In our last action-packed, suspense-filled episode, we left our hero, Insurance, making another great Biblical save. We saw the Abrahamic Leader (think of him as Jimmy Olson, the good-natured innocent who, frankly, needed a bit of Super Help at times) who hasn’t banked orbit-escaping quantities of money just yet purchasing himself some Insurance (specifically, life insurance). We saw why he’d call upon his Super Buddy, how much life insurance he’d need, and for how long. (An aside: the mere fact that we discussed “how long” means that we were talking, in that article, about term life insurance. “Term life insurance” is a specific kind of Insurance Hero that pays you a fixed amount if you happen to die during the next X years, in which that X is your TERM. If you die in X+1 years, you get nothing. In that way, Term Life Insurance is not, sadly, more powerful than a locomotive.)
There is a stripe of insurance that we have foreshadowed discussing that will pay you the death benefit whenever you die (so long as you’ve kept up your premium payments) and it even accumulates cash value over time so that you can borrow against it or just trade it in for bricks of cash if you choose. This strange being from another planet is called “Permanent Insurance”. Permanent insurance includes things like whole life insurance, universal life insurance, and a few other less-popular products. Sounds like an amazing idea, right? Well before you pounce, let me say up front that I’ll be advising most of you to avoid this particular guy… yet there are a few of you who should absolutely put him on your squad.
“How,” you ask, “is a Jimmy Olson supposed to divine which category he falls into, and whether he should befriend Permanent Insurance?”
He reads onward and stops trying to rush me. Sheesh.
Quick Caveat: this family of Insurance-related articles are, admittedly, just skimming the surface of many topics. If you’re already years into one of the policies described below, and are wondering what you should do, OR you’re one of the folks who I say needs to consider permanent insurance, I recommend a (free, no strings attached) personal chat. Hit me up for that purpose by following the link at the bottom of this article or, heck, find yourself another qualified financial planner, as final recommendations on this topic can get quite case-dependent. But for most of you, I’m hopeful that this primer gives you a great handle on the topic of term versus permanent insurance.
There is a time for everything (even permanent insurance), and a season for every activity under the heavens. Ecclesiastes 3:1
Jimmy, I know what you’re asking. You’re a crack reporter and you want to get to the bottom of Insurance’s many identities. I dig it. Ask good questions, Jimmy, and you’ll get good answers.
“Well gee whiz, WHO IS… Permanent Insurance?”
I hear ya, Jimmy. First off, permanent insurance – which includes products like whole life insurance and universal life insurance – combines savings and investment with insurance coverage. If you’re already unsure that you’re going to make it to the end of this article, then you can just jot down our thesis statement right here:
We believe that investing and insurance are both important and good, but it rarely makes sense to combine the two objectives.
How does combining insurance and investing work? Well, as you pay into these policies (you can pay your premium, or more than your premium), they build up cash value above just the normal death benefit that, say, term life provides. With that cash value, you could do any of 4 things:
- Depending on your policy, you could invest it in stuff like stocks and bonds, chosen by you, or
- You could use it to pay your regular premiums (meaning: you could eventually stop paying premiums altogether if the cash value of the policy was growing large enough that the interest you gained covered your premiums–that would be pretty sweet), or
- You could just keep building up the cash value in the policy as an asset- basically, a glorified savings account. Lastly,
- You could (generally) take out loans against the cash value of your policy.
You should know up front, Jimmy, that this Permanent Insurance character, because of his unique properties, is going to run you WAY more on a monthly basis than a term insurance policy with the same death benefit. It’s just… that’s how it is, son.
“Golly… why do people call upon Permanent Insurance, anyway?”
I like how you’re thinking, Jimmy. First off, they buy it because it was sold to them. I know this may be controversial, but I have a hunch that I could leave all you Abrahamic geniuses in a room for a few decades and charge you with designing the right product to insure your families against disaster, and you’d never come up with a product that works like the permanent insurance offerings out there. “Whole life insurance is sold, not bought”, as we say in the biz.
