Why (almost) Every Life Insurance Policy With Cash Value Stinks

by Neal Frankle, CFP ®

Every life insurance policy with cash value is a terrible waste of money. Alright…..almost every policy. (I’ll explain the one exception at the end of this post).

A few weeks I wrote an article that appeared on Yahoo!Finance that discussed 4 life insurance policies you should never buy. One of those I listed was whole life. This got a lot of attention – from whole life agents who took issue with the post. (I found it interesting that not one person who owns whole life defended it or had a positive remark. Seems like the only fans are the the people who sell it.)

I’ve compared whole life vs term before. But here is a brief summary. Term is life insurance you rent. As long as you make the payments, you are covered. When you stop making payments your coverage ends. Whole life insurance premiums are many times more expensive. The selling point is that the companies take the extra money, invest it and grow cash value. At some point, the cash value is so huge (they say) the earnings from it pay for the insurance.

Using this argument, the agents try to convince the unsuspecting public to fork over their money to buy whole life when they could buy inexpensive term insurance at a fraction of the cost. The question is, who is right?

Here’s a little analysis I did that compares apples to apples. It compares dollars in to dollars out. Let’s look at the first salvo.

This chart compares two $500,000 policies for a healthy 41 year old male. The first is term and the second is whole life. As you can see, the premium for the term policy is $495 a year. The corresponding premium for a whole life is just a tad more – $6055 a year. A few shekels more.

life insurance policy with cash value

Over ten years, the term policy cost you $4950 while you shelled out a whopping $65,500 for the whole life policy. Now it’s true that the whole life policy builds up a cash value of $56,500 over that 10 year period. In other words, if you decide to cash out after 10 years, your net out-of-pocket cost is $9,000. So with the term policy, your total cost was $4950 and with whole life, your net cost was $9,000. At the end of the day, the whole life cost you $4050 more than the term.

Now let’s compare the two policies over 20 years.

life insurance with cash value

With term, you paid out a total of $9900. With whole life, you paid out $131,000 but if you cancel the policy you’ll get a nice $144,500 back after 20 years. That means you will get $13,500 more than you paid in. That’s nice. And if you compare it to the term policy (which is the whole point of this) you have $23,400 more in your pocket by owning whole life. Does that mean whole life is a better choice?

Nope.

With the whole life, you shelled out $121,000 more than you did for the term policy. And you got back $23,400 more than the term. Is that a good return? Well you tell me.

The internal rate of return is about 2% on that whole life policy. So if you are willing to invest your money for 20 years and have a 2% return, then the whole life does work. 2% might seem decent right now, but how will it look 20 years from now? Probably very very bad.

Life insurance companies like to show you illustrations based on a 5% return but what you should focus on is the guaranteed values and do a comparison similar to what I’ve done above. Forget about projections – demand to see guaranteed values.

Each situation is different of course. If someone is trying to sell you whole life, ask them to prepare a comparison of the costs and guaranteed surrender values. I believe you will come to the same conclusion that I have. The only time whole makes sense is for estate planning purposes. It does not perform well for family protection.

Do you feel differently? If so…why?

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{ 29 comments… read them below or add one }

Seng V July 22, 2013 at 8:32 AM

Great idea Rourke you have a good point there. I’m happy that Permanent insurance is good for you but it’s not for everyone. The middle income families don’t have that kind of money to buy two separate policy. When agents sells WL insurance I belief they sell the wrong kind of Policy IUL, VL, UL cash value type. Why? Because people don’t know much about insurance all they know is it last until you die and the kids get the money. Life insurance shouldn’t be an investment it’s a income protection while your young just in case disaster hits.
Let me give an example: two couples with middle income age 35-36 buys permanent insurance about 100k each person paying $240/mo and $0 for kids, which they have a house about 200k and debt about 60k= 260k total, if one of them pass how’s the wife or husband survive with that much protection? Are you really helping or your just there to make money? With Term protection you can cover them 5-10x that for $120/mo and put the difference into a IRA for the next 34-50yrs they will be financially okay. Everyone is different, some will do what’s right and some will do it just for money.

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Rourke GT July 26, 2013 at 9:03 PM

Like I said, it’s up to the individual to make that decision. We can go on and on with our discussion, but at the end of the day, it’s Slim Shady who’s going to make that decision. Experience and education works well hand in hand. If a individual learn about what’s available and learn to ask the right questions, they will eventually come to a conclusion on what will work best for them.
These comments I believe are what drives a life insurance company on sales, but also at the same time helps individuals on making a final decision on what kind of life insurance will be best for them. Sometimes many agents are only looking for the best of interest in themselves rather than their clients. I’ve come across many agents in my life time and I would say maybe 8 out of 10 agents would try to convince me into purchasing an Index Universal Life. I would recommend anyone who plans on purchasing life insurance to do their own research before talking to an agent. If you have made up your mind on a certain product and the agent still tries to sell you something else, that probably means that he’s only looking to sell you something that will benefit him in the sale.

