduates from college. A lot of people buy life insurance at this point, and yet there’s still no real reason to. Then the person gets married. If both partners are working, then it still may not make sense to have life insurance. When the wife gets pregnant, then the whole situation really does dramatically change. Now you’re talking about a 20- to 25-year financial burden.
And when those 25 years are up?
As the children get older and you’re able to put away money for retirement, you need less and less life insurance. When your last child enters college you can begin to sharply scale down the amount. After they get out on their own, you may not need any. That’s another reason to choose term insurance–you buy only as much as you need.
How much do you need?
The old rule of thumb is five times income. You can go through very complex calculations, but the last step of any calculation I’ve ever seen is: what will inflation be for the next 25 years? Who knows? So, you may as well use the rule of thumb rather than go through all that tedium and then have to make a wild guess. If you have more than two kids, or an unusually large mortgage, you might need more. But if you have only one child, and other assets, you probably need less. You can buy $200,000 of term insurance for under $500. USAA and Ameritus are the best no-load life-insurance companies, meaning you don’t pay a commission.
If you already have a whole-life policy, should you cash it in and start buying term?
If it doesn’t pay dividends, chances are you should dump it. If it pays dividends, then it’s a very complicated question. Say you made a mistake and bought a cash-value policy when you were quite young. Now you’re 35. The question is, from here on out how does its cost and coverage compare with term insurance? Between 25 and 50 percent of these policies should not be dumped. For a fee, we’ll analyze people’s policies to help them with that decision. Some financial planners will do the analysis, too. But you want a fee-only planner, not someone who earns commissions.
Would you recommend that most people buy disability insurance before life insurance?
Yes. If you don’t have disability insurance through your employer you should buy it. The simplest way to lower the cost is to take a longer elimination period. That’s how long you wait before you begin collecting benefits. If your company has a one-year disability program, you certainly wouldn’t want an elimination period any shorter than one year. If you’re self-employed, ask yourself how long could you comfortably–or maybe a little bit pinchingly–survive. If you’re getting a quote based on a waiting period of 60 days, ask for one based on 120 days. It’ll be quite a bit cheaper. It works like a deductible. Northwestern Mutual, New England Life and Prudential are good places to look at disability policies.
