Last week’s email discussed when to buy life insurance. Since most people do not object to owning life insurance, only to paying for it, this week’s topic is about how to pay for life insurance. The two primary ways to pay for life insurance is with after-tax income and via capital transfers.
The most common way people pay their life insurance premiums is with after-tax cash flow. After the life insurance program is designed, then the premium is shoe-horned into the budget, and therein lies a major stumbling block; the budget is often already stretched to the breaking point.
There are several techniques available to fit the premium in the budget. The first is paring any unnecessary expenses, or at least those that are less important than life insurance, e.g., cable bill. Secondly, if a large income tax refund is usually received, payroll withholding can be adjusted to increase cash flow.
If a savings plan is already in effect, perhaps a portion could be earmarked for the life insurance premium. Additionally, a portion of any raises/bonuses could be allocated to the insurance program.
However, another method to pay premiums is via capital transfers. For example, if the annual premium is $5,000 and at least that much is in a liquid savings account, that money could be used to pay the premium. Since the insurance company will add an interest charge to any premium not paid on an annual basis, it makes sense to pay the premium in this manner when available, even if cash flow permits it to be paid on a monthly basis.
In our example above, a policy with a $5,000 annual premium would require a monthly premium of $435. As a result, $5,220 would have been paid instead of $5,000. So there are two options. One, re-pay the savings account $435/month and have $5,220 available to pay next year’s premium, resulting in a $220 “gain” or two, pay $416.67/month and have the exact amount available for next year’s premium.
The capital transfer method is used most often when the policy has a very large annual premium. Premiums of mid- five figures and above are not usually paid out of cash flow. Someone with the financial wherewithal to pay those premiums usually has the liquidity to make that type of transfer.
In fact, it is often that very liquidity that precipitates the life insurance sale. Of course it depends on age and health (and to a small degree, gender), but a large liquid account can be leveraged into twice the amount or more by allocating the earnings to a life insurance policy.
So since most people only have a problem paying for life insurance, not in owning it, the key is to find a method that makes paying the premium as painless as possible.