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Rourke GT July 28, 2013 at 9:14 AM

Seng,
I have to agree with you on the subject that agents sell the wrong kind of permanent insurance. Anything with “universal, flexible, adjustable” should mostly be avoided. These policy are an expensive way to go if you are looking into long term, especially beyond your 60′s. These products are nothing, but an expensive annual increasing term insurance tied to a savings component. This product should never be compared to whole life because it is limited on it’s guarantees.

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Chris July 9, 2013 at 1:51 PM

I didn’t sift through all the discussions above, but I’ll ask my question through the following statement.

A guy from my college many years ago was getting started in the insurance business and his first prospects were people he knew from college. He wanted to sell me a policy that he said I could borrow against if I needed, and at some point down the road I’d be able to actually withdraw cash from that policy. I think I understood him correctly.

Does that sort of policy exist now, in 2013? If yes, what is that kind of policy called?

Thanks.

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MC July 5, 2013 at 5:06 PM

Dear Neal,

As a fellow CFP, I appreciate your guidance to your readers but also feel compelled to respond to some of the over-generalization in your post.

I have a client who has a whole life policy purchased in 1983 from a mutual insurer. Her annual premium is $2557/yr, which as you know, is a fixed amount that will not increase. This started out as a $50,000 policy.

Now, exactly 30 years later, her death benefit is $283,732 and her cash value is $231,908. Her total cumulative outlay for this policy over these 30 years has been $79,267. If you run this on an excel spreadsheet you will find that her NET rate of return on this policy is 6.04% on the cash values, and 7.08% on the death benefit.

Her first 20 years were not bad either. At the 20 year mark (in 2003), she had $102,499 in cash value and $154,212 in death benefit. That represents a 5.54% NET IRR on the cash, and 8.80% IRR on the death benefit.

Her dividend this year is going to be $4,102, more than enough to cover her annual premium and then some.

Now, I’m no raving fan of whole life insurance who believes everyone ought to own it, but let’s consider why this may have been a good product for her to have owned.

Are there other investments she could have made that *may* have gotten her higher returns? Sure. But as planners, if all we are concerned about is rate of return, then by definition all lottery winners should be placed in the investment hall of fame. Clearly there is the other side of the coin, which is risk. My client achieved these returns over that time period in an instrument that COULD NOT LOSE VALUE. On a risk-adjusted basis, there is no question that this has been one of the best performing assets in her portfolio, and even on a gross basis, it has in fact to date outperformed almost everything else that she has owned. But in the end, the comparisons to other assets and their rates of return undermine its true value, which is that it provided a portfolio diversifier with non-correlated returns to improve the overall risk profile (beta) of her portfolio.

One additional point is worth mentioning. The net returns above are actually a good bit higher if tax-adjusted to reflect the reality that many other investments are taxed each year on their growth, and this is only expected to get worse. This makes well-designed cash value life insurance particularly compelling for those in high tax brackets who have already maxed out of other tax-deferred vehicles such as 401(k)s and IRAs. And in fact, a large majority of corporations and banks use life insurance as a way to bonus their executives for precisely this reason.

Lastly, I’m not sure where you got the numbers you did for your whole life projections, but one thing that many people do not understand is the amount of variance and difference between whole life designs and companies. To simply pick one whole life policy design from one company and apply it across the entire spectrum is akin to picking one stock’s performance and claiming that is how all stocks perform! In fact, that analogy is not far off at all, because what drives a whole life policy’s performance is largely how the underlying insurance company performs. There is an independent company called Blease Research that evaluates insurance companies and performance in an unbiased fashion, and if readers would like to know more, I recommend they look there as a starting place.

Sincerely,
MC

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Neal Frankle July 7, 2013 at 8:40 PM

The numbers listed are from a current quote. I stand by the post. Anyway buying whole life right now has to be ready to lock in ridiculously low returns because insurance companies buy long term bonds. Current offerings are extremely low. Your client bought a policy 30 years ago and over that same period the market did far better.

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Ed July 25, 2013 at 11:27 AM

If one is buying their whole life from a mutual company then the current bond market does not factor in nearly as much. Upwards of 60% of a mutual carrier’s dividend can come from company performance and not market (equity or fixed income) returns. Also, mutual companies have a much better bond portfolio because they did not have to sell off their best fixed-income assets during the financial meltdowns. Just FYI.

