Life insurance has become this excruciatingly difficult topic for most people. It’s not fun to think about, it’s not fun to talk about. And, it’s not fun to buy. It’s a financial product that you purchase that provides a lump sum of money to your family (or to anyone you wish) if you die while the policy is in force (meaning, all the premiums due are paid). Think of it as a savings that you don’t have in your bank account, but are paying for on a monthly basis that is guaranteed to be there if your family needs it. It’s sort of an “emergency” savings. The emergency being your death. Not a pleasant thought.
For some life insurance contracts, the insurance company builds an equity (cash) reserve against that death benefit, reducing the risk to the insurance company and giving you the value of that death benefit in cash over the life of the contract. These are considered “permanent life insurance” contracts. Until you decide to take the money, it just sits there on account with the insurance company. Other life insurance contracts, called term insurance policies, provide just the death benefit, and no access to any of the money you’re putting towards the policy.
OK, so far so good. With any luck, you understand what I just wrote. If you’ve “been around the block before”, you’ve probably also heard some of what I just wrote.
Now for the stuff you probably haven’t heard before. Because the next question that arises is:
OK, so what kind of life insurance should I buy?
This question is always funny to me because it’s like asking “what should I buy for transportation-a bicycle or a car?” If we assume that term insurance is more like a bike and permanent insurance is more like a car, I’m sure you’ll see how the answer to this question really depends on what you need or want the life insurance for. Most everyone living today needs a car if they plan on doing any kind of long distance driving. But, some people, who never plan on ever doing any long distance driving, never buy a car. And, they don’t need one.
The “bicycle approach” to buying life insurance is simple and cheap, but limited in what it can do. It will get you from point “A” to point “B” as long as point “B” isn’t too far away from point “A.”
The “car approach” to buying life insurance requires an initially higher cash outlay and is a little more complex in what you need to look for. But, if it’s a well designed policy, it’ll take you to from “A” to “B” and even all the way to “Z.” Unlike a car, though, you’ll always get back more than what you put into it if you hold the contract to maturity.
Common Misconceptions
If you’re out and about on the Internet, you might have noticed that there are just a few articles about life insurance…and a few more on what kind of insurance you should be buying. Don’t worry, I’ve noticed it too.
However, I’ve also noticed a few misleading statements that keep cropping in these articles, so I thought I’d spend some time clearing up some of the confusion. Most of the misinformation in the industry centers around permanent life insurance, so I think I’ll end up focusing mostly on that aspect of things in this article. OK, so here we go…
Misleading statement #1:
Cash value life insurance is one of the worst financial products available, and it is definitely the worst type of insurance you can buy to insure your life. The BEST kind of insurance is term insurance because it’s cheap and I’m not paying all those extra fees to the evil and greedy insurance company. Besides, don’t insurance companies have a record of being reckless, cheating their policyholders, and systematically going out of business.
Fact: Oh boy. Let’s be very careful when we use terms like “the best”. There is no way to answer this question rationally when it’s posed like that. The best always implies “for whom, and for what purpose?”.
For example, term insurance can be the best type of insurance if you think you only need a policy for 20 years to cover your mortgage and all you are considering is the cost of pure insurance. You’re only paying for the pure insurance coverage, which translates into those dirt cheap premiums you see advertised on T.V. and plastered all over the web.
A term policy is also great when you just can’t afford very much in the way of premiums, but still want to insure your financial responsibilities right now. While annual renewable term carries the lowest out of pocket premiums, at least initially, those premiums rise higher than all other policy structures. A level term policy inflates the cost of insurance, similar to a permanent policy, but by doing this up front, it holds down the cost of insurance in the later years of the term policy which effectively levels out the premiums for a specified period (the term of the policy). The cost of the death benefit still rises, but the premium stays the same for the duration of the term.
Statistically speaking, term insurance doesn’t pay out very well. The industry estimates that less than one percent of all term insurance policies ever pay a claim. Insurance agents sell a lot of term insurance by “selling the fear.” You could die tomorrow, and then what? That’s the summary of a life insurance sale’s pitch. It’s the idea that you have uncovered financial liabilities and unprotected moral responsibilities (i.e. children) that you need to insure right now in the event that you die unexpectedly.
That’s exactly how life insurance agents sell a lot of life insurance policies to customers. Get them thinking that they could wrap their car around a telephone pole on the way to work. Nice huh?
The reality is, insurance companies aren’t stupid. If premature death was that prevalent, there wouldn’t be a life insurance industry. Insurance uses something called the Law of Large Numbers. Basically this is how it works: the larger the group of people you are insuring, the more certain you can be about the number of losses you will sustain.
For example, if we were to start an insurance company and we only had one customer, we would be taking on an incredible risk because of the nature of life insurance. If that one person dies, we could be out of business very quickly (imagine that one customer giving you $20 for a $250,000 death benefit and then dying the very next day). If, however, we have a million customers, then we can better control the risks we are taking by insuring other people’s lives. No one can predict when an individual will die, but if we study a large enough group of people, we can make surprisingly accurate predictions about the number of individuals within that group that will die in any given year.
