In this month’s edition of “Money Matters,” Scott discusses the importance of understanding life insurance, including the difference between types of policies, how much your policy should be worth, and how life insurance policies can help you achieve your financial goals for your beneficiaries.

Choosing a Life Insurance Policy That's Right for You

There are a lot of factors to consider when choosing a life insurance policy. Check out the chart below for more information about issues to consider before choosing a life insurance policy (click images to enlarge).

Money Matters: Life Insurance Transcript

0:00:00.0 Mark: WTIP is pleased to offer Money Matters, a monthly feature intended to help us understand more about managing our finances. Scott Oeth is a certified financial planner and Adjunct Professor. He's taught hundreds of financial professionals' retirement planning and wealth management strategies. Scott joins us now by phone. Welcome, Scott.

0:00:19.3 Scott Oeth: Hi Mark.

0:00:21.9 Mark: What type of life insurance should a person buy?

0:00:27.0 SO: Well, there's a lot to that question, a lot of considerations. It could be a long topic, but I'll give you some general thoughts here. Life insurance can be a wonderful financial tool. If there's financial obligations, you need to make sure family's provided for, a mortgage is paid off, fund college, things like that, life insurance can fill that gap if you don't have time to get there yourself before the clock runs out. So I'll say upfront, I am a big fan of people having adequate life insurance coverage. Not everyone needs it, though, not everyone has those types of financial obligations. Some people are financially independent, or they've reached the stage of life where debts are paid off, or if they die, there's no major financial impact to someone else, and needs change over the course of time. So people need to look at their own situation with their own expert advice and make their own careful analysis, but as a general thought, it is important to have the right type of coverage.

0:01:24.4 Mark: Oh, of course. Television is constantly talking about... They're selling life insurance all the time, it seems like, in the media. Talk about the different kinds of life insurance that are available.

0:01:36.3 SO: Yeah, absolutely. So the most basic type is what's called term life insurance. This is a basic contract between you and the life insurance company where you say, "I would like to secure $100,000 or $1 million with a life insurance coverage," whatever the number may be, and you agree on the period of time, it could be for one year, five years, or 10 or 20 years, and the contract basically says how much you'll pay each year for that. They put you through health underwriting, and if you die during that time frame, your beneficiary gets paid out. That's term life insurance, very simple. It's basically just a contract to pay a claim on your life.

0:02:11.4 SO: Then there's this other category of permanent life insurance, and there's a couple different varieties. There's what's called whole life insurance, or universal life insurance, 'cause they're somewhat different in the design, and then it gets even murkier with... Some can be variable, meaning the cash value component is based on market returns versus fixed, and then there's hybrids. So simple type is term life insurance, the basic, stripped down, just cover you for the course of your life... Over the period of the contract, I should say, and then there's this whole category of permanent life insurance, whole life and universal life insurance.

0:02:46.1 Mark: Alright, so term life insurance, I understand that. The permanent life insurance, does the benefit when I die change, or something like that? What's the difference between the two?

0:02:58.0 SO: Well, it can change, and just what you said, Mark, I think is a key point. Most people can understand, everyone can understand term life insurance, and that's important. We wanna keep our financial lives simple and not get into to undue complexity, and sometimes, there's investments or financial strategies that, while they may have some benefits, they're just too complicated either to understand upfront, you're not sure what you're getting into, or maintain, and people lose interest and it falls apart down the road. But the benefits of permanent life insurance are that the life insurance company's taking a look at you, and the contract agrees that they're gonna cover you all the way up till whenever you die, up to age 100, and so they price it that way.

0:03:38.0 SO: So they're levelizing the premium over the course of your entire life, and as you can imagine, it's a lot more expensive for, say, a 90-year-old to take out a life insurance policy then a 30-year-old, so they have to blend out that premium over the course of your entire life, so the cost just for the insurance is gonna be quite a bit more. The other thing that they do is, they let you put extra money in upfront to build up a cash reserve and build cash value in the policy, so the permanent policies have an investment or savings component.

0:04:07.0 Mark: So I imagine the kind of life insurance that you would recommend would depend, at least, on your age and probably some other factors too, correct?

0:04:17.3 SO: Yeah, absolutely. Age, your situation, how much you can afford comes into play somewhat, but really, the need... This is what I'll say, Mark. This is my 25th year in financial services, I can count on one hand the number of times the past couple decades where I thought permanent life insurance was a good idea. It does work well in special situations, people with large, taxable estates, maybe they have a big charitable interest, they wanna give away assets to a charity and replace that value with life insurance to their family. There's a few unique situations, but the cost and the complexity really makes term the winner in my mind, in most cases.

0:04:54.7 SO: Now, people need to make their own conclusions and get their own expert advice here, because it is a very complicated area, but just a few quick thoughts. Often, permanent life insurance, whole life insurance, is sold based on the savings component, but there's a lot of extra cost wrapped into that type of policy, and often, how it's sold is touting the tax benefits, because cash value life insurance can grow tax-deferred. So what you really need to do is have an unbiased analysis of, are the tax benefits of that investment in the life insurance, do they outweigh the extra cost of the insurance policy? And from when I run the numbers, no, they rarely do not.

0:05:37.3 SO: The people who sell permanent life insurance, and I have a lot of good friends who do this, many who I respect, but as economists say, incentives matter, and they get paid a whole lot more to sell whole life insurance policy than term life insurance policy. I'm a big fan in financial services, getting good financial advice, [0:05:56.6] ____ transparency. Good people should be paid, experts should be paid for their time and their expertise, I'm fully onboard with that, but the consumer should know and should have an idea, because it can definitely skew the advice and the recommendations.

0:06:11.1 Mark: So life insurance is not as easy as the TV advertisements, it sounds like.

0:06:16.5 SO: Well, getting a basic term life insurance policy can be fairly easy.

0:06:21.5 Mark: Easy.

0:06:22.0 SO: It doesn't have to be incredibly painful policy process, but once you get the more complicated types, there's a lot going on there.

0:06:30.0 Mark: Alright. We're talking with Scott Oeth. We'll be talking finances with Scott on the first Wednesday of the month on North Shore Morning every month. Anything else you wanna add this morning, Scott? This has been great.

0:06:40.7 SO: Well, I'd just say, I think this is a very important topic. I highly encourage people to evaluate and re-evaluate, over time, their life insurance needs, and get some help. Talk to an experienced certified financial planner, talk to your accountant, talk to an attorney. Yes, talk to an insurance agent, but understand there may be different points of view, depending on the agenda in their business structure.

0:07:03.5 Mark: Thank you so much for talking with us today.

0:07:05.6 SO: Thanks a lot, Mark.

0:07:06.3 Mark: Alright.