This is the third part in a series of five posts that will last through this week. This series will teach you the fundamentals of financial planning, through a fake conversation, I, as a financial planner, have with my client, (and childhood hero) Rocky Balboa.
The goal of each post, is for you to learn a different aspect of financial planning. Each part of the series, will take you through a different stage of Rocky’s life. Luckily, there were five Rocky movies made (I blanked Tommy Gunn from my memory), so each stage will correspond with each movie.
I hope you enjoy reading it, as much as I have enjoyed writing it.
Background: Rocky is now 32 years old and heavyweight champion of the world. He has a wife and a healthy young son. For the first time in his life, he has a steady source of income from fighting and endorsements. However, I, as his financial planner, still see a few holes in his financial plan.
RJ: Hello Rocky. How are you?
Rocky: Well, things are great. You know? Being heavyweight champion of the world, is pretty nice, you know?
RJ: I couldn’t even begin to imagine. Well let me get right to it, the reason I brought you in here today, was to talk about life insurance. Rocky, are you familiar with the concept of life insurance?
Rocky: Well, sort of…If I die, Adrian gets money to take care of herself and our kid.
RJ: Great, you seem to get it. What else do you know about life insurance? Are you familiar with the definitions of term or whole life insurance?
Rocky: No. That’s your job, you know?
RJ: Haha. I see your point but let me explain the difference between the two because it’s very important you understand all your options. A term life insurance policy, only covers you for a limited amount of time, that’s where the name term comes from. Understand?
Rocky: Got it. I know what a dictionary is now.
RJ: The premium, or the annual cost of a term policy, is also for a fixed period of time. For example lets look at what would happen if you buy a $1,000,000 term-life insurance policy, that is valid for 20 years. First, term life insurance policies, come with an annual premium. Therefore, in order for the coverage to continue, you need to pay this amount each year. Second, at the end of 20 years, you’re no longer guaranteed that same $2,000 premium. The insurance company, has the right to change it, which they will.
Rocky: OK. I think I go it.
RJ: The biggest advantage of a term-life policy, is that it’s cheap. You pay very little and get a lot of coverage. The biggest disadvantage is that term life policies offer no guarantee of covering you for the rest of your life.
Rocky: Oh OK. What’s my other option than?
RJ: The other option you have is whole life insurance. This coverage actually covers you up until you reach the age of 100. So if you pay the premium every year, you’re guaranteed coverage.
Rocky: This sounds like the better deal.
RJ: Well, it depends. The thing about whole life insurance, is that it’s expensive. Say we quote you a $1,000,000, from my experience, that could cost you around $10,000 a year.
Rocky: Wow. That’s a lot of money. You know?
RJ: Well, again it depends. Not all of your yearly premium on a whole-life insurance policy is a waste. Some of it, goes towards the cash-value of the policy.
Rocky: Cash value?
RJ: In a whole life insurance policy, the cash value is sort of like a forced investment plan. The nice thing about that expensive $10,000 premium on a whole life insurance policy, is that it’s part of it is invested.
Rocky: Is that money mine?
RJ: Yes. That money is yours. However, it’s not like it’s sitting in a savings account. If you want to withdraw that money, you have to pay surrender charges. Typically, the earlier in the policy you want to withdraw the money, the bigger the surrender charge.
Rocky: I think I got it. Although, all I really want to know is, what policy do I need?
RJ: There is no right or wrong answer, here. For most people, I would advise to buy the term-life insurance policy and invest the difference. For example, say we get a quote for both a term-life policy and a whole life policy. The term life costs you $2,000 and the whole life policy costs you $10,000. A difference of $8,000. Therefore, you would have an additional $8,000 to invest each year.
Rocky: I see.
RJ: But Rocky, you’re not most people. You’re the heavyweight champion of the world. You, as well as I know, that boxers tend to have shorter than average life spans.
Rocky: I try not to think about that.
RJ: I understand. Here’s what we really need to do. We need to go out and see the quotes for ourselves. Once we have the numbers in for what both a short-term and a long-term policy costs, we can make a better estimate of what we need to do.
Rocky: Yea…Sounds good. How do we do that?
RJ: Well, I suggest you sitting down with a local expert in life insurance. Talk about your situation with this person and mention to them that you’re working with a financial planner, to see what policy works best. I have a list here of a few different CLUs, which stand for Certified Life Underwriter, in the area. I want you to sit down with at least two of these people. See which agent you like the best.
Rocky: Got it.
RJ: Come back to me, when you have a final quote for both a term and whole life policy. For the term policy, find out the difference in cost between a 10,20, and 30 year policy. Once we know that, we can decide where to go next.
Rocky: Sure thing.
Read the rest of the series:
Photo by: Mark Hillary