And I won’t lie to you Jimmy, this does get a bit personal for me. You see, my first experience with these products was as the husband of a physician trying to fend off the suits from Northwestern Mutual. High income professionals tend to be key targets for salespeople of permanent insurance because they can afford the big premiums and aren’t always interested in learning the nitty gritty details about these polices.
To wit: commissions are very different for a term life policy and a whole life policy. If an agent sells you a term policy, they’ll often receive something like 50% of the premiums you pay in the first year and then 10% of your premiums thereafter. So on a $2.5M 20-year term policy with a $1,200 annual premium, we’re talking about $600 bucks up front and then $120 every year that you keep the policy for the term. Compare that with the commissions that are paid on whole life policies, which are FREQUENTLY in the $25-50k range, up front. Which would YOU push if you were only worried about YOU?
That’s right Jimmy, you’re not crooked. I wish everybody was as idealistic as you. Many people just want money. I could zap this whole article with a freeze ray and go on a little tangent about insurance agents masquerading as financial planners while operating with no fiduciary duty to their clients. I could, Jimmy, but I won’t. Let’s leave it at: it’s sad. Let’s move on.
“Where there is no guidance, a people falls, but in an abundance of counselors there is safety.” Proverbs 11:14
“Ok so it’s sold, but… what are the selling points?”
Oh Jimmy, that’s your way, isn’t it? Always bringing us back around. You’re a journalist, son! Well, people buy Permanent Insurance:
1. To get the death benefit when their family will need it.
People buy these products because they do have real needs. They need a death benefit in case they die before accumulating enough wealth to provide for their dependents in their absence, as we have discussed in our previous insurance articles. Whole life insurance does that… but it does it very expensively, Jimmy. Often the premium is 10x what you would pay for a term policy with the same death benefit. TEN X! If you need 2.5 million of coverage, you could easily pay $2.5k per month instead of 100 bucks. The Mutants of Planet 10X are not to be trifled with.
2. To get the death benefit when they grow old and die.
But that whole life policy lasts… for your WHOLE LIFE, right?!? Well, yes. Some people buy these policies because they pay a death benefit when you reach an age where term life insurance would start to get very expensive (think in your 70s or 80s). But if you’ve done your job, you won’t be needing a death benefit at that age, Jimmy! You’ll have saved and invested well and, with the basket of assets you’ll be entrusting to your generations, nobody will be depending on your death benefit for their survival. So this is, to our eyes, unnecessary insurance, if it’s there for the death benefit.
3. Because it’s a good way to invest!
Again, the key selling point is that whole life insurance accumulates cash value over time that you can cash out, borrow against, or pass along to your heirs. (Remember that list up above, Jimmy? I know you do.) Those things are all true. But in order to know if this is a good way to accumulate wealth, we need to consider the alternatives. Comparison shopping, my boy!
Let’s go back to that price difference I mentioned earlier. Let’s say you’ve run your home and dough like a Biblical boss and you’ve got $30,000 per year (!!) to use for insurance and investment. You could go snag a term life insurance policy for $1,200 and invest the other $28,800 in the market, or you could dump the whole deal into a whole life insurance policy. If you took our advice round here and separated your insurance and investing dollars – would you be better off than if you had been building up cash value in a whole life policy AND getting a death benefit (a la whole life insurance)?
The short answer is (usually) yes, if all you’re after is the investment benefits, you can do better by meeting your insurance needs with a term policy and investing your money on your own. If you don’t believe me, ask Dave Ramsey, or The White Coat Investor.
“So why would anyone want to hire this superhero? He sounds more like a superVILLAIN to me…”
Now we’re starting to jive, Jimmy.
But the answer is that some whole life policies do offer guaranteed returns. They can be good options for people who have a ton of extra cash each month… and don’t want to risk the ups and downs of regular market investing.
