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When discussing the topic of life insurance, one common question often arises: Should you opt for a term insurance policy and invest the difference in premium, or should you invest in a whole life insurance product or another form of permanent insurance?
The first step in answering this question is to understand how much life insurance you actually need. The acronym LIFE can help guide this calculation. LIFE stands for Liabilities, Income replacement, Final expenses, and Education.
Liabilities encompass any outstanding debt you have, such as mortgages or private student loans, which should be covered by your life insurance. Secondly, income replacement ensures that your family can maintain their current lifestyle if one spouse passes away. This is typically calculated for a period covering 10, 15, or 20 years. Final expenses include costs such as funeral expenses and any remaining taxes or debts. Lastly, education costs involve planning for your children’s future education expenses, whether for undergraduate or postgraduate programs.
For example, assume a family has two children, and each spouse earns $200,000 annually. They have a mortgage of $500,000, which would need to be paid off. For income replacement, they might need about $1,000,000 to cover living expenses for the family. Final expenses and emergency funds might add another $100,000. Additionally, planning for education costs for two children might require $400,000. Altogether, this family would need around $2,000,000 in life insurance coverage, which is roughly ten times their annual income.
Once you determine the necessary coverage, the next decision is whether to purchase term insurance or whole life insurance. Term insurance can be compared to renting a house: you pay a lower premium, but if you outlive the term, you get nothing back. For example, a healthy individual in their thirties might secure a $2,000,000 term policy for about $100 a month. In contrast, a whole life policy with the same death benefit could cost around $2,000 a month, but it includes a cash value component that builds over time.
One may then ask, why not simply buy term insurance and invest the difference? This strategy is often advocated by financial advisors who argue that you can achieve higher returns by investing in index funds or other financial instruments. On the other hand, proponents of whole life insurance highlight benefits such as lifelong coverage, cash value accumulation, and tax advantages.
For the majority of people, the strategy of buying term insurance and investing the difference is more suitable. If you haven’t maximized your contributions to your 401(k), Roth IRA, HSA, 529 plans, and other tax-efficient investment options, focus on these first. Only when you have surplus money after fully utilizing these avenues should you consider a whole life insurance policy.
Whole life insurance can be beneficial for high-net-worth individuals who have maxed out other savings options and seek additional asset protection, tax-free growth, and safe money alternatives to bonds. It’s crucial to structure these policies correctly and possibly consider an overfunding strategy for a fixed period, such as ten years, to maximize accumulation of cash value.
While term insurance with disciplined investing is generally recommended for a majority of clients, whole life insurance has a place for those with higher incomes and specific financial goals. Understanding the differences and aligning them with your personal financial situation is key to making the best choice for your life insurance needs. This approach ensures that your financial plan supports your life by design consistently and effectively.
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Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
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* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
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* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
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* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
* There is no guarantee a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.
EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
Investments in securities and insurance products are not insured by any state or federal agency.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.