To further illustrate this principle, consider this: A 40 year old male who is a non-smoker may live to be 100 years old. But he may also be hit by a drunk driver tomorrow – it is impossible to know exactly how his life will play out. However, if we sample 100,000 40 year old non-smokers, we can study how many of them will die due to car accidents, how many will die of “natural causes”, and so on. We may develop a statistic that tells us that every year roughly 300 40 year old non smokers will die. We won’t know before hand exactly who those 300 people will be (obviously), but we can make a very accurate prediction that 300 people will die. We can, in turn, use this information to create and price life insurance policies accordingly.
It is no accident that term insurance is the cheapest form of life insurance. Remember there is no such thing as a free lunch. The reason premiums are so low is going to be for one of two reasons: the insurance company expects you to lapse your policy before they have to pay a claim, or, you simply outlive the term of the policy and they raise the premiums high enough to the point where you can no longer afford to pay for the coverage.
Now, that’s not to say that term is a ripoff. It isn’t. You are paying for coverage and you’re getting it. The insurance company is taking a very low risk, and collecting a lot of money from people buying term insurance without the fear of ever having to pay out very many death claims.
In response to the argument that “insurance companies have a record of being reckless, cheating their policyholders, and systematically going out of business”, this is simply a case of mistaken identity. In his book Money, Bank Credit, & Economic Cycles, economist Jesús Huerta de Soto writes that:
The institution of life insurance has gradually and spontaneously taken shape in the market over the last two hundred years. It is based on a series of technical, actuarial, financial and juridical principles of business behavior which have enabled it to perform its mission perfectly and survive economic crises and recessions which other institutions, especially banking, have been unable to overcome. Therefore the high “financial death rate” of banks, which systematically suspend payments and fail without the support of the central bank, has historically contrasted with the health and technical solvency of life insurance companies. (In the last two hundred years, a negligible number of life insurance companies have disappeared due to financial difficulties.)
During one of the most turbulent financial times in our nation’s history – the Great Depression – it was the insurance contract which provided the most stable financial shelter, not the demand deposit accounts (checking and savings accounts) offered by banks. While many banks failed and never reopened their doors, while the stock market crumbled, and many people lost their entire life’s savings, insurance companies were one of the only institutions to survive intact and almost virtually unscathed. This scenario continues to repeat itself during every period of recession or depression in this country.
Even when giants like AIG are supposed to be reeling (but their life and annuity business has not lost any money), the industry as a whole is hunkering down and can (and probably will) weather yet another financial storm.
Insurance companies don’t cheat their policy holders. On the contrary. Because of their more conservative approach to investing and money management, insurance companies can shelter their policyholders from market risk (excluding variable life insurance), are able to avoid calamity, and as a result come out on top when compared to other financial institutions. With a cash value insurance policy, they can actually protect the bulk of their policyholder’s savings from unnecessary exposure to market and bank volatility. With a term insurance policy, the company’s reserve account is kept in tact to pay any claims that need to be paid.
While it is possible, corporate theft in the life insurance business is rare. More often than not, what is often thought of as being “ripped off” is really just “concealment” on the part of the insured. A warranty in the insurance business is a statement made by someone who is applying for life insurance. The warranty refers to a statement made by the applicant. The insurance company is supposed to be able to trust that the applicant is telling the truth-this is the warranty. If the applicant lies about a material fact (a fact that has a bearing on whether insurance would be issued or how an insurance contract would be issued by an insurer), then the insurance company can revoke the contract or alter its terms.
To the unknowing public, this can easily be made to look like an insurance company scamming a poor helpless individual, when in fact, it was the individual that was lying to obtain insurance coverage that he or she may not have gotten otherwise.
Misleading statement #2:
Cash value life insurance is overpriced for what you get. Also, you can never tell how much money you are spending on death benefit and how much money is actually going into the cash value of the policy. With term insurance, the costs are clear.
Fact: “Overpriced” is a very generic term. Overpriced compared to what? When you hear words like “overpriced for what you get” or just “overpriced”, always ask “compared to what?” People who buy life insurance are primarily looking for one of two things (sometimes both)
1) a death benefit and/or
2) a secure savings
With this in mind, compare life insurance contracts. Don’t compare life insurance to other investments. The reason is simple. When you look at financial products, you want to be comparing the product with its peers, not other products that are outside of its investment function or experience.
For example, when you buy a share of Microsoft, you don’t compare it with a real estate investment trust to see if the Microsoft share is a good buy. You compare the Microsoft stock to other software and tech companies (this is actually an aspect of a well known and accepted investment philosophy called fundamental analysis). So, when financial planners suggest that you compare whole life insurance to a stock mutual fund, they are either evading, misleading, or showing you their ignorance of how to value a financial product.
With stocks, it’s meaningless to compare a tech company to an oil and gas company because those two industries have very different growth potential. Their price to earnings ratios, and in fact how the businesses make money, are vastly different from one another. Ignoring this basic principle is actually very dangerous, as it could lead you into making very poor investment decisions. You don’t do it with stocks, and you don’t do it when comparing other financial instruments–life insurance included.
When you buy a life insurance policy, compare it to other policies. There are many different kinds of contracts on the market. Some are built and priced well, some aren’t. It is possible to buy a poorly designed whole life, universal life, or variable life policy. But it’s also very possible to buy a policy that will return 10 times its annual premium in interest or dividend payments every year.