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Landon Buie November 13, 2012 at 11:05 AM

What do you think Equity Index Universal Life? I’ve heard good things from people and agents who know how to sell it.

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Neal Frankle November 14, 2012 at 1:41 AM

Universal life – under any permutation – should mostly be avoided. It depends on your situation for sure. Also, I am not surprised that agents who sell it love it. But thanks for bringing this up. I feel that term is a better choice.

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JP May 2, 2013 at 7:44 AM

Just out of curiosity, what do you understand Indexed Universal Life insurance policies to be?

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Neal Frankle May 2, 2013 at 5:12 PM

Great post idea. I’ll get cracking to explain it. Thanks.

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Rourke GT July 9, 2013 at 7:07 PM

Landon, Index U.L’s looks very good on paper. I mean non-guaranteed illustrations. Like what Neal say’s “… I am not surprised that agents who sell it love it.” Agents makes a heck of a deal on commissions from the companies offering them. People by the way are excited about the products because agents portrays all the positive non-guarantee values and feed them with all the B.S. to make it look good. Most agents would say this, “You will never take a loss if the market performs poorly but will gain if the market performs well for any given year.” What many agents and “people” consumers don’t know about IUL or Universal Life is their charges. This “Universal” product comes with a hefty price tag that increases dearly. Consumers only know and believe that they are earning a good interest on their policies cash value yearly, but missed what a company can do. A Company charges monthly fees on these “Universal” products. A Expense Charge and a Cost of Insurance charge. The cost of insurance increases monthly, so depending on the company chosen, your fees may vary. What people don’t realize is that even if all premiums are made or paid monthly to the company, due to the increasing cost of insurance, the policy may not be able to survive to maturity date. Although most life insurance companies have come up with Guaranteed Universal Life or Indexed Universal Life with a No Lapse Guaranteed Rider available with purchase, these products are so new that one may still need to question it. Only time will tell whether it’s a good product or not. Most agents soliciting these products only know the basics, just enough to sell it, but may not understand what’s in the contracts.

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GTR October 24, 2012 at 6:17 AM

Hello,

I am a successful professional in my early 40′s, between my spouse and me, we have total assets in the 2M range so far. I am still saving a bit after tax and expenses. Do you think whole life is make sense ? He was looking from the estate planning aspect.

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Neal Frankle October 25, 2012 at 4:53 AM

As I’ve said, if you really have an estate planning need, life insurance can be fantastic. However, you are currently well below the estate tax threshold. I’d want to learn more about your needs before I recommend anything.

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GTR November 14, 2012 at 3:47 AM

Saving is currently about 17k extra per month, anticipate no additional expenses in the near future, the agent recommended max insurance policy, btw the agent also deal with our business ‘s pension plan, so trust worthy it seems.
Also with Obama re-elected, and the estate tax threshold going from 5M to 1M, now does it make more sense now ?

Thanks

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Neal Frankle November 14, 2012 at 4:22 AM

I would have no know more than we can exchange in emails.

age
health
objectives
other assets
what the policy exactly promises
do you need income? when? how do you know?

I have always said that whole life or universal are great for estate planning and that’s it. We don’t know what the estate tax threshold will be when you die either. It’s important to plan but to do so judiciously.

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ed October 16, 2012 at 2:08 PM

PS: sorry if any of the above language comes across as confrontational or aggressive, this stuff fires me up! Nothing personal.

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JP May 2, 2013 at 7:40 AM

Gentlemen,
Spirited debate indeed. I thoroughly enjoyed the information you both shared. Having participated in both areas of “investing”, I would say that permanent life insurance is best for me and a lot of people like me. Ed makes great points about the certainties that ARE provided with a permanent policy. Neal, you suggest that a permanent policy will have premuims that “jump up 300%”. One of the reasons a permanent policy is so attrative is that the premiums stay the same. In fact, you can even stop making premium payments if cash value is not a priority. In this scenario, you may contribute to a permanent policy for the same amount of time as you would have for a term policy, yet your policy never lapses. Of course, all this is dependent on the fact that you are dealing with an agent who knows what they are doing. There may be policies that have an internal rate of return of 2% but not ALL policies are like that. Your generalizations are misleading the general public which isn’t really fair to them. By the way, I am not sure which policy you decided to quote for the whole life product but when I did it, two carriers had premiums in the $3,000 – $3,500 range annually. You also left out the fact that you can blend a policy so it has a term rider attached to it making it both affordable and permanent.

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JP May 2, 2013 at 7:46 AM

Ed,
I didn’t see where you mentioned the carriers that you recommend using; only the ones that you wouldn’t (I suppose).
Thx.

