By Joe Dyton, WCI Contributor
If there’s someone in your life that depends on your income, you owe it to them to buy a life insurance policy. Life insurance protects your loved ones, whether it's your spouse or children, in the event of your death. It’s meant to shield your family from the financial consequences of your death as much as possible.
There will be a number of decisions you’ll have to make when you buy a life insurance policy—how long a term, how much coverage, who are the beneficiaries, and what type of policy. Keep reading to learn more about the indexed life insurance option and whether white coat investors should consider those types of policies.
What Is Indexed Life Insurance?
Indexed life insurance is a type of permanent life insurance. The policy has a cash value component along with the determined death benefit. The funds in an indexed life insurance policy’s cash value account can earn interest based on the stock index market that your insurer chooses. While there’s no fixed interest rate, the policy usually has an interest rate guarantee.
How Does Indexed Life Insurance Work?
When you pay your life insurance premium, part of that payment goes toward the cost of insurance and fees. The remainder is added to your account’s cash value. The cash value’s total amount is credited with interest based on any equity index increases. It is not directly invested in the stock market, however.
You might get to pick from multiple indexes, depending on your life insurance policy. You typically also have the option to decide what percentage is allocated to fixed and indexed accounts. Your selected index’s value is recorded at the start of the month and compared with the value at the end of it. If the index goes up during the month, interest is added to the cash value. Index gains are credited to your policy every month or annually.
Any gains from the index are credited to your policy at a percentage rate. Your insurer sets this rate, which can range from 25%-100%.
Who Is Indexed Life Insurance Best Suited For?
The answer of “nobody” is probably a little too harsh, but it is pretty close to the truth. The way most agents sell indexed life insurance (aka Index Universal Life insurance or IUL) is by promising that you will get a lot of the upside of investing in the market without any of the downside. The truth is that you probably give up too much of the upside in order to protect against loss. Plus, it comes with all of the usual downsides of a permanent life insurance policy:
- Very expensive insurance
- Insurance that covers periods of your life when you don't have a need for insurance
- Low returns
- High commissions
- A long period of time before you break even on the investment aspect
IUL is also one of the most complex types of permanent life insurance, a factor that does not work in your favor. Indexed life insurance policies are products designed to be sold, not bought. That makes for a compelling reason for physicians not to purchase them (since they're more likely to be beneficial to those who sell them and NOT those who buy them).
Should Physicians Buy Indexed Life Insurance?
Probably not. We are big fans of life insurance here at The White Coat Investor, but we are not big fans of permanent life insurance policies—like whole life insurance, variable life insurance, and types of universal life insurance such as indexed life insurance.
Physicians should consider term-life insurance policies instead. As the name implies, term-life insurance policies cover a set period of time—or a term. There’s also no cash component involved with a term-life policy, which makes it less expensive. The downside of a term-life insurance policy is if you outlive the policy term you selected, you don’t receive a benefit, so make sure the term covers the entire period until you become financially independent. By then, your savings and investments should be plentiful enough to care for your spouse or other family members in the event of your death. Meanwhile, your life circumstances can dictate how long your term-life insurance policy should be. If you’re single with children who will eventually be financially independent of you, you only need to carry life insurance until that time. Then, you don’t need to carry life insurance anymore.
On the other hand, if you have a dependent partner, you should have a good idea of when you will be financially independent and carry term life insurance until then.
How Physicians Can Purchase Life Insurance
Physicians should aim to purchase the least expensive life insurance policy they can get. This is a relatively easy process if you’re healthy. Go online and gather quotes from dozens of insurance companies without requiring any personal information. Take those quotes to an independent agent and ask them to sell you the least expensive policy for the face amount and term (if you opt for term-life insurance) you selected.
If you’re unhealthy or partake in dangerous activities, the process is a little more difficult. An independent agent will informally “shop you around” to different companies to see which ones will give you the best price. Leniency on various conditions will vary. It will likely take longer to get a life insurance policy, and it will be more expensive.
How Much Life Insurance Do Physicians Need?
To gauge how much life insurance you need, particularly the term-life kind, determine how much income your loved ones would need in the future if you died today. Take your monthly expenses and multiply them by 12 (months) and multiply that figure by 25 (years). That should provide enough for your family to live off of for the rest of their lives, based on retirement withdrawal studies that show you can take out approximately 4% of your nest egg annually in retirement and live off of it for decades.
Next, review your mortgage statement and add on the amount you still owe. If you’re renting, look at how much the house you’d like your loved ones to live in would cost to buy with cash. Use that amount instead.
Another consideration is how much you’d like to have for your children’s education. Plan on $50,000-$300,000 per child if you want to cover their entire college education. That’s a wide range, but education costs can vary.
Other considerations include big-ticket items such as:
- Your spouse’s student loans
- Mortgage on a second home
- Other outstanding personal debts
Add these financial obligations together and subtract your current nest egg and college savings from it. Round up to the nearest $1 million, and that’s how much life insurance you should buy.
Here's one example that provides more context.
Say, you spend around $5,000 per month, have a mortgage balance of $250,000, want to save $300,000 for your kids’ college expenses, and have $175,000 left on your student loans. You have $25,000 in retirement accounts and $3,000 saved so far in the college fund.
The estimated life insurance here would be:
=($5,000 x 12 x 25) + $250,000 + $300,000 + $175,000 – $25,000 – $3,000
=$1,500,000 + 725,000 – $28,000
=$2,197,000
Rounding up, you would want $3 million in coverage.
Pros and Cons of Indexed Life Insurance
If you still think you might prefer an indexed life insurance policy, here are some advantages and disadvantages to keep in mind:
Pros of Indexed Life Insurance
- Flexibility: As a universal life policy, there is great flexibility in premiums and death benefit amounts.
- Permanent death benefit: The benefit is permanent and not subject to income or death taxes
- Lower risk than stocks: Indexed life insurance policies aren’t invested directly to the stock market, which keeps risk down
- Cash value accumulation: Funds credited to the policyholder’s cash value increase tax-deferred and can be used to pay the premiums
Cons of Indexed Life Insurance
- High cost: Permanent policies cost dramatically more than term life policies.
- Accumulation percentage caps: Insurers sometimes limit the maximum participation rate (so, even if the stock market has a really great year, such as the 30% index return in 2013, your return might be “capped” at some lower figure, often in the 10%-15% range).
- Policy fees: These can be particularly onerous with small policies, eating up a large percentage of cash value.
- Fewer guarantees: Because returns are partially dependent on the performance of a stock index, interest is not credited to the cash value if the index goes down. Unlike a whole life policy, there is no guaranteed increase in cash value.
- More expensive insurance late in life: Universal life insurance policies are notorious for crashing when the insured gets into their 80s and 90s. Guaranteed universal life or whole life generally provides a better option for those who want a lifelong death benefit.
Where to Buy Index Life Insurance
There’s no shortage of agents willing to sell you an indexed life insurance policy. However, none of them show up on our WCI list of recommended insurance agents. Since most white coat investors neither need nor want indexed life policies, these agents typically sell term-life and disability policies. If you're really sure you actually want an IUL, be sure to shop with multiple agents to find the best possible deal.
Have more questions about life insurance and what kind of policies would be the best for you? Hire a WCI-vetted professional to help you sort it out.
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