As to the costs of the contract: There are two ways insurance companies calculate the mortality costs for a policy: guaranteed and current charges. The guaranteed mortality charges, which is what constitutes the cost of the death benefit, are the same for all guaranteed life insurance products. This means that the cost of insurance for term, variable life and whole life are all the same. Any person who tells you otherwise is either lying or ignorant.
All life insurance policies use what’s called the Commissioners Standard Ordinary (CSO) Mortality table. This table is uniform for all states. The reason that premiums are higher for permanent insurance is because a significant portion of the premium must go towards investments that build the cash surrender value of the policy. Additionally, sufficient premiums must be collected to provide a death benefit out to your age 100 or 120, depending on the permanent policy you’re buying. With term insurance, the insurer is only providing a death benefit for 30 years or less and does not build any cash reserve in excess of what’s legally required to pay for future death benefit claims. With permanent insurance, the cash value is a cash reserve which is used to do two things: pay for the future death benefit claim and reduce the actual amount of insurance you purchase. The cash value replaces the death benefit.
In all policy types, a cost surrender index is available which tells you the cost of the death benefit on a per thousand dollar of death benefit basis. Costs for permanent life insurance (aside from some types of universal life), normally go down over time. But, the cost index for permanent life insurance starts out higher in the beginning of the contract compared to term life. However, over time, the cost of the permanent policy will be exactly the same as the term policy. In fact, some very well designed policies not only become much cheaper than term policies, the cost index goes negative. This means that the policy has no cost and instead you earn money, on top of what the cash value account of the policy earns, just by having the policy. Term policies will never do this. Ever.
But, permanent life insurance cost indexes sometimes assume that the interest or dividends paid on the cash value account of the policy are paid out to the policyholder. This is rare in real life. Instead, the interest paid to the policy normally stays in the policy and becomes part of the cash value. A better way to calculate the cost is to ask for an internal rate of return report from the insurer (called an IRR report).
Misleading statement #3:
If you are smart with the money you have today and you get rid of your mortgages, car loans and credit card debt and put money into retirement plans you don’t need insurance 30 years from now to protect your family when you die.
Fact: Being a “smart” investor doesn’t guarantee that you will be shielded from market corrections. Many investors who were otherwise pretty good at investing (i.e. high net worth investors) lost a lot of money in the 1930s, in the ’80s, in the 90s, in 2000 and 2008.
It’s true that you might not need a death benefit when you’re old and gray and the kids are gone and your home is paid off. At that point, you might be wondering why you purchased a permanent policy. Of course, the death benefit isn’t likely to be costing you much, if anything, since the net amount at risk to the company decreases as you grow older. Many people would have dropped the death benefit at age 65 and relied on their savings to produce a consistent, reliable, income. Others are OK with having the death benefit that comes with a permanent policy. Paying the cost of insurance at that age is still cheaper than paying taxes on investment earnings and well designed permanent policies tend to be income producing in the latter years anyway (if that’s what you purchased the policy for). So, in terms of the savings component, this is largely a personal choice.
However, one financial responsibility that is certain is your death. You are responsible for your own burial expenses. And, for that alone, a small permanent policy-at the very least-is a wise choice.
Another beneficial reason for owning life insurance in your old age is to offset the taxes that must be paid on retirement accounts or your estate. Your beneficiary will receive the value of your retirement plan when you die and the amount will be subject to income taxes. If you used an IRA and the beneficiary is your spouse then, under current tax law, the spouse can just roll over your IRA into theirs – delaying the tax due until the spouse draws the money out (note: this approach may also increase the RMD on the IRA at age 70 ½). If your beneficiary is not your spouse, and you used an IRA, then your beneficiaries may be able to “stretch” the IRA over their lifetime. They will still pay income taxes on the money, but they are basically just delaying the inevitable – the money will eventually drain out of the account and be taxed.
Since life insurance death benefits are tax free, they can help your beneficiaries pay the taxes owed on these accounts. Obviously, you are under no obligation to buy permanent insurance to cover this cost after you are dead. However, if there are things that you really and truly want to have happen (with your estate) after you’re dead, it’s probably a good idea to make sure that things get done the way you’d like them to get done.
These are just a few examples of when you might want life insurance as you get older. Saying, as a blanket rule, that you’ll never need it is simply not true. You might not, but then again you might.
Misleading statement #4:
Instead of buying a cash value life insurance policy, you would be better off getting a term policy and investing the difference. If a $100,000 whole life policy cost $100/month, you could likely get a bigger term policy (i.e. $150,000) for just $10/month and put the extra $90 in a cookie jar or under your mattress. After 3 years you would have $3,000 and when you died your family would get your savings.
Fact: This is actually something Dave Ramsey uses as an example. If you invest $90 per month, even at a 10% NET rate of return, you have $3,791 after 3 years. Both Dave Ramsey and Suze Orman love to point this out and then say that there’s nothing (or close to nothing) in your cash value life insurance policy.
It’s true, the first 3 years of most permanent life insurance policies have little or no cash values available for you to use (unless it’s a high cash value policy or a limited pay policy, in which case cash is always in there in the first year).
