Understanding Life Insurance

When your employer breaks out the big box o’ benefits, you may be surprised to see that life insurance is on the table. If you’re like me, you probably thought that life insurance was only for wealthy fat cats and rednecks who want to fake their own death, collect on their policy, and escape to Mexico with their wife (who’s also their aunt). But while the vast majority of recent grads might think that they don’t need a life insurance policy, it’s not a completely cut-and-dry issue. Life insurance—like all insurance—can get pretty complicated, but we’ll try to cut straight to the chase: What is life insurance and what are the pros and cons for a twentysomething?

What Is Life Insurance

Simply put, life insurance is a type of insurance in which an insurer (e.g., State Farm) agrees to pay out a sum of money when the insured (e.g., you) dies. This money goes your beneficiaries who are predetermined by you. Beneficiaries tend to be the individuals who depended on the income you do/will generate. Long story short: if you are worried that if you die unexpectedly that any of your loved ones will be worse off financially, you should consider purchasing life insurance.

If your employer is serving you a policy on a silver platter (i.e., no extra monthly/yearly fees attached), then you should certainly jump on it. Even if they ask for you to slightly subsidize it (e.g., $10/month), still opt in. However, even if that small subsidy is too large for your current economic situation or your company isn't providing you with health insurance (and you're on your own), we ask that you still read on and consider acquiring a life insurance policy.

Deciding Whether or Not You Want Life Insurance

From a recent grad’s perspective, the pros and cons of purchasing life insurance are relatively straight-forward.

Reasons You Might Want Life Insurance

• To take care of your spouse/kids/parents. If you have kids or you’re married and your spouse would be severely hurt financially by your passing, you need to look into life insurance, which will provide them with cash when you die. This should help soften the economic blow of your passing. Note: Even if you're single, your beneficiary could be your mom, granddad, sister, etc.
• To Ensure Your “Insurability.” The people who underwrite insurance policies take into account a vast range of variables when calculating premium rates and determining your “insurability”—basically, how much of a risk the insurance company is taking on by insuring you. So if you have cancer or you’re a professional stuntman, you’re far less insurable than a healthy 23-year-old who works in advertising. Thus, most recent grads are highly insurable. This means two things: (1) you can pay relatively low premiums, and (2) getting life insurance now guarantees that the provider must continue to insure you as long as you keep up with your annual premium payments.
• To Leave a Clean Slate. Morbid as it sounds, if you don’t think anyone will be able to cover your funeral arrangements, your life insurance pay-out will ensure that you can be put to rest properly. Life insurance will also cover outstanding debts and medical expenses not covered by health insurance, as well as other costs related to your death.
• To lock in low premium rates. Assuming you're a relatively healthy twentysomething, the premiums you pay today will be much lower than when you reach your thirties, forties, and beyond. By purchasing a policy now, you can lock in those low premiums for life (or for a period, if you select a term life policy; see below).
  

Reasons to Ignore Life Insurance

• You are single and make little money. Maybe no one else (even you) is completely dependent on the income you bring in. If you’re struggling with basics like rent and food, life insurance is not going to be a high priority. And that’s fine—just keep it in mind when the big bucks do start pouring in and you take on more responsibility in your family and relationships.
• You can make a higher return on your savings elsewhere. Maybe you think that you could take the money you'd be paying in life insurance premiums over the next thirty years, invest it, and make a return on your investments that's comparable or better than the pay-out of the policy that you otherwise would have purchased. The benefit here is that if you don't die, all that money is yours and you can do whatever you want with it along the way. That being said, this isn't advisable, and if you opt for a whole life insurance plan, you can still recoup some of the money you've spent on it, even before you die.

While we've covered the main considerations above, there are some additional questions to review when considering life insurance.

Finding the Right Policy

If your employer hands you a plan, particularly if it's for free, clearly you've found your policy. However, if they ask you to chip in, it's worth vetting the provider. And if you're on you're own, then it's time to dig in.

MetLife, State Farm, banks, and all the other financial organizations you see advertised on TV offer life insurance policies, but it’s important to speak with an insurance agent to figure out what type of life insurance (if any) works best for your needs. Also, check out this guide on how to buy life insurance. Ultimately, there are two types of policies you’ll encounter: whole life and term life. And we'll also discuss some other alternatives.

Term Life Insurance.

A term life policy is pretty simple: it has a “face value” (e.g., $500,000) that is paid out to a named beneficiary upon the death of the policy holder. If you’re a recent grad, you’ll probably be more inclined to go with a term policy because they are far more affordable (e.g., $300/year vs. $3,000/year). The problem, of course, is that they do not provide you with coverage for the rest of your life, but instead, only for a specific amount of time (e.g., the next 30 years). Once that period has ended, you will have an option to renew your policy, but your premiums will be readjusted for your health and age and will most definitely increase dramatically.

