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Dear Michael: We have a farming operation with a lot of debt. We have been buying term insurance to cover our debt, but also in hopes of eventually providing an equitable settlement for our non-farming children. However, we have noticed some of our earlier term insurance has been renewed and the premium is outrageous. What should we be doing in the future? – Termed Out
This example is not exclusive to the farming community but to any family that owns a business or has a large estate. Read on
Dear Termed Out: Term insurance is, as the name implies, coverage for a certain term. Normally, these would be 10-, 15-, 20- or 30-year term policies.
Just like you pay a premium on your building, machinery, or car insurance for six months or a year, if you don’t have a claim in that year, the money you spent is gone.
Or it’s like leasing a car versus buying a car. Lease rates are more affordable than buying – unless you put more miles on the car than what you agreed to. Then the costs can get much higher. The problem is when you come to lease the same car three years later, this car has risen in price since then by $15 thousand. Now your lease amount will be higher.
In the term insurance world, the cheaper the term insurance – or the shorter the period – the less chance your beneficiaries have of collecting. Sure, people die of accidents or come down with fatal diseases while having term insurance. The insurance company has accounted for this. Ten-year term insurance has less than a half of one percent chance of your heirs collecting. But it is cheap and for some reason, farmers hate life insurance, so they pick the cheapest cost.
This leads to 10 or 15 years later when your “lease” is up and now a new policy is much higher than what it was initially.
Insurance companies use two metrics to determine the cost of life insurance. For a man, it is “will the term length you choose to cover the age of 78 to 80?”
If so, then you will pay a much higher premium because men die – on average – right around age 78. Conversely, if you buy term insurance that runs out before age 75, your costs will be about half.
The same is true for women although their age is 84. Any term insurance you buy that comes up short of these ages is quite cheap – for a reason. There are seldom claims. But, like your car insurance, building insurance, farm insurance you feel better knowing that you are covered.
Oddly enough, I find farmers spend a lot more money on their building and machinery insurance than they do on their life insurance. I guess they value those things more than their own economic impact.
In estate planning, life insurance is counted as an asset but only if it’s a permanent – not term – insurance policy. Why? The chance of term insurance being a part of your estate is less than five percent. Term insurance is great for young parents with big mortgages, lost lifetime incomes – the economic impact of a life cut too short. But term insurance is cheap for a reason. Most things in life that are cheap usually are cheap for a reason.
But if you are setting up assets to go to your non-farming children, know that your children will have less than a five percent chance of ever collecting on term insurance.
When should people consider buying permanent life insurance? When they know they have a lifetime goal of providing assets to their children.
They should do this before 55 because between 55 and 60 your body changes. Suddenly you must take high blood pressure medication. Why? Because your arteries are not as elastic as they used to be, and you need thinner blood. Or you must start taking cholesterol medication. Why? Because you do not work off the cholesterol in food as you did when you were younger.
In estate planning, there is no less expensive option than using permanent insurance to provide assets to your children. Over your lifetime, you will spend 25 to 30 cents on the dollar to provide tax-free benefits. It just doesn’t get any cheaper than that no matter what option you look at!
If I had $2 million in my 401K, I’d take a lifetime withdrawal of $80,000 per year, pay $20,000 for $1 million of coverage and have a heck of a fun life with all the rest.
The kids are covered – let’s go spend the rest!
