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Can You Make Money Investing in Life Insurance?
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by - October 16, 2013 - 10 Comments

For most of us –  life insurance is a way for our heirs to replace our income in the event that we succumb to an early death. However, I’ve recently heard quite a bit of chatter from “experts” that whole life insurance should be used as an investment vehicle. We sent our Penny Hoarder team out to investigate….

(Side note: our investigation team is an intern and the office mascot, Franklin the labrador retriever. Nevertheless, what they’ve found is fascinating.)

In one corner we have the personal finance gurus like Suze Orman and Dave Ramsey that speak of whole life insurance like it’s the devil. In the other corner, we have investment bankers and CNBC hosts that often insist that whole life insurance absolutely be apart of our investment portfolio. Quite frankly, all of these people have their own agenda, so who do we trust?

Before we issue a ruling, it’s important to first understand the difference between the two most popular types of life insurance – term and whole life. The simplest answer is that with term life insurance a death benefit is only paid to your heirs upon your death. However, whole life insurance not only pays out your policy benefit upon your death, but it builds up a cash value that can be cashed out or borrowed against while you are still alive.

With term insurance, if you stop paying the premiums, your policy is canceled and voided – end of story. Conversely, if you stopped paying premiums on your whole life policy you’d receive a check for the current cash value of your policy.

At first glance you might say to yourself that whole life insurance sounds a lot better. Who wouldn’t want the policy with a cash value, right?

Well, it’s not necessarily all it’s cracked up to be. To better understand the benefits and risk of each type of insurance, lets do a side by side life insurance comparison…

Premiums

Whole life insurance is expensive. Like hella expensive. :) In fact, whole life insurance can often be as much as ten times as expensive as term insurance because you are paying for not only the insurance, but the investment portion of the policy.

Tax Benefits

One of the selling points you’ll often hear with whole life insurance policies is that the interest you earn is tax deferred. That’s true, but there are numerous other investment vehicles that can defer taxes on your earnings including IRAs. In less you’re consistently maxing out on your allowable IRA contributions, I fail to see how this is a valid reason.

Investment Quality

The problem with investing in whole life insurance is that the insurance company often charges huge fees that reduce the investment return. Our friends over at SmartMoney.com recently explained:

“These policies come with high fees and commissions, which sometimes lop off as much as three percentage points from the annual return. On top of that, there are up-front (but hidden) commissions that are typically 100% of your first year’s premium….

To get a real sense of the value of term, let’s compare a term policy and a universal (whole) life policy. Say a 40-year-old nonsmoking male has a choice between a $250,000 Met Life universal policy with a $3,000 annual premium and a same amount of renewable term coverage with a 20-year fixed premium of $350. At the end of one year, the universal policy, assuming it paid 5.7% per year, tax-deferred, would have a cash value of exactly zero (cash value is the amount you would get back if you canceled the policy).

But say he had instead invested $2,650 (the difference between $3,000 and $350) in a no-load mutual fund that averaged a total return of 10% annually. At the end of the first year, he’d have $2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10 years, he would have accumulated more than $46,000 in after-tax savings in the mutual fund. Over the same period, the cash value of the policy would have climbed only to $31,819.”

Final Verdict

In less you own your own island and are in desperate need of a tax shelter, stay away from whole life insurance. Stick with term life insurance, from a place like Lifebroker. There are better ways to invest your money…


 

  • http://yourfinancessimplified.com YourFinancesSimplified

    I agree with your conclusion 100%. I do not believe life insurance should be used as an investment vehicle hence I’m pro term insurance over whole life. In order for me to even consider whole life insurance I would have to exact all other forms of investments. Even then I would probably decide against it.

    Great post!

  • EvilBob

    Whole Life Insurance is an insurance policy wrapped around a crappy investment. Guess Dave Ramsey was right.

    • Lady Meow

      The problem with Term insurance can be the term you choose is too short,
      or you can be denied renewal. When we bought our insurace, waaaaay last
      century got a blended version.

      $10,000 Whole Life, with a 10 year term rider for $250,000. I think 10 years was
      the longest term they offered. With the Whole Life, the term is guaranteed renewable.
      And, as our needs grow less, and the kids get married, we can decrease the amount of the term.

      Don’t know if this is still an option, but it worked for us. The dividends from the Whole Life help offset the cost of the entire policy.

  • Brad

    We decided to get a mix of whole and Term. We believe that it benefit us because it forces us to invest which without it being inside of the life insurance it would not happen. Also I am still trying to figure out how to get that 10% return the author is talking about.

    • The Penny Hoarder

      They must have bought a mutual fund that only invests in Apple and Google. :)

  • Barry

    Not really all that great of an analysis. You’ll probably still need some insurance when you are old if for nothing else other than to get buried. If you will have a sizable estate, then you will need a policy to cover the Death Tax, Try getting Term insurance for that when you are old!

    No, get some term to cover you until your kids are able to fend for themselves, and have a Whole Life policy to give you coverage until you die.

    I know that in most cases, a Catholic Order of Foresters 10 pay whole life policy builds more cash value by the 10th year than you have put in and the coverage never goes away. In effect, you get FREE coverage after 10 years good for the rest of your life. How can any Term policy compete with that?

    Oh, and BTW, the article is inaccurate in at least one aspect – Universal Life is NOT the same as Whole Life. Universal is different in that it may not be permanent. It consumes the cash value when you quit paying on it.

  • http://www.indiafirstlife.com/ Life Insurance

    With term insurance, if you stop paying the premiums, your policy is canceled and voided – end of story. Conversely, if you stopped paying premiums on your whole life policy you’d receive a check for the current cash value of your policy.

  • Licensed Rep

    Universal and Whole Life are a big rip off, period!!! For those that don’t know, it may sound good to have savings (investing) and insurance all in one. But if your rep is honest with you, they would be offering a product that is good for the client and their family, not what provides the biggest compensation.

    Here’s a great explanation of why Universal/Whole life are the devil!!. Let’s say the customer needs to use money from their savings account, from the money they put in every month, they have to borrow the money from the bank, with a interest rate from 8-10%. What! Why is that, if it’s their money? Also, what is not disclosed to clients is that the bank has the right to hold the payment to the client for up to 6 months before the funds are released. So I guess, you better borrow 6 months in advance of your unplanned emergency to make sure you get the funds in time. Oh yeah, before I forget this too…..don’t plan on borrowing anything from your savings account for almost the first 3 years. No money is even put in the savings account. Here is where the rep’s commission comes from. Oh wait! You didn’t know that either? Also, most policies will only pay the face amount of the policy upon death to the beneficiary. There are only a few that actually give the face amount and the attached savings account.

    I hope you can see why this is the worst insurance you can have.

    Term Insurance is the only way to go!! In most cases, I can double the amount of coverage for a cheaper price than what is being paid for Universal or Whole Life and guaranteed renewable. From this point, my team and I will help our clients either invest the difference with rate of returns from 8-12% or use those freed up funds to pay down debt faster and/or give them access to other financial products that will allow them to improve their financial outcome. We are there to educate them and actually help them get ahead and win the money game!!

    • Z

      Thats not true, money borrowed against a universal life policy does not incur a fee. It is your money and is borrowed free of charge and is not required to be paid back. The money you borrow is tax free on gains and the back end and just takes value away from the death benefit, but people using such as an investment do not care about the death benefit because they are using it as an investment.

      • Licensed Rep

        I advise you to look through your policy with a fine tooth comb. It’s not borrowed for free. Maybe your rep didn’t tell you that.

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