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Life Insurance Part 2: Should I Buy Whole Life Insurance?

February 27, 2008 by Pinyo.

In the first post “Life Insurance Part 1: How Much Life Insurance Do I Need?,” I worked with my insurance sales agent on how much life insurance my wife and I need. One of his suggestions is to buy a minimal amount of whole life insurance so that we have a little something to take care of our final expenses. The plan he suggested is the one that we would pay until we turn 65.

Colorful Life Vests

Photo by miragebym via Flickr

These are the whole life premiums I shared:

Description	My Policy	Her Policy
$50,000 whole life - pay to 65, standard (there’s no elite option)	$65.16	$41.27
$100,000 whole life - pay to 65, elite (minimum coverage to qualify for elite)	$115.00	$67.95

So, I did a little analysis on the numbers, and here’s what I’ve found.
Note: To keep it simple, my calculation assumes 8% investment growth rate (CAGR), no yearly capital gains, no fee, and invested at the beginning of each year instead of monthly.

Description	My Policy	Her Policy
Lifetime premium paid (note, I’d have to pay for 30 years and my wife for 37)	$24,240	$18,324
Years to reach $50,000	23	28
Years to reach $56,500 (since insurance payout is non-taxable, we actually need $56,500 to get about $50,000)	24	29
Investment value at 65	$104,162	$108,614
Investment value at 75	$224,879	$234,490
Investment value at 85	$485,496	$506,245

What does this all means?

Insurance sales agents often cite the fact that we are getting more than what we’d have paid — i.e., for $50,000 coverage, the total payment only adds up to $24,000 (for me) and $18,000 (for her). For these small sums, we are getting lifetime coverage of $50,000 each. So, we are getting a really good deal right? Well, not so fast.

I’d have a $50,000 portfolio in 23 years and my wife in 28 years if I invest our premium payments in an investment vehicle that returns on average 8% per year (i.e., the stock market). To account for the fact that our investment would be taxed, while the insurance payout wouldn’t be, we only have to invest about 1 more year each to accommodate that.

Now, this is where it gets really interesting.

If we invest the premiums instead of using it to buy the policies, we should have more than $100,000 each
If we stop adding new money once we turn 65, and keep investing what we have:
- By 75, we each should have more than $200,000
- By 85, we each should have more than $475,000

Wow, that’s a huge difference!

How insurance companies make money with whole life insurance

Basically, this is how the insurance companies are profiting from your money.

They ask you pay the premiums upfront
They invest your money and grow it at high rates of return — i.e., 7% or more
They promise to pay you back a fixed amount when you die (or when you surrender the policy)
Since only a small percentage of people actually die early, the investment turns out to be much larger than the payout (as you can see from the numbers above)

The Verdict

So it doesn’t look like buying whole life insurance is the right thing for us. We could buy 20 years, or 30 years term life insurance for the coverage that we need to cover each other and our child(ren). If we are disciplined, we can invest the difference and come out ahead of the curve.

In the third part, I will walk you through my analysis of term life insurance and share my decision with you.

Other articles in this series:

While you wait, here are some other good articles about whole life insurance:

One Critical Thing You Need to Know About Life Insurance at Generation X Finance
We’re Cashing Out a Whole Life Insurance Policy at Blogging Away Debt
Top 5 Investing Regrets In My Life at Canadian Personal Finance Blog

This article was featured in:

The Cavalcade of Risk #47: March Madness (Play at Your Own Risk) hosted by Regulating Health Insurance. For more information please visit the Cavalcade of Risk.

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6 Comments

Kevin @ Change Your Tree, 27. February 2008, 7:18

You forgot to mention that when you die, your heirs only receive the policy’s face value amount and the life insurance company keeps the investment portfolio you worked so hard (against their astronomical fees and expenses) to build up.
Ron@TheWisdomJournal, 27. February 2008, 20:39

I have $1.5 million on me with a 20 year level term. I’m seriously thinking about raising it even more so that my wife would never have to worry about anything. We have three children and weddings to pay for and grandchildren to dote on. If I’m not here, I want her to be able to live as full a life as possible and life insurance will help do that.

I have to say that I’m completely against whole life, though I do have it on all three kids. I bought it when they were two months old and it costs so little, I don’t even know how much it is!
Pinyo, 27. February 2008, 20:52

@Kevin - I didn’t know that! I just sent my parents’ agent some questions. They were sold whole life policies that they have to pay until the day they die. I am looking into what we can do to recoup what we can at this point.

@Ron - That’s the other school of thought. One is to give them enough to keep them afloat for a few years; another is to replace your portion of income for the spouse entire life-time.
jason, 27. February 2008, 21:14

A couple other points. My wife and I are going through the same scenario.

1. Life insurance payouts are tax-free whereas you will have to pay taxes in many other accounts (roth’s would be an exception but you should probably fund one of those anyway.) And this could be a way to offset any estate taxes.

2. If your whole life policy is fully funded, you could borrow against it while you’re still living making it an investment vehicle if your pre-tax account balances would have you paying more taxes in retirement than you would while working. There’s a fed reserve article floating around somewhere that details the break-even points for income, rate of savings, and pre- and post-retirement taxes.

3. Kevin isn’t entirely correct. You can take the cash-value of the policy at any time after it’s fully funded or you can let it continue to build or you can leave the policy in place and collect the dividend. All of this income is tax-free because it’s life insurance. This also makes whole life policies good investment vehicles.
Make Friends, Earn Money, 28. February 2008, 4:20

Insurance is always a difficult subject. It’s important to have especially if you have children but, like you mention how much is enough? I think a basic insurance package is essential but I think that insurance companies also prey on our fears about what can happen. If you combined a basic insurance package with a good savings programme, personally I think that this is a better option than investing large amounts in high coverage.
Adfecto, 28. February 2008, 9:56

Whole life is a huge rip off for most people. Stick to a combination of a strong savings plan and fixed term life insurance. If 30 years from now you need a large death benefit you’ve done something wrong along the way.

Estate planning does have some use for whole life style policies but most people won’t have an estate that is large enough to need to duck the estate tax and gift tax laws.