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Terracotta Army of Life Insurance

June 21, 2010

You don't need an army to take care of you after you die, just a little life insurance.

            When the first emperor of Qin, Qin Shi Huang, was 13, he started preparing for life after his death. In 246 B.C., he started a project that would use around 700,000 workers to build his Terracotta Army. It is believed there are no two statues alike among the 8,000 soldiers, 130 chariots, 520 horses, and 150 cavalry horses that have been found. There also were ancient writings that said Qin Shi Huang’s tomb also contains palaces, scenic towers, and valuable utensils. This major construction was undertaken to help the emperor rule in the afterlife.

            Today our approach to preparing financially for after our death has taken a different approach. We realize the money and possessions we gain on this earth will stay here after our death, so financially our preparation for the end of our life deals more with taking care of those we leave behind.

            The major way we try to provide for this is through life insurance. The only problem is there are a wide variety of options for types of insurance to purchase and how much life insurance is needed. There are different guidelines saying you should buy a set percentage of your income in life insurance, or you should have x times the amount you earn in life insurance.  No one system is the best, but there are a few key things to examine.

            The first question to answer is if you even need life insurance. Life insurance is designed to take care of those who depend on you financially. When you are young and do not have a family, there probably isn’t any need for life insurance. If you die, it would be good to have enough assets to take care of your final arrangements, but after that, there is no real set need that should be met.

            If you have people who depend on you or your income, you probably need life insurance. This brings about the next question, should you purchase term or a cash policy (the two major types of cash policies are whole life and universal life)? Term insurance provides you life insurance for a set amount of time, such as 10 or 20 years. If you die within that period, you collect the insurance; if you do not, you lose the premium dollars you paid.

The cash value policies have a component that pays for the life insurance, but then also has a savings component. You can set up your life insurance policy to build savings that continue to accumulate as long as you have the policy. Individuals usually keep this insurance their whole life and their beneficiaries collect the insurance when they pass away as long as you keep current on your premiums.

Based on the first look, it would seem it would be better to buy a cash policy, but it is important to look at the premiums. Term life premiums are usually significantly cheaper than cash life policies. For example, when I was 23, I purchased my first universal life insurance policy.  The agent signed me up for $100,000 of coverage with a premium of $70 a month.  I could have gotten by paying $35 a month for $100,000 of coverage, but I kind of liked the idea of building up cash value in my policy. After 10 years, I’ll have about $7,000 built up in cash value savings of my policy after paying approximately $8,400 in premiums.

After looking at current term rates, I could have purchased $100,000 in term insurance for around $12 a month. Then, I could have taken the other $58 a month and even if I invested it in a simple savings account, I would have just a little more money than in my current policy. If I would have taken the extra $58 and invested it in a mutual fund, that could have averaged 10 percent like the entire market has done since the 1920s, the amount saved up would be right around $12,000.

In another 10 years, I’ll have around $15,000-$16,000 if I keep my current universal life, but if I would have stuck with the term insurance and invested the rest and the market could average 10 percent, I would have around $44,000 saved up. Now, this is a simple example and the market has had one of its worst 10-year periods over the past 10 years, but I would still be about even with where I am now. If I could continue investing the same $58 a month and get a 10 percent annual return after 30 years, I would have $131,000 saved up and even though I would not have the $100,000 in life insurance coverage because my term ran out, I would have more saved up that could continue to grow. For example, after 40 years, it would be up to $366,800. (This example also shows the power of compounding your money over time).

If you have the discipline, buying term and investing the rest can be the best route to go. Eventually you will lose your insurance coverage, but if you stay committed to your long-term investments, you will eventually have a much larger sum to pass along to your beneficiaries after you die.

You may not build an entire Terracotta Army, but should leave enough to help change your family tree. Next week, I will examine how much insurance is enough.

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