I don’t really like the way interest is compared using these kinds of comparisons because it compares the savings without the cost of the term added in. Remember, with permanent insurance, the savings and insurance are lumped together. When you figure out the effective yield on Ramsey’s “superior” plan, it’s a measly 1.73% (you contributed $3,600 over those 3 years with the cost of the term added in and your total cash at the end of 3 years is $3,791).
Ramsey loves to think that anyone can average 10%, 12%, or even 15% in their mutual fund for 20 or more years. There is some research done by DALBAR Inc. that suggests that most investors only earn 2%-3% in mutual funds. Most whole life policies earn 3%-4%. A well designed policy will earn 4%-6%.
And, besides that, averaging investment returns can be a bit deceptive in and of itself, so I caution anyone, even those interested in some of the fancier life insurance policies with investment sub-accounts, that averaging doesn’t always tell the whole story. Actual compound growth can differ significantly from your averages.
Fixed cash value life insurance is guaranteed to pay a set rate of return that will be there in the future. Some policies also pay dividends which do not normally fluctuate in the same way that many other types of investments fluctuate in value.
Buy permanent life insurance if you want to leverage your savings. What I mean is this: you don’t have $500,000. An insurance company does. You pay premiums to buy this death benefit. A cash value policy builds a cash reserve that is set aside to offset the future claim (death benefit). By buying a cash value policy, you are effectively leveraging your future savings. If you die before you’ve accumulated the death benefit amount, the insurer pays the death benefit. If you live to the point when your cash value equals your death benefit (usually age 100, but some policies stretch out to age 120), the insurer cuts you a check for the death benefit-turned-cash value. With permanent life insurance, the whole idea is to buy enough savings (death benefit) that will be there for you if you live to an extremely old age or pay your loved ones the savings if you don’t make it (the latter being what usually happens).
Buy mutual funds if you want to invest or speculate. Buy stocks if you want to invest or speculate.
Misleading statement #5:
Cash value life insurance is a complete rip-off. When you buy a cash value policy, you pay high premiums, and you start to build cash value, but when you die, the life insurance company effectively “steals” the cash value you’ve worked so hard to save up and your family never sees a dime of that money.
Fact: Cash value life insurance is not a “rip off” at all. The life insurance company isn’t stealing anything from you, or anyone else. There is no trickery or malicious intent involved at all. You are getting exactly what you paid for – a leveraged savings tool.
The cash value is a cash reserve. When the cash value accumulates in a policy, it builds up against the value of the death benefit and effectively replaces it. When you take out a policy loan or withdraw money from the policy, this is why you see the death benefit decrease along with the cash value. When you die, you can’t have your cake and eat it, too. In other words, you get the death benefit, part of which is comprised of the cash reserve. During your lifetime, that cash value kept you from paying ever increasing costs of insurance. That’s why your premium remained level.
You may have put $15,000 into a life insurance policy, and may only have $10,000 in cash value in the first 5-10 years. At death, your heirs will have to “suffer” with $100,000 of death benefit you purchased, which is 10 times the amount of the cash value. How, exactly, this is supposed to be a rip off, I’m not sure.
If the life insurance company has received $15,000 in premium payments from you, and they turn around and pay out $100,000, it doesn’t take a math wiz to see that you are benefiting here. There is just no way that you could have somehow given your family $100,000 income tax free with $15,000 sitting in a savings account earning 1% (even 5% on high yield savings accounts).
Some “gurus” argue that if you died and had bought term and invested the difference, you would have the value of your savings plus the term insurance death benefit. And, you could, but these “gurus” are forgetting that most term policies never pay a death benefit so this theory just won’t come to fruition for most folks. So what you are really getting is a taxable savings that may or may not go through probate (depending on whether you had all of your savings invested in a retirement account, or sitting in a savings account).
If you actually held a term policy until your death, you would likely pay much more in insurance premiums than what the “gurus” would have you believe, since term insurance becomes quite expensive in your old age. If you died young, then you simply wouldn’t have the savings built up that the “gurus” promise.
If you really wanted to try to pull off getting the death benefit plus your savings, buy a dividend-paying whole life policy or a universal life insurance policy with an increasing death benefit. Your death benefit grows over time, effectively giving you the savings plus the cash value of the policy. Problem solved.
Misleading statement #6:
There is no way a life insurance company can guarantee anything in their cash value policies. This is all just a big “trust me” scam. I could do better if I took the money and stuffed it under my mattress or better yet, put my retirement savings where it belongs – in a 401(k).
Fact: I’m not sure when people started believing that stuffing money under mattresses was safe, but in any case this again is simply untrue. The guarantees provided by fixed life insurance come from bonds and bond-like instruments that the insurance company holds.
A bond is a long-term IOU. It is a contract that represents a loan from a corporation or the U.S. Government. With a bond, you know up front exactly how much interest the bond will pay, what the returns will be, and these returns are guaranteed. The only real risk taken in a bond is whether or not the institution will pay. If the institution that is issuing the bond can meet its financial obligations, then it will pay the interest specified in the bond every year and no less.
Many of the bonds in a life insurance company’s general investment account are investment grade bonds. Investment-grade bonds are bonds, like corporate bonds, that have a very low risk of default. These are bonds that are usually issued by very high profile, old companies with a solid track record or repayment history.