So why would you only want life insurance for a certain amount of time? You may want to make sure that today, in a worst case scenario, a spouse, a child, or even a parent can be provided for, whereas in thirty years, you're comfortable that your children will have jobs and let's just say that you probably won't have to be paying for your parents anymore. So, in short, term life offers a reasonably inexpensive way to hedge against a tragedy during the period when you think it would be most devastating (financially) to those who rely on you. You can, however, always change to a whole life plan down the road when that change is appropriate (e.g., when instead of just worrying about having to provide for your dependents, you're also doing estate planning).

Whole Life Insurance.

As the name suggests, whole life insurance covers you until the day you die (or at least until you’re 100). Unlike term insurance policies, it also incorporates guaranteed cash payout available before you kick the bucket. This portion is contractually agreed up and will represent a percent of the total annual premiums you've paid. If you are in a jam and need cash, you want to forfeit your life insurance policy at any time, you'll receive the guaranteed payout (if you die, your beneficiaries will just receive the amount the plan was made out for, e.g., $500,000). The cherry on top? You can even borrow against this guaranteed payment (e.g., the investment portion of your whole life insurance policy can serve as the collateral for a bank loan).

Other differences between life and term is that in many cases, after you've paid your annual premium for 15 years, you're covered for the rest of your life without having to spend another dime. And finally, the annual premium you pay today is locked in for the rest of your life.

The downside? Whole life is considerably more expensive than term life insurance policies. Rich folks like whole life because they can do things like use the proceeds of the policy to pay off their estate taxes and ease the burden on those who will inherit their estate. Recent grads may like it because it helps them get a jump on the whole life insurance game AND they recognize that down the line, whether they're signed up for a term plan or just getting insurance, the premium they've locked in today may be less than what they'll be quoted in the future.

Universal Life Insurance

Essentially, universal life insurance policies are a hybrid of term and whole. They enable you to determine your monthly payments and benefits, and also allow you to alter them over time. While this plan is something you certainly can explore, we recommend making a decision between whole, term, or the following.

An Alternative Life Insurance Plan

If you’re in your twenties and just starting to pull in a consistent salary, term life insurance may be the only affordable move. If you are raking it in, then whole life also becomes an option. But there's yet one more alternative: what could you do with the funds that you otherwise would be "investing" in life insurance? You could possibly invest them over the years and provide yourself with a larger lump sum down the road. Or maybe you could purchase a term policy (for $300/year) and invest the difference that you would have spent had you opted for whole life insurance (e.g., $3,000 - $300 = $2,700). The reason people consider this is because (1) they believe they can earn a better return on investing that money than if they'd spent it on purchasing life insurance, and (2) they'd rather have control over that money in the event that they don't die (e.g., to buy a second home down the line, to put it into a college fund, etc.).

Many posit that in general, people aren't disciplined, and when given the option between spending cash on hand or investing it, will more often spend. And even if they do invest, will they invest wisely? Moreover, look at the stock market over the past couple of years. What if the unthinkable happened and your beneficiaries had to cash out? You can probably sense where we're going with this: Don't do it. We've shared it with you because it is an alternative, but we don't really recommend it.

Deciding on a Life Insurance Policy

So at this point, if it were up to us, you'd be left with a decision between whole and term life policies. If your company isn't providing you with a plan, as a recent grad, term life makes a whole lot of sense if people are relying on you. It provides you with ability to still make sure that your beneficiaries paid out in a worst-case scenario, yet is a fraction of the cost of Whole Life. That being said, if you purchase a term life plan and your term concludes without your dying, that money has gone down the train. And if you decide to renew your coverage, your annual premiums will skyrocket.

On the other hand, if you're doing well for yourself, purchasing a life insurance plan is certainly something worth considering. Look at it as an investment in everyone who you care about's future. And, if you ever really need the cash, you can take it out. Let the following be some food for thought: a friend of Gradspot, Ron Rosenfeld CFP, has been helping his clients with insurance for over fifty years, and guess how many have died during that period? Just 26. Had everyone spent money on term, while giving them some level of comfort, they essentially would be throwing that money down the drain. Ultimately, whole life is a much better product if you can afford it. And if you're company's paying for it, even better.

The decision of whether or not to purchase life insurance will be based on the same thing that almost every other insurance decision will be based on: your level of risk tolerance. But here at Gradspot, we'd rather play it conservative, even if it means that we have a little less spending cash laying around today.