January 9, 2012

Closer Look at a Whole Life Insurance Sales Pitch

Over on FreeMoneyFinance there was a discussion in the comments a long while ago about certain insurance investments.  One person there linked to this video on Youtube.   I found the video interesting in itself. 

The video is comparing a cash value policy to buying term and investing the difference.  I noted the following points from the video:

1. They cite a $840 annual premium for $1M level term. I get quotes of around $700 annual for $1M.
2. The video assumes a 30% tax rate. Marginal tax bracket of 33% kicks in around $200k taxable income. Which is the top 1-2% of the nation.
3. They assume a 2% management fee on your investments that you might make instead of the cash value insurance. Thats high I sure hope people aren't paying that. Index funds are more like .1%-.5% and mutual funds 1.5%.
4. They base the performance of the cash value policy off of assumed dividend rates that are not guaranteed.    A mutual insurance company pays dividends but these are not guaranteed.  Its a fairly safe bet you'll get a dividend but the specific amounts will vary and depend on the financial performance of the mutual insurance company.

They are stacking the deck in favor of the cash value insurance.

The rate of return on the cash value insurance is about 4.6% initially.  Then they add the impact of avoiding the 30% taxes, 2% management fee and not buying the over priced term policy and it the effective return they claim for the whole life goes up to 9.8%.

Why would someone be paying 30% on a mutual fund anyway? Are they going to do nothing to avoid taxes and shouldn't it be taxed at the 15% long term capital gains rate?   Or better yet you should put your savings first into a tax sheltered retirement account and possibly avoid taxes all together.   Who's going to pay a whopping 2% expense fund on a mutual fund?   You shouldn't be buying funds with such high expenses since that alone will erode your returns significantly.   Don't over pay on term policy.   Why wouldn't you shop around for your term policy?

Today a 20 year AAA municipal bond rate is around 3.4%. Those are tax free and can be bought with marginal initial fee and no ongoing expenses. However a couple years ago muni's were going for 5.5% and yields on safe bonds are sure to climb in future years when interest rates go back up.   We can't stay at rock bottom interest rates forever.

Now that 4.6% internal rate of return on the whole life policy is not bad at all in my opinion.   I don't know if that would be the current rate of return from the policy since the example is a bit old.   In any case this is actually a fairly decent whole life policy from that return rate.  Of course the details of what kind of return you'll get on insurance policy depends on the policy, your situation and the often performance of the insurance company if its a mutual paying dividends like in the example.

If you are looking at whole life insurance make sure you are getting a clear picture of the financial performance of the investment component.   Don't expect whole life insurance to give you 9% returns and if someone claims it will then be very suspicious.

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