This is Part 2 of a series exploring how and why Dividend Paying Whole Life Insurance may be the only allocation one needs for the fixed income portion of one's portfolio. Part 1, linked here, was our introduction. Part 2 will explain the various insurance policies one can purchase.
Life insurance is protection for your loved ones in case you pass away early. The amount of insurance to purchase should be enough so your family can maintain the same lifestyle as when you were working. Not one year's worth of your current salary, but more like 10-15 years' worth of your current salary. The amount of life insurance one individual can get on him or herself is a simple calculation depending upon how old you are. A person in their early 30s can get 25x their current annual salary in life insurance, while someone in their late 30s can only get 20x (your chances of dying are higher). This calculation is used no matter what type of life insurance you end up purchasing.
There are different types of life insurance to purchase. Term insurance is exactly that - you are purchasing for a specified number of years (a term). Once that term is over, you are either alive and nothing got paid out, or you were one of the unlucky 1% who did die and your family received a death benefit. And that is the statistic: For every 100 term premiums an insurance company receives, it only pays out, on average, for 1 individual. It is cheap premiums (a healthy male in his 30s can get $1 million in coverage for about $700 for the YEAR) and is the bread and butter for life insurance companies. It is ESSENTIAL if you have a young family to have life insurance. If this is all you can afford to do, do this. It's better than not having any and your family having nothing if you pass.
The other broad category is permanent life insurance, which includes whole life and universal life. This series will not talk about universal life because it tries to mix life insurance with investing, which is not smart, in my opinion. Whole life (WL) covers your entire life. The traditional policy has a very expensive annual premium, about 10-20 times more than term for an equivalent death benefit, and you continue to pay this premium for as long as you live. Insurance companies love doing these policies too because they only pay out 10% of all whole life insurance policies written. Why? Because the premium is so high, people can only afford it for 3-5 years and then let the policy lapse, so the insurance company wins again. So why do people buy this product? Because the insurance agent talks about something called Cash Value. You pay such a high premium because you are building cash within the policy that could be removed in a financial emergency. The problem lies that in a traditional WL policy, the insurance agent emphasizes the death benefit and it may take about 15 years to get the cash value equal to the amount of premiums paid. When the death benefit is higher, your annual premium is higher, the agent's commission check is higher.
I mentioned a couple paragraphs ago that "life insurance is protection for your loved ones in case you pass away early." That is not entirely true. The owner of the policy (the one who pays the premiums) can purchase life insurance on anyone that he/she claims to have an "insurable interest." How exactly do the life insurance companies define "insurable interest?" The obvious answer is the owner of the policy would be the insured as well. Other examples of insurable interest are spouses; parents; business partners; children and grandchildren. This is the most important point: The owner of the policy is the one who controls the cash value in the policy. The life insurance company will only talk to the owner about accessing the cash value even though the insured could be a (grand)child. This is how a policy can become a great multi-generational asset because the (grand)parent owner does not have to relinquish the policy if he or she finds the insured is poor with finances or has made bad decisions regarding about health (alcoholism or drug use, as examples).
So why do I continue to talk about this? Because R. Nelson Nash, the creator of the Infinite Banking (IB) concept, spun the idea on its head and said, "What if we DEEMPHASIZE the death benefit and focus more on the living benefit?" In other words, can a whole life policy be structured so that it has a minimal death benefit but we can stick a lot of cash into it to maximize the cash value and use the money while we are alive? The answer is yes. When properly structured, a whole life policy done in a "banking" way focuses less on the death benefit and gives you the opportunity to get to the cash within that policy. As I said the paragraph before, the traditional whole life policy may take 15-20 years to get that cash value = premiums paid, while an IB whole life policy could be done in 4-7 years to get back to break even (and you have a death benefit to boot).
[Note: From a marketing angle, if you peruse the internet enough, you may read the terms Infinite Banking, Bank on Yourself, Safe Money Millionaire, the 101 Plan, and other interesting names. These are all just marketing titles using whole life insurance as the vehicle. For this article, I will continue to use the term IB for simplicity's sake.]
Why don't more insurance agents do this or explain to their clients this is possible? The biggest reason is commissions. When properly designed for you, their commission will be about 30-50% of the commission of a traditional whole life policy. So why would they try and look out for your best interests when it doesn't seem right for them? The smart agents realize they will get more referrals from people who are happy to do it this way and the financial flexibility it provides.
The next article will discuss the basic concepts on how a whole life policy should be structured to benefit you, the consumer.