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®.