UPDATED: Nov 20, 2013
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For the vast majority of people, term life insurance is a much better choice than whole life insurance and I am going to show you why.
Prior to writing this, I did some research on the topic to see what was readily available for consumers. I was shocked to see how much misinformation is prominently displayed on some of the top financial sites across the web. Nearly every major publication has somewhere in their life insurance categories, a complete guide to why people should buy whole life insurance.
And then it hit me. There is so much money to be made in the whole life game, that you have an entire industry going up against a few people with calculators who are actually doing the math. Not to mention that most of these guides were written by “insurance experts,” also known as insurance sales agents, who have everything to gain by spreading this misinformation.
Well I am one of those people with a calculator. And I am going to show you the math.
Let’s take a 30-year-old male, married, with a couple children. Perfect candidate for life insurance.
According to State Farm, he can get a 20-year term life insurance policy with a face value of $1,000,000 for $48 a month. This rate assumes no tobacco use and excellent health. The same 30-year-old male can get a whole life insurance policy for $915 a month.
So to recap:
- 30-year-old male
- Married with two children
- Excellent health
- $1,000,000 policy
- Term – $48/month
- Whole – $915/month
Of course the whole life premium looks very high compared to the term, but they are not the same products. To be fair, whole life doesn’t expire and there is a savings aspect that builds cash value over time. That means you can use some of that cash later in life, like money from a savings or retirement account. Just do not kid yourself and think that cash value is going to grow to anything sizable, because it won’t.
Now for the Math
This 30-year-old decides to go with term life insurance and invest the difference in premium between the two policies. That means each month he puts $48 into life insurance and $867 into an investment account. Effectively, he is paying the same amount as just buying the whole life policy, except he is saving and investing himself.
For many people that are unable to max out their 401ks and other retirement accounts, that is a great place to put these extra dollars. But for this example, it really does not matter.
For 20 years he invests $867 in a few different mutual funds and earns a reasonable return of 7%.
After 20 years, the kids are grown and out of the house. They are probably done or close to being finished with college. Hopefully there was actual retirement savings going on, and the house is probably getting close to being paid off.
What about the investment account he has been putting $867 a month into? It’s now worth over $450,000.
Now there is no life insurance. But for the vast majority of people in this situation, they would no longer need it. The kids are gone, the bills are getting paid off, retirement savings has been growing, and not to mention the nearly half a million dollars saved just from the difference in the whole life and term life insurance policy.
For argument sake, let’s say this guy just really wants to have another life insurance policy. Since the majority of people are still healthy enough to buy insurance at 50, he could buy another term policy. According to State Farm’s website, a reasonably healthy person (downgraded his health a bit) could buy another 20 year term policy for $212 a month. But there is a good chance that policy will cost more 20 years from now due to inflation, so we will double it and add a few to make it an even $500 per month.
So let’s do this again. Now this 50-year-old, reasonably healthy guy with no kids to raise still wants a $1 million policy that costs $500 a month. So he takes $500 and pays towards his term policy and puts the remaining $415 into the same investment account that is already worth over $450,000.
When this person turns 70, his term life insurance policy will expire and his investment account will be worth almost $2 million dollars.
So in this scenario, he never had less than $1,000,000 of life insurance until reaching the age of 70, at which point he had almost $2,000,000 saved just from investing the difference in the two premiums. And here is a little news flash, in those 40 years, the cash value of the whole life insurance policy would be a very small fraction of the face value, not even remotely close to the $2 million he saved by investing himself.
Why Whole Life is Sold So Aggressively
You should know that life insurance agents often make close to 10x the commission from a whole life policy vs. a comparable term life policy. That is why they are so heavily pushed by a lot of agents. This doesn’t mean whole life insurance agents are bad, though. Many of them truly believe whole life is a better product, because they read the same marketing material produced by the insurance companies.
At the end of the day, for most people whole life insurance is a flat out rip off. Insurance companies and agents make a lot of money off of these policies, and that is why they are so heavily pushed. If you are being shoved into one of these expensive policies and are actually considering it, find a not-for-profit financial planner that charges by the hour (not commission) to review your personal financial situation. They can give you an honest opinion as an industry professional that has nothing to gain either way.
- This is not one-size-fits-all, but it is a one-size-fits-most.
- If you make hundreds of thousands of dollars a year, have millions in assets, and have all retirement vehicles maxed out, there may be a place in your portfolio for whole life insurance. For everyone else, there usually is not.
- The rates of return listed above are not guaranteed. 7% is a reasonable rate of return for a well-balanced stock and bond investment portfolio based on over 100 years of stock market data.