October 16, 2009

Yet Another Example of Bad Cash Value Life Insurance Performance

I've talked before about some examples of cash value life insurance policies that proved to be poor investments: One example, another example, another and another.

On another episode of the Suze Orman show a caller had a cash value policy which (surprise) was not a good investment at all. The details of their policy are as follows: They had a 'Variable Appreciable' insurance policy. I'm not sure what a Variable Appreciable policy is exactly but from what I can gather its just another name for a variable life insurance policy.

Premiums of $28/month for 20 years
Total paid = $6,700
Cash value = $4,870
Death benefit = $50,000

The 'investment' lost 28% of the money put into it. That is not a very good investment at all.

A term policy would cost much less. A 30 year old man can buy a $100,000 term policy for 30 year term for about $132 a year and of course it would have been much cheaper 20 years ago. So their variable policy is costing them at least $204 more than what a better term policy should have. If they had been investing that $204 difference at just 4% returns for the past 20 years then they would have over $6,000 today.

Option A: Buy term and Invest the rest:
$100,000 death benefit for 20 years + $6,000 in the bank

Option B: Buy variable appreciable insurance:
$50,000 death benefit for 20 years + $4,870 in the bank


Seems to me that option A is the clear winner. With the term policy you'd get 2x the insurance coverage for 20 years and then end up with more money in the bank. In fact the amount you save with the term policy should be MUCH more since the cost of the term policy 20 years ago would have been significantly less than the cost today simply due to inflation.

What about the permanent nature of the cash value policy? You should not need a life insurance policy in your old age. By the time you retire you should have fixed income from your retirement and should not need a life insurance policy to replace any earnings. I guess there are some exceptions to this so in those rare cases where it might make sense to have insurance for a long period then you could get a term policy with a rider called a 'conversion option' or a 'policy exchange option'. Those options would allow you to convert your term policy to a cash value permanent policy at the end of the term if you choose to. A key to doing that would be to get such a rider that does NOT require further evidence of insurability. Otherwise you might hit middle age and try to convert an expiring term policy and then just get denied due to a minor health issue.


Yet again we see an example of a cash value policy that turns out to be a poor investment over time. I have yet to see a cash value insurance policy that did any better than buying term and putting the difference into US Treasuries. Many of the cash policies do much worse than others and its common for them to lose money compared to the premiums paid.

13 comments:

  1. Jim, I've decided to jump over here from FMF to challenge your beliefs on whole life insurance.

    Here's something to think about... How much is your term life policy worth at 20 years and 1 day?

    Wait for it... NOTHING! If you are outside of the term and still alive, all of the premiums paid are lost.

    The whole life policy will likely be paid up at 20 years (not require any more premium), will have cash value, and will still provide a death benefit at 20 years and 1 day (and beyond).

    Care to reassess?

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  2. RX,

    I actually cited the term policy for a 30 year policy. So you'd still have coverage for 30 years.

    After 30 years our future children will be grown adults and my wife will qualify for social security and pensions. There will be no need for life insurance after 30 years. Even if someone did need life insurance for a longer period you can convert most term policies to cash value policies with no physical exam as most term policies have such a rider.

    Jim

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  3. So let me ask the question again... What happens at 30 years and 1 day? You have nothing. No cash, no insurance. Nothing. So you could convert it, but at what cost? When you convert it from term to whole, you will pay the rate based on your age/health at the time you convert. And what were your costs for the rider for all those years? Sunk.

    I get the feeling you don't really understand this issue very well, but rather just parrot things you hear on the internet.

    I'm interested in this "future" you speak of, though. This "Social Security" and "Pension" is quickly going by the wayside. Social Security's surplus is gone (borrowed), and about the only place you can get a pension is the Fed, but it sure isn't like it used to be either.

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  4. After 30 years I'll be retired. I'll be living off of retirement money. I would have adult children. I would have no need for life insurance.

    Yes all the premiums paid are "lost" just like any unused insurance like auto insurance, health insurance for healthy people, home owners fire coverage for 99.9% of people, etc. Do you think I should invest 10 tims as much in my auto insurance in order to get a below average investment return so that my auto insurance premiums are not "lost"?

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  5. Are you an insurance salesman?

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  6. I'm a pharmacist. Your closed-minded approach to personal finance might be the reason you weren't free at 40.

    I don't know what "retirement money" you are referring to, but my life insurance is part of my retirement money. You mentioned a pension, how secure is that? http://www.brookings.edu/papers/2009/0529_gm_pensions_elliott.aspx

    Maybe social security? http://www.heritage.org/Research/SocialSecurity/wm1429.cfm

    Qualified plans? Susceptible to the whims of congress. Here's a short history of the changes from inception to 2005: http://www.ebri.org/pdf/publications/facts/0205fact.a.pdf

    You argue that you "pay 10 times more" but the money is yours! It's like a savings account. You can use it if you want! Does your term let you do that? Pay your premium, then borrow it if you want to? None I've seen.