Let’s assume that you buy a whole life policy early on in your career and hold it until you die (something that almost never happens, but… we’ll get to that). If you are one of the rare birds who sticks to the original plan, you’ll usually see guaranteed returns in the 2% range. But don’t worry – your unbiased agent will assure you that projected returns are much higher than the guaranteed minimum, likely in the 4-5% rage. Translated into plain terms, your total returns on this sucker when you die will be between those two numbers, probably between 3 and 4 percent. So I ask you: if you’re going to commit a rather massive chunk of your monthly income to an investment for the rest of your life, are you ok with a 3-4% return? I’m not (and you shouldn’t be, either).
And even if you feel OK about that return – how do you think the insurance companies are generating the returns on your cash value? Why, they’re investing in the very same things you could invest in yourself, but they’re adding a layer of fees onto those investments.
You can do better on your own, Jimmy- or perhaps with a good advisor’s assistance. Again, we believe that investing and insurance are both important and good, but that it rarely makes sense to combine the two objectives into one mutant being.
Of course if you surrender the policy early (that just means that you stop paying the premiums) – as 80% of all people who purchase whole life policies do – you’ll have a much smaller (often severely negative) return. It’s a sad tale, Jimmy.
“But Mr. Wallet”, you say, “I want to reduce estate taxes and I have more than $23 million dollars, or I have a special circumstance that requires a permanent death benefit!”
Jimmy! Why didn’t you say so!? Permanent insurance is JUST THE THING FOR YOU!!
Whole life or universal life can fulfill a unique need for estate planning in high net worth households or certain business planning situations. This is when a permanent insurance policy does something that no other financial instrument can do! In that case, put Mr. Permanent Insurance on your speed dial and call him early and often.
But like I said… that’s just not where most people live.
The only other time when I start to bring up permanent insurance with clients is when they are already maxing out every other tax-advantaged savings opportunity and they are still looking to save more money in a tax-advantaged vehicle. Often that means they are saving more than $100k per year in tax-advantaged accounts. If that’s you, and you’d like to save even more, then you may also want to explore permanent insurance as an option.
“Okay well… could you summarize and conclude, and try to justify this whole Superhero gimmick you’ve been using all day?”
I sure could, Jimmy. I sure could.
Permanent Insurance came from a faraway land, hatched by some insurance egghead who knows that complexity is sometimes good for sales. He has powers… that are rarely useful to normal people. Always approach him with suspicion… because he’s got tiny returns in store for you. In sum:
Whole life insurance has sharply negative returns when you hold it for a few years (or less), and low returns even when held for decades. So:
- If you’re reading this and you’ve already held a whole life policy for a couple of decades, that policy might actually have pretty nice returns for you going forward. That’s to say, you’ve already done the bleeding that these policies demand in their early years. Depending on who you ask, the inflection point seems to be somewhere between 15 and 20 years. If that’s you, it may be wise to just stick it out.
- But, if you signed up 5 years ago or less, it’s almost always the right call to RIP THE BANDAID off. You still need to do your due diligence on the policy to find out what the right move for your situation is, but get to work on that because waiting and hoping for the policy to do you right is a bit foolhardy. For most, cashing the policy out and investing that money wisely elsewhere, will be a winning strategy, long term.
- As said before, if you fall into the narrow slice of our readership for whom permanent insurance is smart and helpful, just make sure you know exactly what you’re purchasing and why, and buy it from a trusted advisor.
- For the rest of you, who’re just considering your insurance and investment options, I’m here to encourage you, once again: just snag an appropriately sized term life insurance policy and proceed with the construction of your Abrahamic empire. Do it in normal ways, by living below your means, axing debt, and investing in the market.
Jimmy, there’s a lot of big bad guys out there, and I want you to know them when you see them. Not every hunk wearing a cape is your friend. But with the information above, and your own diligence, you’ll sidestep every huckster and weird investment product that rolls into town. I believe in ya, Jimmy.
Now go write yourself a great story, kid.
(Pst, kid… we are still rolling in this insurance series – check out the next installment here on disability insurance.)
*Mark Parrett is one of the founders of Abraham’s Wallet. When not blogging for you here, he’s raising a family in Salt Lake City, UT and working as a financial planner at Outpost Advisors.
