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Whole Life Insurance - What You Need to Know

Before I begin the analysis, I think a fundamental question should be asked – “Do I need life insurance?” My answer is “yes” in 2 circumstances:

  1. I have dependents/others relying on my income, and/or,

  2. When I purchase an asset (i.e., a dental practice) and it’s required.

In these situations, I recommend a term life insurance policy. Some advantages of a term life policy are the premiums are significantly cheaper vs. a permanent life policy (whole, universal, variable, etc.) and the term life premiums are paid for defined period of time, say 20 to 30 years. With proper financial planning, you should be “self-insured” after that period of time. Self-insured means your net worth, after the term policy period ends, is sufficient to sustain your family’s income needs.

Now whole life – it’s typically structured with two components; 1) life insurance, and 2) an investment vehicle. The life insurance death benefit is “permanent” as long as premiums are paid. The pitch presented by agents might empathize the investment side of whole life. The agent might tout the tax-free growth of the cash value (I’ll address soon) and the ability of borrow against the accumulated cash value tax free.

It is my position that your whole life premiums would better serve you if you invest that amount in a diversified indexed stock fund(s) for the period of the whole life policy, maybe 60 years. To test my position, let’s analyze a whole life policy illustration.

An agent should present an illustration which projects the cash value and death benefit year over year. Below is a whole life illustration. Key items of the policy:

  • Whole Life Legacy 100 – you pay premiums until 100 years old. When you die, your beneficiary receives the death benefit and cash value (your legacy).

  • Insured – 35-year-old male, preferred non-tobacco.

  • Death Benefit Face Amount - $500,000

  • Annual Premiums = $6,105 This assumes a lump sum payment at the beginning of each year. If you select monthly premium payment, you’re charged an additional $270/annually in interest.

  • There is both “Guaranteed” and “Non-Guaranteed” Values

Below the illustration, I will first discuss the Guaranteed values.

Whole Life Illustration

I’ll assume that the insured does need life insurance because he has a family dependent on his income. He’s able to secure a 30-year term $500,000 policy for $100/month or $1200/annually.

Guaranteed Cash Value Column (in the above Illustration)

This column represents the accumulated cash value at the end of the year. After years 1 & 2, there’s $0 cash value, after year 5 there’s a cash value = $15,945, year 10 = $47,765, year 20 = $122,715, year 30 = $209,270, so on. Now, how much did you pay in premiums to generate those cash values?

It’s not until year 20 do you break even, which results in rate of return of 0.048%/year. At 30 years, your net is $26,120 or 0.85%/year rate of return.

Let’s consider an alternative investment strategy – you purchase a $500,000 30-year term policy for about $1200/year. You have approximately $5,000 annually to investment given the difference in whole life – term life premiums.

Okay, let’s further assume you’re able to generate a 6% annual investment return. Here are the investment values at the end of the same periods:

How about an 8% annual investment return?

The whole life cash value at year 30 = $209,270. Investment value with 6% return at year 30 = $419,008. That difference is ~$210k. And at 8%, the difference is $402,459.

I’m sure some will ask how to get 6% annual investment return. Notwithstanding today (10/10/18), the S&P 500 historically returns approximately 9%. Please visit this website of S&P 500 return data:

Wow, that’s part 1. Still more to cover…

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