Some of the bonds in the insurance company’s investment portfolio are U.S. Government bonds. These bonds pretty much never default. By investing in both types of bonds, an insurance company can make a meaningful guarantee to the policy holder that actually has substance.
One important thing to note is that, unlike bonds, a life insurance contract provides guarantees that, generally, a bond cannot. Additionally, in fixed-type permanent life insurance, your interest credited to the policy may rise if interest rates rise. This is true with dividend paying whole life, interest-sensitive whole life, and fixed universal life insurance. So, when interest rates climb, you’re not stuck with a low fixed rate in your policy.
Misleading statement #7:
Cash value life insurance is a rip-off because if I ever want to access the cash value of the policy, I have to borrow it and pay the insurance company interest. Why should I have to pay the insurance company to use my money?
Fact: You are not borrowing your own money. It’s idiotic that the anti-cash value crowd insists on saying that you are, especially when those people are Dave Ramsey and Suze Orman-they know better. You are borrowing money from the insurance company. Now, it’s not exactly the same as taking out a personal loan, which is normally unsecured and requires an application and credit check.
All you have to do is ask for the money. The insurance company uses your policy’s cash value as collateral for the loan. It’s sort of like putting money into a savings account and then getting a signature loan. What does the bank do with a signature loan? They secure it with the money you deposited in your savings account. It’s the exact same thing that happens with a life insurance policy loan (except that the insurance company pays a much higher rate of interest on that savings account to offset the interest on the loan you are taking).
When you run out of collateral, you can’t borrow any money from the insurance company. But, because the policy is being used as collateral, there are no applications, credit checks, or anything else associated with these loans. You just ask for the money and they give it to you. Unlike traditional loans, you get low-or 0%-interest rate for the life of the loan, which doesn’t ever have to be paid off until you die (and then, they take the money from your death benefit to satisfy the loan). You couldn’t ask for better loan terms from any bank or any other financial institution for that matter.
Well gee, you put money into this policy and you can’t just take it right back out? I have to borrow money from the insurance company and use my policy as collateral? I’m not sure I like that….wait….do you want to know what the major benefit of having a savings like this is?
You get all of that money on a tax-free basis!
Holy cow, that’s amazing! Yep, you-and only you-get to control your savings without worrying about paying taxes on the money because you are “accessing” the money through loans, which is not income or gain according to the IRS. And, did I mention that the loans carry low (1%) or no (0%) interest on them? Meanwhile, the policy’s cash value continues to grow and continues earning interest to offset the interest you’re being charged for those loans. To be fair, you also need to make sure that you do not “overloan”. Overloaning is when you attempt to borrow more than what is in the policy and it lapses. If this happens, the loans are considered “forgiven” and you need to pay taxes on all of the interest you’ve earned for the life of the policy. Insurance companies are very good and preventing this from happening by either suspending borrowing when you’ve borrowed 95% of your cash value, or they at least warn you that you are about to lapse the policy and that it’s time to pay back some of the money you borrowed.
Another option on some life insurance policies is a withdrawal option. You don’t have to pay interest to access your money (even though, as discussed above, this is not really a major issue due to the design and terms of policy loans). Most policies have a withdrawal option where you may access either all or part of the cash value of a life insurance policy directly without taking loans. The terms of withdrawals vary from company to company, but are typically very liberal – especially in the later years of your life when you are most likely to need or want the money.
Conclusion
All in all, it sounds like I am a something of a cheerleader for cash value insurance. I’ll admit, I do like the contracts that are designed and built well. They’re becoming fewer in number, but they’re still out there. However, it’s not all glitz and glam and I’ll be the first to admit that.
The company you purchase your life insurance from should not necessarily be cheap on their pricing, but they should also not be wasting money, either. They need to be structurally sound with consistent managerial principles and a good industrial philosophy.
If an insurance company gets bought out, the new owners may not share the same vision that the original management had. For a cash value policy, this can be detrimental to policy performance. The new management may want to raise the internal cost of insurance or move those “trust me” movable parts found in many policies.
There’s nothing like buying from an insurance company whose management decides to change the assumptions that you thought would never change 10 years after you’ve been paying into your policy.
Look for companies that are either mutual companies or are structured in a way that offers a clear benefit to policy owners. Most, but not all, permanent policies have moving parts to make sure that the insurance company can make enough money to keep paying claims (that’s a good thing).
But those moving parts can be abused by new management that doesn’t share the same vision as a management team focused on maximizing policy values to the policy owners. Don’t be afraid to ask representatives of the company what can happen to the movable parts in the permanent policy if the company gets bought out, and what the company has done to protect their policy owners from being taken advantage of by inexperienced or overzealous management.
The best protection against a policy going south on you is to just purchase a policy with few or no real moving parts. A basic, dividend paying, limited pay, whole life for example.
It’s hard to know who to trust in the financial industry sometimes. Some of the biggest names in the business have it all wrong. Some “gurus” try to paint every individual with the same brush, eliminating the context of an individual’s life. This makes for a terrible advisor, and downright dangerous financial advice. If you ever encounter a financial adviser who starts spouting any of the lies in this article, my suggestion would be to run for the hills and find yourself another adviser who knows a little bit more about insurance planning.
