I don't sell life insurance, and I have no interest in any entity that does. However, I am concerned with the lack of planning I see in the financial statements of many investors I advise. One common mistake is that many investors follow this oft-repeated advice: Buy term life insurance and invest the difference.
Suze Orman tells her readers ". . .the only type [of life insurance] you need is term insurance, because it's simple and affordable. Other plans include investing components, but you'd do better to buy the cheaper term policy and invest on your own."
Dave Ramsey says "no way" to buying cash-value life insurance. He also advises buying term.
Not Such a Good Idea
I have a problem with this advice for several reasons.
First, most people who buy term insurance don't "invest the difference." They "spend the difference."
Second, for those who do "invest the difference," there's no assurance their investments will be profitable. Many investors don't understand risk and lose a significant portion of their invested funds.
Third, most term insurance policies lapse without paying out a claim. Premiums for these policies increase as you age, making them unaffordable when you need them most. At that time, you may not be able to obtain any life insurance if you have serious health issues.
The Problem With Insurance Agents
What are the alternatives?
The primary problem with exploring insurance options is the necessity to consult with an insurance agent. Most people don't understand that their insurance agent isn't a fiduciary. The agent has an interest in generating commissions, and that creates a conflict of interest. This can mean an agent won't necessarily present you with the low-cost alternatives that may be in your best interest.
The solution is to not rely on agents. Instead, if you're considering life insurance where the annual premium will be $10,000 or more, you should retain the services of a fee-only insurance consultant. These little-known specialists charge an hourly fee, and they have no interest in any policy you may purchase. They provide unbiased advice and act as your fiduciary.
A competent fee-only insurance adviser should save you many times his fee. Glenn Daily, a fee-only insurance adviser, has a list of other advisers on his website. As he notes, there aren't many of them.
Building Cash Value
I interviewed one insurance adviser, Scott Witt, who's a former actuary for a large insurance company. I asked him to give me an example of a policy that would be a wise purchase but that an insurance agent would be unlikely to recommend.
Witt said a 29-year-old, in excellent health and a nonsmoker, could purchase a cash-value life insurance policy with a death benefit of $1.2 million and pay a premium of $17,000 a year.
Here's the kicker. After only one year, the illustrated cash value of this policy would be more than $15,000. After only five years, the total premiums paid would be $85,000, but the illustrated cash value would exceed that amount. In 20 years, it's extremely unlikely that any additional premiums would have to be paid to keep the policy in force.
At that time, the illustrated cash value would be $584,132, representing an internal rate of return of 4.9% on the amount invested in the policy. This is a higher after-tax return than you're likely to earn by investing in high-quality bonds.
When our hypothetical 29-year-old gets to age 49, she'll have insurance in force of $1.2 million. She can take the cash value out of the policy if she wants, up to the amount of the premiums paid, tax-free (but this would reduce the death benefit). When she dies, the death benefit will be paid tax-free to her beneficiaries. Do you think she believes she made a dumb investment?
Lower Sales Costs = Lower Commissions
Why is your insurance agent unlikely to present you with this type of policy? Because it's a "blended insurance policy," meaning it combines whole life and term into a single policy, resulting in higher cash values. It can do this because of lower sales costs. Lower sales costs mean lower commissions. Now you have the answer.
Several large, highly rated insurance companies sell blended policies, including Northwestern Mutual, Guardian, New York Life and Mass Mutual. According to Witt, these companies have a history of using reliable illustrations, based on recent experience.
No single type of insurance is suitable for everyone. But for some well-advised investors, buying this kind of cash value life insurance can be a very smart choice.
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