I have been dealing with insurance a lot recently, and as expected, one of the insurance agents pitched a whole life insurance for my child with the usual emphasis on it being dirt cheap to get a policy. Actually, he was quite a good salesman and at one point he had me convinced that I am getting a great deal by investing $23 a month on a whole life insurance with a death benefit that goes up over time. I even picked a random number of 35 and did some quick calculation to confirm his sales pitch. Over 35 years, I would have spent $9,660 for an $84,323 policy — what a great deal!
However, I am the type of person that likes to mull over financial decisions for a while before making any move. One thing I like to do is figure out the opportunity cost of paying for something like insurance. Here’s the definition of opportunity cost from Wikipedia:
Opportunity cost is the cost (sacrifice) incurred by choosing one option over an alternative one that may be equally desired. Thus, opportunity cost is the cost of pursuing one choice instead of another. Every action has an opportunity cost. For example, someone who invests $10,000 in a stock denies oneself the interest that one can earn by leaving the $10,000 dollars in a bank account instead. Opportunity cost is not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered.
To calculate the opportunity cost, I assume that I would instead invest the $23 month premium in the stock market, earning on average 9% annually. In this scenario, the investment produces $67,661 after 35 years according to Bankrate’s calculator — so the insurance policy is looking great!
Well…there is more to it than this…
- First, we would only have to continue to invest for another 3 years for the investment to exceed the insurance death benefit.
- Second, his chance of dying before the age of 35 is quite small — based on this Wikipedia page, he is expected to live to about 77 years of age.
According to the insurance agent, the death benefit at 80 would be a respectable amount of $300,000. So, let’s run the number again using Bankrate’s calculator. What happens if he continues to invest $23 until he turns 80 assuming average annual return of 9%?
Are you ready for this?
The investment would’ve grown to almost $4 million according to the calculator. Even if he was taxed annually at 29.5%, the investment would still have grown to almost $700k — more than double the death benefit!
Of course, whole life insurance have additional benefits like cash value, and the beneficiary doesn’t have to pay federal income tax on the death benefit. But I think you’d agree that investing is about 4 million reasons better.
Pinyo Bhulipongsanon is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.
Pinyo-I love how you apply basic business tools to personal finance decisions. When you look at the long term picture whole life is a bad deal. Another way to view it is that the insurance company is in business to make money. There is a reason they push whole life so hard. The premium is based on your age and health. The younger you are the less per month you pay so it makes sense that it only costs $23 per month!
Unless whole life products have changed radically over the past few years, it’s a bad deal and a poor investment — basically because it’s an old, old product with the odds stacked decidedly in favour of the old boys of insurance. Term insurance is the way to go for risk protection — you’re right, do your investing elsewhere.
Excellent article. I totally agree. Whole life insurance is not the best way to invest your money. Excellent explanation.
I’m not an insurance agent. However, it may not be as bad as you think. First, why would you pay for an insurance policy for your son when he’s 35 years old? He should have his own insurance by then. If you make him the owner and pay the premium right from the start then a more likely scenario is that at age 25 he gets married and you give him the policy to pay. Now he starts paying the $23/month which is probably substantially lower premium than he would pay if he took out his own policy for the… Read more »
I really enjoyed the breakdown. Ultimately, the purchasing of peace of mind is an intangible that is difficult to measure, but on a purely financial basis the death benefit is certainly the clear loser. Looking forward to hearing what you decide in the end.
if your child dies, you likely will not want to work, but you will also have that bank account that covers that time off. When your child is an adult, he can do something else with that money, fund retirement and put a beneficiary on the account that will get it when he dies. You can keep a small portion of what you saved for him in an berevance account for yourself to take time off for any deaths in the family. (your parents, children, siblings). In the meantime, when everyone is healthy and young, I agree that saving the… Read more »
I’m not an insurance agent either. But whole life insurance is a product that I love. It is the backbone of our financial plan. The problem with whole life insurance is that many people don’t understand it…even insurance agents! There are many “living” benefits to whole life that many don’t know. For example, you can access your cash value whenever you want tax free, it is protected from creditors in most states, there is a guaranteed rate of return, and velocitizes your money. Can a 401k provide any of that? No. Best of all, you can create your own personal… Read more »
Ok so with a whole life policy you are paying for two things: 1. Insurance death benefit and 2. Cash value. If you die you get only one…the death benefit. The cash value goes to the ins company. Now in the above example where you they say you can access your cash value at any time, tax free…that is exactly right. However what they failed to mention is that the insurance company requires you to pay interest on any money you borrow from your cash value. You must pay the ins company interest for borrowing your own money! God forbid… Read more »
You’re right, term life insurance is cheap and there’s a reason. Less than 1% of all polices ever pay a claim. The time to get your greatest return with a term policy is if you die on the way home from signing the contract. So, do you think term policies make them a lot of money? And you’re not borrowing your own money when you take out a policy loan. You borrow from the life insurance company and your cash value still earns interest. So, as you’re paying back the balance with interest on a decreasing balance, you’re earning compounding… Read more »
How’s that “opportunity cost” thing working out for you now? You shouldn’t have assumed an 8% annual return. Funny thing is….my whole life policy actually increased in value this year. my IRA and all my other investments have taken a huge hit that will take several more years to recover. In fact, my whole life policy premium was $1,200 and the dividend payment from the insurance company was $1,750. I guess in a way my life insurance premium is tax free! (you might have to really think about that) 🙂
As with most financial advice, there are no simple solutions. When a colleague (or blogger) tells me I am wasting my money on whole life insurance premiums, it gives me pause-am I stupid or just cautious? Yes, we considered the expense and loss of commission to the agent in the decision. We are fortunate enough to be able to afford the premium and are willing the spend the money on the peace of mind. Pinyo makes unrealistic assumptions on the stock market as 8% annual returns are absolutely unattainable in the evolving global economy. Furthermore, if you think the bond… Read more »