Before you make a final decision on whether to buy term or cash value life insurance, consider what you are really looking for. Regardless of what type of insurance you buy, the strategy is essentially the same. You’re buying life insurance and building a savings simultaneously. The only question is whether you can do a better job of building that savings than the insurance company.
If you are really very confident in your investment abilities, or are just looking for an investment, then be prepared to look for stocks, bonds, no load mutual funds, options, and other various financial derivatives (and learn how to research them). Then, you would buy a term life policy to cover you until that savings was sufficient to pay off all your financial obligations. If you aren’t that confident in your investment ability, or you just want an integrated savings and insurance product, then cash value life insurance would be your best bet.
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October 2nd, 2012 | by David | 26 Comments
I need to get information on decreasing accidental death insurance for my home. Is this a good investment. I have tried to get term insurance in the past but was rejected because I am a diabetic. What advice can you give me on this. It seems to be reasonably priced per month and no medical checkup is needed.
Great article. I really appreciate the author's objective, unbiased viewpoint.
Hi. I followed your link from a Money article.
Sorry, but I was having trouble separating where the sales presentation ended and the analysis began.
Buying life insurance is a form of risk transfer. And of course, it makes sense, but depends on the risks being managed.
But the amount of coverage one needs will vary dramatically over the course of one's life.
It is not static.
Therefore, Term is infinitely more flexible.
A young married person with a family to support, as sole income earner, may have a huge risk to fill.
Having the proper amount of term coverage at this stage of life is much more important than having a lesser amount of whole life. Affording the proper amount of coverage is the important thing.
Protecting future earnings, so junior goes to college is the critical point. Supporting junior when he's 25 is not.
That only a negligible percentage of these policies pay off, is shocking?
Hello?
Because I have not filed an auto or homeowner claim in the last twenty years, does that make the accumulated amount I paid in auto and homeowner premiums wasted? Of course not.
I have had clients who were not properly covered by the whole life policies they were sold in the past. Thankfully, nothing bad happened.
But neither did anything good happen, either. The accumulated cash values are a relative pittance.
They could have been more adequately covered by term AND have had their mortgage paid off by now.
And where's the Commissioned Based Product Salesperson (CBPS) who sold them their policies? I wonder where he's vacationing this year?
Too bad he wasn't a fiduciary, as all people calling themselves advisers should be.
Dear writer:
This is the best discussion of the merits of whole life as a guaranteed leverage and savings tool that I have ever read.
Old fashioned uncommon sense is genrally far superior to the redefined gospels of the new guru's. The so called guru's of investments say what they say with a hand in your pocket and expect you have the attention span of a squirrel. Sound bites are for people who want to follow conventional wisdom down the drain.
Thanks,
Mike
That’s a really comprehensive post offering some new food for thought. Thanks for that. And I totally agree with you about making sure the insurance company you buy your policy from is financially sound. Therein lies the crux of a permanent life insurance policy truly working in your favor. When choosing a life insurance company, you need to be sure that the company is financially strong, and exhibits a good performance record with a reputation for integrity. Your online insurance provider should be able to furnish you with financial information of all the insurance companies on its database. A good website will only deal with companies that have proved themselves and can provide you with the A.M. rating (the most recognized rating organization in the country) of the insurance company you are interested in. Look for ratings of A or higher (the highest being A++). Other organizations that rate services are Standard and Poor’s, Moody’s, Fitch, and Weiss. An insurance website should be able to provide you with ratings from any of the above. Also make sure that these ratings are current and have been updated recently.
Denise at AccuQuote
Disclaimer: I work for AccuQuote and this is my personal opinion.
Are you serious?what about the surrender amount on whole life?what about the fact that the rate increases every year and at age 70 you can pay as much as 30,000 a year for that policy and if you don't it lapses and you get nothing.If you buy term and invest the difference using the rule of 72 you money will double at 12% every 6 years.Lets not forget when you put away $90 a month that money is compounding at a rate of 12% over the course of 30 years not 3.When we say invest the difference we are not saying it in a short term time period but in a long term period just like whole life but when you die you really get your investment not the insurance company.If you die within your policy period in whole life you only get the face amount and you lose the investment.When you buy term you get the face value and your family gets your investment.You do know that whole life agents just buy cheap term for thier clients and give them 3-4% on there so called investment and they keep the other 7-8% for themselfs.So why have them make money on your money when you can do the same as them and keep your investment?Cut out the middle man and make money on your own money.
Its pretty obvious you support Cash value policies! People do your research! Cash value policies are definetly more expensive, a bad investment, and a rip off! My late cousin passed away and she had a cash value policy! She was only 33 years old and she left her children with only 25,000k! The savings account she was paying for went straight back to the insurance company! They failed to mention this when she purchased the policy! She would have been better off purchasing a term policy! She would have gotten way more coverage and her separate investment would have continued for her children to get when they go older! I use to work for a company that promoted whole life policies! I felt convicted after I found out the truth about these policies!
