Life Insurance Basics - Should Young People Get Insurance?

Life Insurance is a great investment. Sometimes life insurance works our great for you, however, other times its great for the insurance company. The insurance company loses a lot of money on many of the policies it sells. However, insurers are similar to a casino. The casino may lose big to one person one night. However, over any longer period of time and larger population, the house will win. Let's try to optimize your choices to put the odds in your favor.

Quick Summary:

• Buy term insurance with conversion riders to cover your mortality needs and give you future options

• Use a laddered approach to purchases

• Max out other tax-advantage accounts before you look at permanent insurance

• The only good type of PUA

Nothing in here is financial advice since everyone's situation is different. Do your own research. I provide some general guidelines and insights to help you get started.

First off....

Does a Young Person Need Life Insurance?

Great question. The answer is a resounding "it depends".

Go back to the basics. At its core life insurance provides money to your chosen beneficiary in case you die. Therefore, the first question is, "does anyone depend on you for money at this point in your life"?

If you are 18 years old, probably not. Maybe you help with bills around the house.

If you grew up poor and your parent(s) helped you get through school and into a good career in your early 20s, maybe you buy some life insurance to help them out.

Honestly though, you likely don't need life insurance until you get older and have dependents.

If you have children and don't have some form of life insurance, you are a bum. Unless you are massively wealthy, you need to provide something to make sure your children are set up. Ideally, you have a will, a trust, and guardianship all spelled out. You can have the insurance policy pay out to your child and if they are underage go into a trust with explicit rules on how it is used. All this can be worked out with a lawyer.

What should you buy?

First Life Insurance Product for Young & Healthy

Go buy term insurance with a conversion rider.

I assume most people are 20-35 years old when having children. Most 20-35 year olds should be in good enough shape to get the top underwriting class (if not....bro....start going to gym and getting in shape. Just because you are buying life insurance, doesn't mean you want to get a good ROI by dying soon).

Term insurance can come in my different length terms. For your first policy, ideally get 30 year term which is the longest option. This means for 30 years your premium won't change. This is the 30 year level-pay period. Also, make sure you have a conversion rider that lasts for the entire 30 years. Now a 30-year term will be more expensive than 10-year term, but this first policy should be about setting a nice safety net in case you die. The 30 years should be enough to last through all your kids growing up.

Example of Term Insurance Premiums

Below is a sample of the monthly cost to you for a $250,000 death benefit and a $1 million death benefit.

A couple things to call out:

• Cost of the coverage goes up as you get older

  • EXCEPT for males in their 20s where the cost goes down from 20 to 25. This is because 20 year old males are stupid. The amount of accidental deaths in that age group is very high. If you are a male, think of all the times in your 20s you almost died doing some stunt.

• Female premium is less than males as females live longer, do less dangerous jobs/hobbies, and have less addictions

• The higher the face amount (death benefit) you purchase, the lower the relative cost of the insurance is.

  • Notice the $250k face premiums are higher than 1/4 of the $1mm ones

Lastly, notice how little change there is in the premiums from age 20-35. There is little benefit from rushing to buy term insurance before you actually have dependents that need it as the price you would pay purchasing the policy at 35 is not materially more than at 20.

How Much Life Insurance Does a Young Person Need?

How much insurance do you need? The rule of thumb is typically 10x your annual income.

You can add an additional flat amount per child (ie-$100,000 additional policy per child)

You can add additional coverage for any mortgage or debts (ie- $250,000 mortgage and $50,000 student loan and other debts would be a $300,000 policy).

The good thing about insurance, is that you can always go and buy more. Make sure that whatever amount you purchase, you will be able to pay the premiums for the life of the product. Don't buy too much insurance and then not be able to pay it and have the policy lapse. Insurance companies make money off lapsed policies as they collect your premium and don't have to pay out any claims. I am going to repeat this below for emphasis:

Insurance companies make money when you can't pay your premium and lapse. Make sure you will be able to pay your premiums. Don't give profits to the insurers, man.

-A Effin Wise Man

You can always go back and buy more policies. There is no limit to the number of policies you can own.

Honestly, the first couple policies you buy likely should be term products. After getting your one large 30-year term product, you can start buying smaller 10 or 20-year term products. Why not more 30-year products? You could, but the price on a 30-year product is 2-3x the premium on shorter term products. I prefer to ladder the maturities and have the smaller face amount policies maturing sooner since these would be the first policies you convert to permanent products.

