Businessman Dave Ramsey is one of the leading voices in the financial and business sector. As an author and radio show host, Ramsey’s goal is to educate viewers on paying down debt and making choices that will provide you with financial freedom.
Ramsey also talks a lot about making smart life insurance decisions that will help people gain security and grow their money while they do so. We’ll go over common types of life insurance and why Ramsey recommends them.
Whole Life Insurance
Whole life insurance is a permanent life insurance. It’s a common policy that covers someone for their entire life.
Today, many people are opting for whole life insurance policies as a combination of an insurance policy that pays a death benefit while also being an investment account. Your monthly premium goes toward the death benefit as well as cash value that the account grows.
This may sound like a great policy, but it’s not recommended. This is because whole life policies are doing two things at once: growing cash value while also providing a death benefit. You often get less insurance for a more expensive price.
Instead, Dave Ramsey recommends taking a term life plan for less money and investing the extra money you would’ve dumped into a whole life plan into a solid mutual fund instead. This will provide the death benefit you need, and grow your money more effectively.
Term Life Insurance
While whole life insurance products guarantee a death benefit when the policyholder passes, Ramsey suggests shying away from those products. Instead, he recommends opting for a term life insurance policy for a number of reasons.
First, these plans are generally lower in cost than whole life plans. Simply put, this is because term plans have a shorter coverage period than whole life plans. Typical terms can be for 10, 20 or 30 years.
Ultimately, a term plan accomplishes the main thing that life insurance is meant to do–it replaces income for your loved ones when you are no longer here. In other words, it’s a proactive way that you can take care of your loved ones today so they don’t carry a significant financial burden when you’re not here.
How Term Plans Work
Term life insurance plans cover the policyholder for a set number of years, known as the term. The most common terms are 10 years, 15 years, 20 years and 30 years. How long of a plan you should take depends on how old you are at the time you get the policy and how long you believe you would need to cover your loved ones in case you pass away earlier than expected.
If the policyholder passes away during the term of the life insurance plan, the policy will pay what’s known as a death benefit. This benefit is equal to the total amount of the policy, as determined when the policy was initiated.
For example, if you take a 20-year term life policy for $400,000 and you pass away within 20 years of the start of the policy, your beneficiaries will receive a check of $400,000 from the life insurance company. If you don’t pass away in that time period, the policy simply ends with no death benefit paid.
In return for this coverage, you will pay a premium that is most likely paid on a monthly basis. How much your premium is depends on a number of factors, including the length of the term, the total amount of the policy as well as your demographics.
The demographics taken into consideration include age, gender, current health conditions, lifestyle choices, life expectancy and medical history. Most term life plans will require a full medical exam be completed, though some newer plans allow you to skip the medical exam for a streamlined plan.
Why Term Life Plans?
Life insurance plans provide financial security and peace of mind to beneficiaries as well as policyholders. While there are a plethora of savings plans available to take care of loved ones, there aren’t many that would provide a bigger return on investment than a life insurance plan.
Of course, not all term life insurance plans result in an actual return on that investment. As discussed above, if the policyholder doesn’t pass away within the term, no death benefit is paid. However, most policyholders and their beneficiaries would consider that a good thing, since the policyholder is still alive.
Ramsey shies away from suggesting people get whole life insurance plans because he believes they are often much more expensive than their worth. He generally suggests people who are considering whole life plans invest their money in other more liquid accounts that can be left to loved ones.
Life insurance serves as a buffer and shield against financial ruin should a policyholder pass away earlier than expected.
How Much Coverage Should You Get?
Ramsey recommends getting a term life policy that covers between 10 times to 12 times your annual income, on a pre-tax basis. So, for example, if your annual pretax income is $40,000 per year, then you’ll want a term life policy valued anywhere between $400,000 and $480,000.
He recommends this much coverage for one basic reason. The surviving spouse in this hypothetical case could invest the death benefit from this term life insurance plan into a solid mutual fund that provided a return of 10% to 12%. Based on that scenario, the surviving spouse could take $40,000 per year from the investment to replace the lost income, and never have to cut into the original amount of the investment.
This would be a great way for the surviving spouse to get the same annual pretax income, plus have a nice nest egg for retirement or other big events in life.
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