As a financial planner, one of the insurances we get the most amount of questions on is life insurance.  Those in the market for life insurance can be overwhelmed by the sheer number of products available. However, at its most basic level, life insurance can be divided into two main categories; term insurance and permanent insurance. As an analogy, term insurance would be similar to renting an apartment, whereas permanent insurance is akin to buying a home and building equity.

A term life insurance policy is designed solely for protection. If a death occurs during the duration of the specified term (usually anywhere from 5-30 years), the benefit amount is paid to a designated beneficiary. From the insurance company’s perspective, it is a matter of “if” they will have to pay out the benefit. Most term insurance policies do not end up paying out, so term insurance is the least expensive form of life insurance.

On the other hand, permanent insurance takes many forms, but essentially, it combines the protection of term insurance with an additional feature of cash accumulation. This type of policy has what is referred to as “cash value” account that you can borrow against and accessed while the insured is still living. Whereas term insurance is a matter of “if” the company will have to pay out a benefit, permanent insurance is more a matter of “when”.

When securing life insurance, the first step is not to select which type of product to use, but rather, to determine how much death benefit is actually needed.  Once the death benefit is determined, then the next goal becomes figuring out which product best meets this need, given your individual circumstances.  

Think of it in these terms: if a new in-practice physician passes away prematurely and leaves behind a spouse and two young children, unfunded college savings accounts, and a large mortgage – the surviving spouse will care less whether it was a permanent life or term life policy.  The only concern at that point is whether there will be enough money to keep the kids in the same school, whether they can keep the house and whether they can avoid unneeded financial stress in an already overwhelmingly stressful situation.

Usually, the cheapest way to secure that protection early on is through term insurance. This is a temporary solution, however. Most (but not all) life insurance companies offer term insurance that is fully convertible; meaning that at any point within the duration of the term, without medical underwriting, you can convert all or a portion of the benefit to a permanent product designed to last as long as you live.

The idea behind this concept is to secure the less expensive coverage while you’re young, healthy, and on a limited budget – while leaving you options and flexibility down the road. This is a great strategy for physicians doing a residency, fellowship, or relatively new in practice.

Permanent insurance has a wide variety of different options (whole life, variable life, universal life, etc.) to meet any number of goals. Some people desire pure insurance protection to last forever; whether that be to leave money to a charity or future generations.  High net worth individuals often use permanent life insurance in estate planning to help pay death taxes.

New in-practice physicians may use permanent life insurance to pay off debts and provide income replacement to their young family, while also building cash value that can be used as a supplemental income stream in retirement. Others use it purely as an accumulation vehicle due to the preferential tax treatment it receives.

The old adage was to “buy term and invest the difference.”  For most people, this is very appropriate advice, however, for high-income earners, there are often not a lot of other alternatives where you can invest in a tax-advantaged basis beyond your employer-sponsored retirement plans and your personal IRAs.

As an example, say you are a physician earning $500k/year.  Typically, we recommend that our clients aim to save 20% of their gross income for long-term planning.  This is not to say that those who do not save 20% will never retire, but this typically puts someone on pace to retire before “normal” retirement age, while being able to maintain a similar standard of living to that of their peak earnings years. 

In this case, we’d always want to see the client take advantage of any retirement plans available through their employer.  As of 2018, with some exceptions, the most they can typically contribute is $18,500, which amounts to less than 4% of their income.  They could also look to contribute to a Roth IRA (via a non-deductible IRA conversion), but that is only another $5,500/year (note: please consult with a financial or tax planner before doing this). 

We are now at a little under 5% of their income saved…where do we go from here?  Well, they could contribute to a non-retirement account, but the growth in this account is subject to capital gains. They could also look to invest in real estate or a business, but that may be an illiquid asset and they may not have the time to manage their investment properly. Not to say that permanent life insurance doesn’t have flaws (it certainly does), but at this stage, it could be a nice component to a financial plan (not “the” plan, though). 

When using life insurance as an accumulation vehicle, you definitely want to be cautious. A lot of times, we see it recommended inappropriately and for those to whom it does makes sense, it is frequently structured incorrectly. Due to the sophistication of this financial product, you will want to make sure you are reading all the fine print and fully understanding the fees, commissions, surrender charges, etc. before you purchase it. When structured incorrectly, it can amount to one of the worst financial decisions you can make. When structured correctly, it can give your plan a lot of flexibility and can help control your tax burden in years when taxes are high.

As with most financial decisions, the debate between term life versus permanent life insurance is not black and white. It depends on your short and long term goals, income, assets, liabilities, time horizons, and many other factors. In addition, there is no such thing as one insurance company that will have the best coverage for every person on earth. It is best to consult with an independent advisor to see what makes the most sense in your situation.  Financial freedom doesn’t happen overnight – it takes time, consistent energy, and methodical effort. This is why financial planning for physicians is important.

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Author:Karl Rainer, CFP, ChFC

Financial Advisor & Branch Manager

Finity Group LLC

Registered Representative, Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Finity Group, LLC and Cambridge are not affiliated.