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Ed October 16, 2012 at 6:03 AM

Neal,

I feel compelled to respond to this article as it was brought to my attention by a client. Let me start by saying I am a CFP that sells a lot of life insurance (both term and whole life) as well as offers brokerage and advisory accounts for investments. I believe that your view on whole life is one sided and somewhat lacking in comprehension. The key back up that I have for this assertion is proven in your above “analysis”.

First off, you are right that 60-75% of whole life policies are not worth the paper that their illustrations and assumptions are printed on. So for the sake of this conversation, I am only referring to whole life produced by mutual companies. As I am sure you know (but some of your readers might not) mutual companies are owned by the policyholders, aka the clients. When these companies have profits, those profits go to the clients in the form of dividends. The four companies that I mentioned above have each paid dividends for OVER 100 years. That means over 100 years of consecutive positive growth above and beyond the guaranteed values.

With that type of track record, I find it difficult to understand why you would be so adamant that a client only view the guaranteed values for a policy. When you recommend investments, do you tell the client to only invest in mutual funds or stocks based on what the worst case guarantees are? A mutual fund or a stock could become worthless, right? (Enron, Lehman Brothers, Bear Sterns, etc) How do you justify having a client invest in a product that has NO guarantees when you say that the guarantees that a whole life policy have are not great enough?

One of your main focuses seems to be that life insurers are “lining their pockets” with profits from whole life sales. In a mutual company, owned by the clients that pay the premiums, who does that benefit?

Finally, you skip right over the permanent need for life insurance. It does not apply to everyone, but there is a large segment of the population that WANTS to leave money to their family when they die. The most efficient way possible to do this is through life insurance. I understand from your articles that you view success as a point in your life where you no longer “need” life insurance. But you should know that there are many people out there that get to that point and end up wanting the life insurance.

I cannot figure out what your bias is against whole life (In total, not the bad products). Again, there are many bad products (and bad advisors for that matter), but that should not be enough to lead to this general bias you seem to have. To say that “Every life insurance policy with cash value stinks” (with the only caveat being estate planning) seems to discredit you immediately. Whole life has been around in its current form for over 150 years. It is designed by some of the most financially sound companies on earth, and bought by some of the smartest financial minds that the world knows. For you to dismiss it as all bad seems to indicate either an ignorance to how it truly works or a viewpoint that is pandering to the general public (i.e. the 60% or so that should never consider it).

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Neal Frankle October 16, 2012 at 6:34 AM

Ed, thanks. Your arguments are interesting and thanks for taking the time to write.

You make a few interesting points. First, we agree that most hypothetical illustrations are worthless. But clients can’t tell the good from the bad and neither can you or I. That’s because these companies can do just about anything they like down the road and blame it on “performance” unless the returns are guaranteed. You know this and since you’ve been in the business, you have seen examples of this yourself.

Insurance isn’t like a mutual fund. You buy a policy for certainty and most whole life policies never deliver that. Your comparison between life insurance and an equity investment doesn’t really work with all due respect.

If someone wants to leave money to their heirs, this insurance is not the way to do so. My analysis shows why. Look back at the numbers Ed. If your goal is to grow assets for others, read http://wealthpilgrim.com/best-investments-for-retirement-income/

If you take the time to read the article and really understand it, the numbers tell you exactly why I have a bias against whole life. This is not an investment. The only time it works is when a client has an estate planning need – this is also explained in the post.

Hyperbole aside, look at the numbers and tell me how the analysis is flawed. I’m dying to hear back from you.

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Ed October 16, 2012 at 1:50 PM

Thanks for the reply Neal. I have limited time, but here goes, and I will start with quotes from above:

“But clients can’t tell the good from the bad and neither can you or I. That’s because these companies can do just about anything they like down the road and blame it on “performance””

Untrue. I have seen companies that have consistant performance for over 100 years of history. This allows me to tell the good from the bad. There is not a mutual company that I mentioned that has missed a dividend in over 100 years. Can you ell me one mutual fund account that has 100years of positive growth? And as far as the comapny “doing anything they like”, why would a mutual company all of a sudden start screwing over policy holders who are the owners? What group would that help?

“Insurance isn’t like a mutual fund.”

Exactly. I only keep the comparisons going because you do. Insurance is different than a mutual fund, so therefore there are different goals. Some people likme the idea of a portion of their portfolio growing at an average of 4-6% tax-free per year, knowing this is not guarenteed, but also knowing that past dividends are vested and can NEVER lose value. I only bring the mutual fund comparison up with advisors who bash whole life with the guarantees, only to provide an alternative (mutual funds) that have no guarantees.