You are mistaken. Cash value policies are not "more expensive" or a "bad investment" nor are they a ripoff. The mortality tables are the same for cash value and term policies. Thus, the cost of insurance is the same. What's different is how long the policy term lasts and how the company can afford to pay for the death claim. As for premium payments, whole life insurance is cheaper on all accounts if you analyze the whole life policy against the same term policy for the SAME NUMBER OF YEARS. Comparing apples to apples, the cash value account prevents you from paying more than you receive from the policy's death benefit. Of course, if you only want a policy for a set period of time, term might be the best bet for you.
Wow, I'm still trying to digest all of that. One thing I've never understood about life insurance companies is how they stay in business…I mean, eventually they have to be paying out more than they bring in on a client, yes? Which, if true, would mean they're making money now to be bankrupt in the future…then again I really have no idea how much some people get charged either.
Insurance companies operate on the law of large numbers. Not all of the policyholders die at once. This expectation, along with invested premiums, provides more than enough money to pay claims. Insurers also protect themselves through reinsurance (they insurance from other insurance companies) thus creating a huge financial safety net. This is why even when you do hear of insurance companies going under, their policyholders rarely (if ever) feel the effects.
Dear writer:
This is a great article. I'm 23 years old and started my policy when I was 22. I have a Global Index Universal Life Insurance plan. I have been told this may be the best way to build cash value with the potential of the market and not lose money. Is this true? please respond I would deeply appreciate it.
My guaranteed column which has a guaranteed interest rate of 2.00% for the basic interst account and 1.00% for the index account my policy would lapse at 68. This column really scares me. The company is Western Reserve Life and they have a very high rating. Is there anything I can do to make sure this happens and outpace inflation? please respond when you have the chance.
Contact my office. I might be able to help.
I need your contack info. I live in San Francisco. Furthermore about my GIUL, I read in an article that I should only be funding it to the MAX-non MEC or there's no point in having this product. Is this true?
Bassy,
My contact info can be found on the bottom of my website or here: http://www.twintierfinancial.com/contact_financia…
All of the issues you've raised have already been answered in various places on my blog. I won't address them here but would suggest you reread this post and several others.
There's no smoke and mirror. The basic principle of insurance happens regardless of whether you buy whole life or buy term and invest the difference. All of the issues you've raised have already been answered in various places on my blog. I won't address them here but would suggest you reread this post and several others. It's all a matter of policy design, your skill and ability as an investor and your financial goals along with the purpose for those goals. Some people are not well served by a permanent policy. Many others are.
Henry Glodny stated my points quite well above. You however continue to wave the smoke around and confuse people. An example is your statement above that cash value insurance policies are not a bad investment, more expensive, or a rip off. You go on to explain tha the mortality tables are the same for cash value and term policies. Listen, people do not care about the inner costs in a company, they care about what they are paying each month for the product. It is an undisputed truth that term life insurance costs less than cash value life insurance when compared dollar for dollar in face value amount. If a person buys gasoline he/she does not care that the companies all pay the same for the ingredients. They just care what the cost is to them at the pump!
It does not matter the investment skill or ability of a person.or if a person can or cannot develop a good savings habit if they are seriously underinsured. The vast majority of people who are sold whole life policies cannot afford to buy what they really need to replace the loss of an income due to death of a breadwinner. You speak of goals. The NUMBER 1 goal is be properly protected and in this case it is with insurance. Then and only then should a person work at the secondary goal of saving. Only a small minority of people can afford the protection they need with whole life insurance. It is just too expensive. Folks, PROTECT your loved ones first, then worry about the rest of your future. Without proper protection there will be NO FUTURE!
In your response to "misleading statement #5" you state that "When the cash value accumulates in a policy, it builds up against the value of the death benefit effectively replacing it". You also state that this is why the premium remains level. Folks, this is the same thing as getting term at a more expensive 2nd term of time once the initial period ends. Every time your cash value goes up, the actual insurance part goes down in a whole life policy. Eventually, if you do not die and you do hold on to your whole life policy past, say 20 years (most term insurances are 20 yr level premium/face value policies), a large part of what you are paying for is not insurance but for the small amount of insurance left and your so called savings. Now, if you want your savings for say, collage costs, you either borrow it and pay interest (some savings!) or you must cash in your policy to get the cash free and clear. This 2nd way leaves you without insurance. This is how most people get their savings as most cannot afford to pay the high policy cost (most are by then retired and on fixed incomes) plus the interest on the "loan". Does this really sound like a good deal??? At the later years of paying for whole life you are paying the company to hold their savings (it is theirs, not yours).because the savings has replaced the insurance as the author here has himself stated!!
Hi Ed,
You seem to be very passionate about your views. That's fine. However, I think your comments are somewhat misleading. Here are two examples (although your recent comments are littered with half-truths):
Not true. As the difference between the cash value and the death benefit decreases, the cost for the insurance also decreases. This is not at all the same as buying term insurance at a higher rate on an annual renewable basis. In fact, with a permanent policy your insurance cost decreases while the cash reserve increases. As I have said and written many times, the cash value represent a cash reserve which is a cash advance on the death benefit. It's not a demand-deposit account, but it has advantages that demand-deposit accounts cannot offer. If you don't like those terms, you do not buy the policy.
That's right. They have to "suffer" with a zero percent net rate policy loan, or worse, a policy loan rate which is less than the interest earned in the policy and not pay taxes on the money they receive. Most people find this more attractive than paying 15 percent capital gains or ordinary income tax rates.
