April 16, 2009

An example of Whole Life insurance investment return

A week or two ago on the Suze Orman show she had a caller with a whole life insurance policy. Put very simply a whole life insurance policy is an insurance policy that has a cash value built up. The caller in question was 38 years old. He had a whole life insurance policy with $200,000 worth of death benefit. He had been paying $50 a month for 15 years. His cash value in the policy was currently $9,200. He was wondering if he should keep the policy or what. Suze generally hates cash value life insurance such as whole life. She told him to cash out his policy and get a term insurance policy instead.

On first glance this isn't a horrible investment. HE didn't lose money and he has $9,200 in the bank. I'd say he didn't get "ripped off" with this policy but he could have easily done better by buying term and investing the difference. Lets look at the alternatives he has with term insurance and how that might have worked out for him.

Term insurance is cheap. You can get quotes for term insurance at Quick Quote without having to give personal info. A quick search on Quick Quote shows that if the caller were in good health then he could get $200,000 of coverage with a 20 year term policy for as low as $156 a year. That's $444 less than he's currently paying for the whole life policy. That gives him a lot to invest. What if he'd done that from the start? Lets say he was 23 today and he had the choice to make again, then he could get the $200,000 term policy for as low as $134. Thats $466 a year less than the whole life policy. If he put that $466 a year into a safe investment making 4% then in 15 years he'd have accumulated about $10,170. The callers investment on the other hand netted him $9,200 at the end. To get that amount of cash value with $466 a year you'd have to get about 2.75% interest.

Whole policy: $200,000 coverage at $600 a year = $9200
Term policy & invest the rest : $200,000 coverage for $134 a year + $466 in savings at 4% = $10,170

He would have come out ahead with the term policy by $970.

Now I am assuming a 4% return for 15 years. I chose that 4% since I think its a typical safe, long term return. I think it shouldn't be hard to safely hit 4% after tax on investments. If you have a home mortgage you are probably paying 5-6% on it so throwing extra money into your mortgage principal would net you around 4%. You could also invest in bonds which have historically averaged 6% returns. And to be a true apples to apples comparison the returns on your investment would have to be after tax or tax sheltered.

Another thing to consider is if you have enough insurance. $200,000 is not that much insurance really. If the caller had $50 to spend on insurance he could have instead gotten $1,000,000 coverage from a term policy for that much. The first priority with insurance is to make sure you have enough. This is another reason that term insurance is better since you can get a lot more coverage for the same price.

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