    You keep it your WHOLE LIFE to insure against your death and pass those assets to your heirs TAX FREE. If you think estate tax isn't important, look at this table - it also illustrates how much of your taxes are at the whims of congress which seem to make these rates arbitrarily: http://en.wikipedia.org/wiki/Estate_tax_in_the_United_States#Exemptions_and_tax_rates

    Any response?

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  7. Calling me 'closed minded' is pure ad hominem that doesn't compel me to run out and buy some whole life insurance.

    Nothing is guaranteed. Your insurance policy is not guaranteed and only as safe as the financial stability of the insurance company that issued it. Pensions, social security, life insurance and annuities are all backed by the US government. But if someone felt that an insurance company was more secure than an IRA or 401k than they could invest their retirement funds in an annuity of some form.

    "You argue that you "pay 10 times more" but the money is yours! It's like a savings account. You can use it if you want! Does your term let you do that? Pay your premium, then borrow it if you want to? None I've seen."

    You sound like you are talking about something other than the article above. In the article above I'm recommending buying term and investing the difference. In the example above doing that ends up with $6000 in savings as opposed to the $4870 in the cash value policy while having double the death benefit. So yes my term + invest the rest option would act like a savings account that I can use any time I'd want.

    Estate taxes only apply to estates worth millions. My estate is not worth millions and I'm assuming none of my readers are millionaires either. If someone is a millionaire then I'd recommend they talk to an estate planner for recommendations in sheltering their estate. A paid insurance salesman is not an unbiased expert source of opinion on that topic so I wouldn't go to a salesman for my estate planning.


    Whole life policies have very high premiums for the amount of death benefit. You have to pay a commission to the salesmen and/or there are surrender charges that lock you in for several years. It takes several years of paying on a whole life policy before your cash value accumulates. THese are all very clear negatives to a whole life policy.

    I'm guessing you have a whole life policy yourself right? Would you care to share the details of what its costing you and what the death benefit is?

    Jim

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  8. *NO BRAINER: if cash value life insurance was such a bad investment, why did the federal govt. HAVE to pass legislation in the 1980's restricting the amount you could put in them????!!???

    ANSWER: millionaires and money wise persons were LOADING these things up, taking advantage of great returns and AMAZING TAX FREE favored status.

    You have little wisdom regarding money. That is not to say you are poor (but if you don't get the dichotomy then you're even more behind then I thought). Cash value life insurance is a very good investment when done correctly (taken to the GLP with a great company, WL or UL). There are so many things to consider when talking rate of return (ROR). There is no way to calculate that with cash value life ins, for many reason (liquidity, tax-free status and borrowing, opportunity cost--ask Walt Disney), etc...).

    btw, Suze Orman is an AWESOME saleswoman, AWESOME, but as an investment/wealth-building adviser, she stinks. First bad sign, she doesn't even follow her own advice, NEVER trust a chef who doesn't eat their own cooking!!!

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  9. There are 3 statuses of money the government acknowledges:

    Taxable: CD's, Stocks, etc..

    Tax Deferred: 401k/403b/457 IRA, SEPs, etc..

    Tax Free: ONLY Roths, Cash Value Life Ins, fist 500k of a home sale*, Muni-bonds

    hmmm...WHERE ARE MOST OF YOUR PORTFOLIO DOLLARS?????

    Get a clue, get some cash value life insurance, and cap out your ROTH (with an indexed annuity)

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  10. The example above clearly shows an example of someone losing money in their cash value life insurance. This was clearly a horrible investment. There are a lot of very poorly performing cash value insurance policies out there. And this is one very good reason to avoid them. Yet the actual content of my article is just ignored and I'm attacked by anonymous individuals with insults.

    To address a point above millionaires may be restricted on the amount they can put into cash value insurance since they were using it as a way to avoid estate taxes. If you are a multi millionaire and facing estate taxes then cash value life insurance may make sense. But not the kind of insurance that gives you a negative return over 20 years like in the example above. So to any multi millionaires out there, you may want to look into cash insurance but I'd certainly recommend you consult a estate planning professional who isn't a insurance salesman for an unbiased opinion on your individual situation.

    Jim

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  11. I appreciate your speedy response Jim, I didn't expect a rebuttal today, but I'm glad I got one. I also appreciate you posting an anonymous post that harshly criticizes your opinion, not everyone would do that. Thank you for having a truly open forum.

    Alright, back to personal finance. There are a number of reasons many wealthy did, and still do, over-fund life insurance policies, but I am glad you brought up taxes. Because they play a very important role in this. And I'm not just talking about estate taxes, everyone already understands the huge advantage of leveraging life insurance dollars for estate tax planning, but lets talk income tax:

    Do you think taxes are going up or down in the near and far future? Here is a hint, we have two wars unpaid for, the medicare/social security/now health insurance issues to deal with, along with a runaway debt and a consistent deficit. So its very very likely to go up, for everyone, it just is what it is. That being said, why would anyone be deferring taxes from a smaller bracket and paying the taxes later in a larger tax bracket? That's an instant loss (always tax your seed and not your harvest). So many qualified plans out there (401k/403b/457/IRA...) are in for a surprise.