Buying different term policies with different level-pay periods over a few years gives the option to convert to permanent products at a later date

By stacking a few policies you leave yourself options and do so at a reasonable cost. In the exhibit, as you age, gain more dependents, and get a higher salary, you stack on more insurance. At age 31, you have $1.4 million in death benefit and 6 years to decide if you want to convert your first $100,000 policy to a more permanent insurance. (Numbers and ages for illustrative purposes only).

Permanent Life Insurance Product for Young and Healthy

You purchased a reasonable sized 30-year term product and scattered in a few shorter term products. Now you are looking for something more permanent. STOP.

The major benefit of permanent insurance is the tax-free growth of your account value with the death benefit as a nice added benefit (remember you have a 30-year large term product with a conversion option, so if you find out you have a life-shortening disease you have optionality on that). However, you are paying very high fees to the insurance company on any permanent product. Therefore, you should focus on maxing out other sources of tax-advantaged accounts before going out and buying a permanent product.

Do you have a 401k at work that you are max contributing to? Do you max contribute to your IRA? How about an HSA if you choose that health plan?

If you are maxing out these tax-advantage accounts, then putting money in a permanent product as a next option may make sense. However, if you are at the income level that you can max out these other accounts, the smart move may be to just purchase a standalone permanent product if you are still in great health.

Converting a term policy typically allows you to convert to any currently sold permanent product. So if you can still get the best underwriting class, it is no different than going and purchasing a new standalone permanent product. You should keep your old term products to keep the option to convert in the future open. However, if you get a worse underwriting class, I would convert a term product instead. The price differential between classes can be thousands of dollars. You definitely want to get the best possible underwriting on your permanent product.

From Part 2, you know there are many different types of permanent products. Which one do you choose?

Which Permanent Life Insurance Product for Young Person?

This question is going to be very individualized. Different products have very different designs for a specific use. However, as someone young who is making enough money that they maxed out their tax-advantage accounts and is looking for a permanent insurance product, whole life insurance is usually a good starting point.

Yes, whole life insurance is the most expensive.

However, it is a 'jack-of-all-trades" product that provides account value growth, growing death benefit, and financial flexibility. Since you are young, the most valuable thing is having optionality. Five years from now you may be on a different path. You don't want inflexible products that don't meet your new needs. Not to mention, at this point in your life you should be focusing on growing your income, not twiddling around with a small insurance contract.

Whole life is very much a set it and forget it product. You pay the premiums and the account value will continue to grow as the company pays dividends in.

Paid-Up Additions (PUA) on Whole Life Insurance

Make sure your whole life product has paid-up addition

When purchasing a whole life product you should elect to receive dividends as 'paid-up additions (PUA)'. In short, this is like a dividend reinvestment plan (DRIP) on a stock. If you elect to DRIP your dividends, they automatically get reinvested in another share of the stock. Over time you have more shares which leads to more future dividends in a compounding manner.

Similarly, in a PUA each dividend the insurance company pays is used to buy an additional amount of whole life insurance. This additional amount is fully paid, therefore it doesn't change your annual premium. However, going forward you will earn an additional dividend on that new piece of insurance.

Good PUA = paid-up additions on your whole life product. Bad PUA = pick-up artist dressed like this at the bar drawing a bunch of attention to himself trying to be an alpha peacock

A PUA will also increase your actual death benefit amount (since you are literally purchasing more insurance). Have your advisor show you an illustration and you will see by using a PUA, the actual death benefit of the product will double and then some over time. That $250,000 policy your purchased can grow to be $750,000+ and provide you with cash value in the $100s of thousands by time you hit retirement age. (Again, at a fairly high relative price of $1,000s in premiums every year).

Wrapping up Life Insurance for Young Persons

There is many different ways to to structure your financial situation. What is outlined above is one option (albeit a very very good options if you ask me).

Life insurance isn't the most exciting, but the return to your beneficiaries on a term policy is in the 10,000%s. I know, I know…only 10k%, you can pull that with the most recent sh!tcoin ponzi. Insurance does come with little chance for a rug pull though.

The IRR on a whole life policy if you survive is typically 5%+ and it comes with the option of a much higher return if you die. Add in the benefit of tax-free growth and the ability to access your cash value through a loan and you end up with a fairly good deal.