With that said, I think it's wrong to say that permanent insurance is right for everyone and likewise it's wrong to say it is wrong for everyone. Of course, you're welcomed to your opinion but I would again suggest you take a gander at some of my other posts since all of this has been addressed previously.
Thanks,
David
You said nothing in response to the fact that eventually your cash value clients are paying the insurance company to hold their savings as it is replacing the face value. You smoke screen again by saying "zero percent NET rate plicy loan". Tell me (everyone) straight out, does this mean the person "using" their savings pays absolutely no interest at all in any way shape or form? You can play with figures a lot when you throw in a concept such as "net" in the equation.
There is too much smoke screen about the correct TYPE. As for singles or couples with no dependants, I do not know why anyone would mess with cash value insurance policies when there are so many great mutual funds available in various vehicles. I stand my ground. The number one most important factor in buying insurance is to get the amount needed to cover all your financial needs. Period!!
If you want to waste your money investing in a cash value policy, go for it. But your insurance needs are much more important so PLEASE do not combine both. They are two totally different goals and should be handled in different manners.
I care only to help educate those in need of insurance enough that they do not get sold a policy that could ruin their lives..
Your views are immoral. Whole life and Universal life are nothing but a rip off. The agents mislead people who buy those products so they can make a good commission. The problem is the devil is in the details and many fail to read the contract and agents fail to explain how whole/universal life policies work.
@ Cron–I am not infringing on anyone's right to their own life, liberty or happiness, and I am not advocating any kind of self-sacrifice on the part of the client so I reject your assertion that my views are immoral. Whole life and universal life aren't a "rip off" for the same reason that any other financial product can't be a rip off. I don't mislead people, so I think you need to check your premises there. In fact, I'm one of the few advisers that actually delves into the inner workings of how these products really work.
Interesting read. I would like to ask a couple pointed questions if I may. I have two whole life policies. I have had them for 12 yrs. I believe we are heading towards severe inflation in the future. I know insurance companies have survived those before, But, I also see loss of the dollar both in terms of dollar devaluation and confidence world wide. I think this could destroy Insurance companies that invest in stocks, real estate and bonds.Some insurance companies may default by not being able to pay out their claims. I am thinking of moving my money to gold and cashing out of my policies and buying Term insurance. If I live long enough, I will not need my death benefit, and if I die in the next 20 yrs I would have an affordable death benefit.
Ok, now my two questions. First, if my cash value is accumilating and it causes my death benefit to increase, when I die ( assuming before age 100 which is end of my policy) do I only receive my FACE VALUE of my policy or the higher NET Death value due to cash accumulations.
Second question: do my PAID UP ADDITIONS actually pay out and cause my FACE VALUE number to increase AND will that be paid out upon my death IF before age 100 ( end of policy)
Last question, as my cash value increases on the term of the whole life ……….IF I live to age 100, is that the only time I would receive my cash value since it should equal my DEATH BENEFIT? Both are so high and above the FACE VALUE of my poiicy. It appears to me this is the ONLY time I would recieve a greater death beneift. IT APPEARS ANY DEATH during the policy, The insurance company keeps the cash value, which may be greater than the FACE VALUE. Is this true? Yes or NO.
Thank you
You present an interesting question: If you really believe insurers won't make it, you've answered your own question, but presented yourself with an interesting contradiction. Why waste money on term insurance if you think insurers will fold? Surely, if they cannot pay their death benefit obligations, it doesn't matter whether they are paying out a term policy or a permanent policy.
As to your other concerns, some insurance companies *do* buy gold. For example, Northwestern Mutual buys gold to hold in its investment portfolio. If you thought hyperinflation was on its way, Northwestern Mutual could insure your risks better than you could as an individual. After all, if you could fully self-insure, you would be an insurance company.
Finally, I do not know whether you would "need" your death benefit or not later on in life. I would also need to know more about the details of your policy before I could really comment on what your paid up additions will do (there are several options for dividends), whether you could receive your cash value prior to death, and what your beneficiaries would be paid. If you don't know how your insurance policy works, and it sounds like you have some questions about how your death benefit and cash value works (which is understandable), then you are in absolutely no position to decide whether you will or will not need that insurance. At this point, your best bet is to speak with an insurance professional.
My question is similar to part of walter’s and I wish you would answer it. If the cash value of a small policy increases to a level greater than the face value, what is the benefit at death, the face value or the greater cash value?
Thank you for commenting. Beneficiaries always receive the death benefit amount at death. Your question implies a slight misunderstanding of how the policy works. Technically, you never receive the cash value amount – even for universal life policies with increasing death benefits. No worries though – the death benefit would almost always be higher than the accumulated cash value because of IRS rules concerning the definition of life insurance (IRC sec 7702). The only exception to that rule would be if you reach age 100 and the cash value equals the death benefit or if the policy becomes a modified endowment contract (that rarely happens these days except in the case of single pay life insurance sales for seniors).
But to your question: you could think of it as receiving the cash value plus the death benefit in this sense if that helps with the understanding (this is how life insurance marketing department describe it). Regardless, you’ll get the higher amount (the death benefit) less any outstanding policy loans and surrender charges left on the policy. I hope this helps.