    So, lets talk money that is taxed up front but can STILL grow interest that will be considered tax free. Roth and Life INS. Roths are awesome, if you dont have one, go out and get one. But here's the question, what investment are you going to have inside of it?

    **********************************
    This is where it get fun:

    How many directions can the market go?
    Three. Up, down or straight. If I could take one of these directions out of your portfolio, which one would it be? Obviously its the one that goes down. This is ONLY available with Index credit strategies. What are Warren Buffets first 3 rules?
    1. Don't LOSE!
    2. Refer to rule number one (seriously, its dont LOST again)
    3. And last, buy low, sell high.

    (continued)

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  12. (continued)

    Now, I'm sure you and I can agree Buffets a solid investor, and his first three rules sound pretty good, wouldn't you agree? But in reality its A LOT easier said than done. And why? Because nobody has a magic 8 ball to tell individuals when to buy and sell. Most ppl play the market scared and actually buy high and sell low (yikes). Alas, there is one strategy that allows you to do this, Index crediting.

    Now would you say the market is going to go up for 5-10 straight years, down the next 5-10 straight years, or fluctuate up and down like its done in its entire history? I ask this because there are esentially only 3 kinds of investments out of the THOUSANDS of products that exist, seriously, only 3:

    1. Fixed (companies don't promise unless its low, always)
    2. Variable (ride the wave)
    3. Index (caps and floors)

    So, if you believe up for next 5-10 years, invest directly in the markets, variable annuities are than an option. If you believe down 5-10 years straight, get a fixed option. But if you think it will fluctuate, like it always has, buy a product with a Index strategy, that has a floor (zero) and a cap. Indexing always out performs variable and especially fixed over time. It NATURALLY buys low and sells high for you. When the market goes up, your money goes up, when it goes down, your money is captured and the worst you do is a zero percent year. btw ZERO is a lot better than a negative, wouldn't you say?
    ***************************

    Back to the Roth and Life INS:

    What are the ONLY two vehicles that offer INDEX strategy crediting???????

    Annuities and Life INS.

    Ok, now with Indexing there is a cap and a floor. What are the caps on Annuities? Can be 6% to 8% on the high. And what are the caps on Indexing with a life insurance product? 12%-15% (actually 17%). What gives you a greater chance of solid average return over several years? Obviously the Life INS, BUT annuities are still great for other things (ex: income riders that guarantee 8% roll up for 10 straight years).
    A LIFE INS company I place many of my clients has an average of 8.75 over 25 years, and 8.34 over that last 15 years (including the giant market downturns of the early 2000's and the one we are in now).

    (continued)

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  13. (continued)

    Can we touch back on taxes? We know they are going up, but here's something else. The money that comes out of a Roth is untaxed, awesome, but it raises your adjusted gross income (AGI), and thus will affect your other income. Example, if you make 32k and above 50% of social security is table and 44k and above its 85% table, if your married (if single its 25k and 34k).

    Why did I bring this up. Roths are great and other investments are great, because at least you have money coming in. But if you study money long enough there is one undeniable fact: avoiding Uncle Sam's taxes has a overwhelmingly large impact on wealth. So I brought this up because of this, the money people use from LIFE INS to draw an income for retirement is technically considered a "loan" against THEIR own money in THEIR own policy...and in the united states, a loan is neither considered income and is also untaxable (already mentioned). So my clients pull out money for retirement, to fund kids college tuition, etc. with INVISIBLE money. Its not taxed and doesn't increase your tax bracket which then doesn't affect their other investment's tax-ability.

    Another issue, 34% of Americans wealth is spent on interest from borrowing. Some of this is good interest, like deductible house interest, but a lot of it is bad interest. The reason they borrow is because nobody has access to their capital (some ppl just dont have any capital but thats a diff discussion). But my clients borrow from their LIFE INS for major purchases and pay themselves back with interest INSTEAD of paying a bank or credit card company interest. This has a tremendous affect on wealth accumulation. What does is matter if you are making 8% returns in a 401k if you are then paying 8% interest to the bank for the car you drive to work everyday. You are then neutral. There is NOTHING more liquid then Life INS, as far as financial vehicles go, NOTHING.

    Last, 27% of Americans will not make it to age 65, sadly they will have past away. When my clients sign paperwork and begin over-funding a policy, their family INSTANTLY steps up in basis, by literally hundreds of thousands and sometimes millions. And this money is past tax free upon death (you already know that). What happens with typical investment vehicles?? They receive what in the policy, MINUS income taxes, and an increased AGI and tax bracket.

    There are literally TONS more reasons to have this as a part of your portfolio, and the reason I gave you some (btw, what you will know from studying the details of what I've mentioned will put you FAR ahead of most advisers, including that idiot Suze Orman) was because your article mentioned a bad case with a particular person. Yes, that happens, especially with underfunded variable policies that are not taken to the guideline level premium (right below the MEC line)...but that's one bad case...I can give you a million bad other cases for 401ks and IRAs alone. So, I gave you some ammo for the upsides, and the good cases. Lets see if you use or publish it.


    Thanks Jim.
    (have a head-ache and its too much to proofread, so excuse any errors)

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