Q. Sitting around a campfire on a hunting trip in west Texas, I posed a question to four of my 50-year-old companions on whole life versus term life. They said, buy term. My question comes after a financial plan review with a large service-oriented insurance company. Their process is supposed to separate the financial planning aspect from the sales motive. But now I'm not so sure.
We are 50 and 46, with two kids, 14 and 8. Our net worth is about $2 million. We max out our 401(k) and contribute to a 529. We both have professional jobs. Hers is more stable than mine, but mine is relatively stable. Our financial planner recommended whole life policies in the amount of $250,000 for each of us. I only minimally participate in my company life insurance. My wife is provided twice her salary in life insurance. She also has a $500,000 term policy with the firm our financial planner represents.
It is not clear to me why I would want whole life over term life. A second call to the financial planner failed to clarify the financial planning reasons I would want whole life versus term. A term policy is about $80 a month for 25 years. The cash value policy is $250 a month. Can you help me understand why I should, or should not, choose a whole life policy over term? —M.T. by email from Plano, TX
A. The difference between term and whole life is that whole life has a savings component and builds cash value. The earnings on that cash value are used to pay part of the rising cost of insuring your life as you age. That’s the only way the premiums you pay can be held constant since your risk of dying increases with age. Whole life policies are good choices for people who have commitments and obligations that won’t go away. They are also useful for people who need to bankroll the payment of a future estate tax against illiquid assets such as a family-owned business.
Term life policies are a better choice for most people because most of our long term commitments are fulfilled well before retirement. In due course, the kids are educated, the mortgage is paid off and your retirement savings will provide enough income so that you don’t have to work anymore. When that happens, you don’t need life insurance because your earning power no longer needs to be replaced. The vast majority of households have no need to plan for estate taxes because their estates won’t be large enough to be taxed and, if they are large enough, they will have enough liquidity to pay the tax.
Your best course is to measure the resources your family will need in the event of your death, and then insure for that. Not more, not less. If you financial planner hasn’t done that, and it appears he hasn’t, you need another financial planner.
Q. Do you really think that a 50 percent to 75 percent stock exposure is a good idea in light of recent stock market problems? I'm retired. It would be nice to have more income to spend, but I also like to sleep at night. A 50 percent to 75 percent commitment to equities wouldn't give me much rest time. —D.H., by email from Austin, TX
A. You're the one to set your risk tolerance, so you need to set your portfolio where you can sleep at night. The 50 percent to 75 percent equity commitment is based on portfolio survival studies, not sleep studies. If your equity commitment is 50 to 75 percent, your portfolio is likely to deliver a reasonable inflation-adjusted annual withdrawal without exhausting the portfolio before you die. Knowing that you have a better shot at NOT running out of money in the long run should allow you to sleep a little bit better in the short run.
Beyond that, there have been more than a few comments about the developing "bubble" in bonds. Bond yields are un-naturally low. Money has flowed into bond funds almost to the exclusion of other asset classes. So it's difficult to think that bond fund returns are going to be as kind over the next three years as they have been over the last three years.