“You buy a policy for certainty and most whole life policies never deliver that.”

Actually, you are exactly wrong here. Whole life is the ONLY life insurance that can provide certainty. You are certain of what the death benefit will be the day you die, regardless of when that is. Term cannot do this.

“If someone wants to leave money to their heirs, this insurance is not the way to do so. ”

Again, dead wrong. Life insurance is the best way to leverage your dollars up in a tax efficiant manner. With a participating whole life policy through a mutual insurer, your death benefit increases as years go on to provide a higher death benefit than the orriginal face amount. And this is all income and capital gain tax free. That cannot be said for investments or real estate. The numbers you quote above are not in depth enough to go into, but I could provide you details if you so wish, proving this fact. I will repeat that, this is a fact.

Fianally, I read the referenced article twice. I did not see any valid point in it. You said that equities and real estate are the best investments for retirement. Did I miss something? I agree that they are both good, but imagine if you had a whole life policy at age 70 that you purchased at 35. Imagine this policy had $300K in it growing at 5% with no taxes, no chance to EVER lose money, and if you died, $800K going to your family with no taxes. Granted, you would have put probably $100K-$150K into this policy, but how would that be bad on your balance sheet?

So again, whole life is not for everyone. But it is for a lot of people. Based on you insistance on analysis and guarentees, I can only imagine that the whole life you have seen is more of a universal type policy sold by a stock owned company (MetLife, Prudential, Hancock, etc). I agree that these typically do not perform well. But it is like apples to oranges when compared to a participating policy with a mutual insurer.

And to reiterate one point, there is no way that an equity based portfolio or real estate is a better tool for passing wealthon at death. What if the market is down (equities or RE)? What if the property can’t produce income or can’t be sold? If you were to inherit $500K, would you want stocks (and their capital gains tax), real estate, or tax free cash?

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Neal Frankle October 16, 2012 at 10:04 PM

Ed, Again, thanks.

Rather than respond to each point (I have already answered each of your points. I stand by my statements.
a. The best way to leave money to heirs is to grow your assets by making smart investments. My analysis showing that internal rate of return on insurance is somewhere around 2% makes this point.
There is risk in this but over many years, that risk is well worth it.
b. There is no certainty when insurance companies aren’t bound to a return. No certainty if you are looking at this as an investment. And if you are unable to make the premium payments – because they jump up 300% – you don’t have the death benefit either.
c. You aren’t really responding to the numbers and the alternatives.

We disagree. That’s OK. I am sorry that you didn’t get anything out of the other article I suggested. In it, I make the point that you have to look at investments and returns over the time frame that you plan on investing. The numbers I provide in this post shows that over the long run, whole life sucks given there are better alternatives. Enough said. Thanks for remaining civil.

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NJ October 2, 2012 at 11:12 AM

I have a question. My mom took someone’s advice like yours and has out lived two policies. They are kind enough to let her keep it for 5x the premium she has been paying. So what’s the next step?

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Neal Frankle October 2, 2012 at 10:45 PM

It’s wonderful that your mother has such great longevity Why does she still need life insurance?

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ed October 15, 2012 at 8:40 PM

Maybe she wants to leave her family money?! As a CFP I find it very surprising that you would have to ask that question.

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Neal Frankle October 15, 2012 at 9:55 PM

Ed. I did. She didn’t.

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Seng V July 21, 2013 at 10:32 AM

Look, if she wanted to leave money to her family while in the early year of her term policy she would of save some money into some kinds of mutual funds and IRA. By the time when the policy expired she wouldn’t need insurance because she’ll have enough money for her family. Is it because no one showed her what to do next after owning a term policy? In this industry of insurance, there have been many case of WL agents selling the wrong products to families which doesn’t provide enough protection when disaster hits because its too expensive.

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Rourke GT July 21, 2013 at 2:03 PM

Well said here. First of all this should have been up to the person buying the insurance policy. Forget all this buy term invest the difference…. Many times, most consumers buy term and spend the difference anyways because their agents may not even have a security license to help their customers with investing the difference. In this scenario, it’s good to know that your mother has outlived both of her term policies. What the agent should’ve done was asked his/her customers the right questions to begin with. Whether the person need temporary, lifetime protection, or maybe both. This is what I suggest, because this is what I believe works well for myself. She should have bought a smaller burial participating whole life policy and then buy a larger term policy during the early years of her life. If she would have done this, after outliving her term policy as you mentioned, she would’ve still have coverage because of her remaining burial participating whole life policy that will always be there regardless of her health and age. I hope this makes sense, although everyone does have their own beliefs, and like I said, this works well for me.

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