The Lowdown on Cash-Value Life Insurance

A few weeks earlier, I presented a column entitled: “” that covered some information regarding my opinions about life insurance. Though I recommend Term Life Insurance without reservation, I didn’t go into much detail about why I absolutely hate cash-value life insurance. This week I’ve decided to present that information to you, and explain why cash-value life insurance is “one of the worst financial products available.”

Cash-value

Cash-value is a life insurance policy that, in addition to providing a death benefit, also accumulates cash that enables benefits to be paid out before death. The three main types of cash value insurances are: whole life, variable life, and universal life.

1. Whole life remains in effect for the lifetime of the insured or until you no longer pay the premiums and the policy lapses. The rate of return (earnings) on the cash-value portion of whole life historically has lagged behind other investments, such as stocks and mutual funds.
2. Universal life allows the customer flexibility in choosing and changing the terms of the policy. As long as you pay the minimum required to maintain the death benefit, you can choose how much you add to the reserve fund.
3. Variable life gives you the choice of investing in stocks, bonds and money market funds.

Example of Cash-Value

Let’s say a 30-year old has $100 per month to spend on life insurance…after shopping the top five cash-value companies, they’ll find that they can purchase an average of $125,000 in insurance coverage. They’ll be presented with a sales pitch about buying a policy that will build up savings for retirement, which is what a cash value policy does. However, if that 30-year old were to purchase a 20-year level-term insurance policy with coverage of $125,000, the cost will be about $20 per month, instead of $100.

Question: if they decide to go with the cash-value option, would the insurance company put the other $80 per month in savings? Well, not really…you see there are expenses and fees.

High Fees

One of the problems with cash-value policies is the enormous fees you will pay within the policy. When you pay your policy premiums, the insurer uses some to pay for the death benefit, and puts the rest in a reserve fund, where it builds up like savings, and may earn income from dividends or interest. If you decide to end the policy, you get some of the savings back (the cash surrender value). But first the insurer deducts commissions, expenses and other fees. Because of this, the premiums for cash-value policies are considerably higher than for term policies.

After paying for the death benefit portion, all of the $80 per month disappears in commissions and expenses for the first two to three years (meaning your savings balance is zero). After that, the return will average 2-4% per year for whole life, and slightly more for universal life, and variable life policies.

The GOTCHA!

Worse yet, with whole life and universal life, the savings you finally build up after being ripped off for years don't go to your family upon your death. The only benefit paid to your family is the face value of the policy. The savings portion is retained by the company—and that can be tens of thousands of dollars my friends!

The truth is, you would be better off buying the $20 term policy and putting the extra $80 in a cookie jar! At least after two years you would have $1,920 and if you died during the policy period, your family would get ALL your savings and the death benefit.

Life Insurance Is Not an Investment

Remember this… life insurance policies were never meant to function as investments or savings because the returns are pitiful. Agents may show you robust predictions of growth and high returns, but these rarely prove accurate. Also, you have to consider the opportunity cost of pouring your money into a cash-value life insurance policy. You will spend more of your money on premiums every month, and that means less money for things like savings, health insurance, mortgage payments, etc.

When you speak with many life insurance agents, you will most likely get the impression that cash value is the only acceptable form of life insurance. Agents try to convince consumers that purchasing term coverage is irresponsible, shortsighted, and financially wasteful. They try to explain that consumers are to irresponsible to save for themselves, and that you need them to do it for you…I don’t believe that. Sadly, over 70% of the life insurance policies sold today are cash value policies, even though consumer advocates almost ALWAYS recommend people not to.

The Term Life Option

Instead of wasting your money on a cash-value policy, purchase a 20 or 30-year term policy and invest the difference on your own. Even with today’s returns, you should be able to accumulate a nice nest egg by the time your term policy expires. At that point, you will be able to "self-insure" (meaning that you’ve accumulated enough savings to cover your insurance needs). Furthermore, when your term policy expires, it's unlikely that you will still have children depending on you, house payments to make, etc., so you probably won’t need the same amount of life insurance coverage. In the event of your untimely death, your spouse could live off of the money you've built in your investments.