June 23, 2010

High Cost of Surrender Fees for Cash Life Insurance

A few weeks ago I watched an episode of the Suze Orman show and a caller had a cash value life insurance.
I've previously talked about several examples of how cash value insurance turned out to be poor investments:
One example, another example, another, another, and another.  You can add this example to the list primarily due to the steep surrender fees.

The Cash Value Insurance Details 

They had two policies for $1 Million of death benefit.   Policy #1 they had for 9 years with a $500 monthly premium and Policy #2 was 6 years old with a $650 premium.

They had a cash value of around $40,000.   They had also previously cashed out $40,000.  If they want to cash the policies out now they'd have to pay surrender fees for $18,000.   Their policy's surrender fees last for 16 years.

Premiums spent :
policy 1 : 9 years x $500 x 12 months = $54,000
policy 2 : 6 years x $650 x 12 months = $46,800
total = $100,800

Current value :
cash value = $40,000 + previous withdrawal = $40,000 - surrender fee = $18,000 = $64,000

So they're currently in the red for $36,800.

Compared to Term

Lets take a look at term policies to compare.   QuickQuote.com gives quick quotes on term life insurance.  Lets say I'm a 35 year old male who doesn't smoke in good health in California.   (just arbitrary chosen)
A 30 year term policy for $1 M in coverage would cost about $1000 a year.   A 25 year policy would start under $900.

If I got two 30 year term policies one for 9 years at $1M and another for 6 years at $1M then I could get  both at a total cost of  $15,000 (9 yr x $1k + 6 yr x $1k = $15k).

Total cost of equivalent term insurance = $15,000

Cash policy cost $36,800 vs Term policy cost $15,000.   They would have saved $21,800 with the term policy.

Why That Surrender Fee Really Hurts

Notice first that the surrender fee is going to last them another 16 years.   Thats a looooong time.  This acts to lock them into the cash value insurance for a long time with heavy fees.

The $18,000 they would have to pay in the surrender fee is about half the money they'd be in the red.   If the surrender fee didn't exist then they'd be looking at currently $18,800 in the red.   Thats only $3,800 more than the term policies.   Plus they pulled $40,000 out of the policy in the past which hampered the cash values ability to grow.   If the surrender fee didn't exist then these cash value policies wouldn't be such a bad deal really.  

The surrender fee locks them in to the policies for a long time and really undercuts their actual cash value.

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