Insurance can be a very complicated topic, and life insurance especially so. Along with estate planning, life insurance is one of those areas of planning that a lot of people put off until “later”. But getting the right amount of life insurance for physicians is very important and can usually be accomplished quickly and relatively painlessly.
After you’ve protected your greatest asset by getting disability insurance, the next step in insurance coverage for a physician is to purchase the right life insurance policy. My hope is that after reading this article you’ll feel confident enough to choose a policy that fits your situation.
Key Points
- There are two main types of Life Insurance: Term and Permanent.
- Term Life Insurance is usually the best option. If you are considering buying permanent life insurance (or more likely it’s being sold to you) do your homework and make absolutely sure you understand why it’s a better fit for your situation than a term policy.
- Getting a term policy when you are younger and don’t yet have a family to help support can still be a smart financial decision. Life insurance gets more expensive as you get older, and you never know when a health issue that makes you uninsurable may occur.
Two categories of life insurance: Term & Permanent
There are two main categories of life insurance: Term and Permanent. A term policy lasts for a specified period of time (5, 20, 30 years, etc.), and a permanent policy lasts until the policy holder’s death as long as someone continues to pay the premiums on the policy.
Term policies tend to be much less expensive, because they have an end date and may not have to pay out a death benefit. In fact, according to some studies 98% of term policies are never used.
Permanent policies tend to be more expensive for a few reasons. They don’t expire like a term policy, so as long as someone continues to pay the premiums, they will have to pay out a death benefit someday. These policies can also include investment options and other complicated provisions and options that you can adjust later on.
For Physicians, a Term Life Insurance policy is almost always the best option
Before going any further, I want to say that there are probably some people for whom each of these types of policies is a fit, but many people are sold permanent life insurance policies (whole, universal, variable) when a term policy would be much better – and less expensive – for them.
The insurers tend to make more money from permanent policies, so the commissions (what the insurance salesperson earns when selling a policy) tend to be much, much larger for permanent policies than term policies. Since the salesperson is incentivized to sell permanent policies, more permanent policies are sold. This is another place where getting guidance from a fiduciary advisor, who is legally bound to look out for your best interest, can help you analyze your insurance needs and options and make sure you don’t end up paying more for insurance coverage you don’t need.
For a physician in their prime working years, life insurance is there to provide financial support for their spouse and/or children if they were to suddenly pass away. A term life insurance policy does this quite well.
Term Coverage Example
A 35-year-old can buy a 30-year term policy to help pay for their kids’ college education and provide for their spouse in the event they should pass away. By the age of 65, the need for this insurance coverage has passed and they should be fine letting the policy expire.
A permanent policy will be more expensive and by the time you reach 65 you will be in the same boat and shouldn’t need the policy any more. At that point you face the difficult decision of continuing to pay the premiums for coverage you don’t really need or letting the policy lapse and losing any future benefit.
A term policy is as simple as it gets in the life insurance space. Proponents of permanent policies will argue that you can use their policies to build cash value and invest as well, but these options are more complex and expensive. You are almost always better off buying a term policy and investing in your retirement accounts or a brokerage account.
Different Types of Life Insurance
Term Life Insurance: expires at the end of the term, set premium, set death benefit, easy to compare between providers, less complex
Term life insurance policies last for a set term (length of time). Typical term lengths are 10, 20, or 30 years. Term life policies are typically much cheaper than permanent life policies for this reason.
With a permanent plan the insurer knows that they will have to make a death benefit payment as long as the insured continues to make their premium payments. However, with a term policy once the term is up the insurer is off the hook for the death benefit.
A possible downside to term insurance – though rare – is that you might outlive your policy. If your need for insurance still exists after the term has expired you will likely have to pay more in premiums for an additional term.
Term insurance is by far the least complicated type of life insurance. There are only two components to decide on: the length of the term, and the value of the death benefit. Because of this it is much easier to compare between term plans from different insurers, and there are many places online where you can compare quotes for the same policies from different companies.
For almost all physicians, a term life insurance policy is the best option.
Whole Life Insurance: policy is permanent, premium is set, death benefit is set
Whole life insurance, sometimes called “ordinary life” insurance is a type of life insurance which is guaranteed to remain in force for as long as the premium payments are made until death or until maturity if a maturity date is part of the contract (typically maturity dates can be 10, 20 years or to age 65).
The premium for a whole life insurance policy is typically fixed (meaning the premiums will always be the same, also called a “level premium”) at the time the contract is purchased.
Upon the insured’s death and payout of the policy, the payout is typically paid tax free. When discussing permanent insurance policies, you will often hear the term “cash value”. As the premiums are paid in a whole insurance policy, part of the premium pays for the death benefit and a portion goes into the cash value of the policy and builds over the whole life of the policy. In some cases, a policy can be cashed out prior to the insured’s death (policies differ, but usually the premiums paid must be more than the value of the life insurance), in this case the dollar amount paid over the value of the insurance will be taxed as ordinary income.
Universal Life Insurance: policy is permanent, builds cash value you can use to offset premiums, option to adjust death benefit
Universal life is similar to whole life in that it provides a death benefit and remains in force as long as the premium payments are made. A main difference is that later on in the policy you can use a portion of the cash value of the policy to pay your premiums, lowering your out of pocket costs for the policy. The interest rate is typically tied to a market rate, so as rates change your ability to tap into the cash value to adjust your premium fluctuates as well.
Within most universal life policies there are also options to adjust the death benefit. Raising the death benefit amount will probably require additional underwriting, while lowering it will probably not. In either way you can expect to pay some additional fees to make the change to the policy. The ability to tap into the cash value and adjust the policy are benefits of a universal life policy, but the added complexity comes with an added cost versus a whole life policy.
Variable Life Insurance; policy is permanent, option to invest cash value in mutual funds, option to adjust death benefit (VUL)
A variable life insurance policy, is similar to a universal life policy, but whereas with a universal policy the cash value grows within a savings account in the policy, with a variable life policy you can invest your cash value in mutual funds. But, rather than in a brokerage account where you have access to all manner of investment options, with a VUL you only have access to the fund options available with that insurer.
With a variable life policy, the death benefit is typically fixed, as it is with a whole life policy. You can also find a sub version, a variable universal life (or VUL) policy which possesses the investment options of a variable policy along with the policy flexibility traits of a universal policy. As I stated above, along with the additional options and flexibility involved in a variable or VUL policy comes additional expense and complexity.
Other Life Insurance Offerings
The four types of insurance listed above are the main types of life insurance offered, but by no means are they the only kinds available.
Declining benefit insurance: Where the value of the death benefit declines over the term of the policy. These are usually designed to match the mortgage amortization schedule on a home, so that if the insured dies prematurely the death benefit from the insurance policy will pay off any remaining mortgage balance.
Joint life insurance policies: Where two people are covered with the same insurance. These can be designed to pay out when the first person dies or after the second person dies, depending on the underlying reason for the insurance.
Final Expense Insurance: Often called burial insurance, is a policy designed for older individuals who want to make sure their final expenses are covered and their family do not have shoulder the costs after they pass.
Wrap Up
When evaluating insurance, you should ask yourself the question “what am I insuring against?” and keep this Einstein quote in mind.
“Everything should be made as simple as possible and no simpler”
For most physicians the simplest answer is a term policy that protects their family during their prime working years. If your situation requires something different or you were too intimidated to look into life insurance before, you now have a bit more information to help you with your search.