Just last year I had the fun experience of learning how to play roulette my real life version of the movie The Hangover. I had a great time and may play again for fun, but if that is the last $20 I lose at a roulette table I won’t be sad about it. As you probably know when you go to a casino the odds are never in your favor. If you play long enough you will lose money and the casino will profit. Insurance companies work under the same basic premise, but instead of offering you entertainment they offer to moderate the risks in your life so that if you have a true catastrophe you have some sort of coverage. In exchange for the coverage of your family not starving if you die they charge you money every year and you both move on hoping that you don’t die. However, not all insurance products are the same. Before you buy any kind of life insurance there are some important things you must know.
The Sales Pitch
A reader was recently approached by an insurance salesman about converting his Term Life Insurance into Permanent/Whole Life insurance. Below is a snippet of the illustration he was give. The numbers look really nice, but I wanted to do a side by side comparison with buying Term and investing any savings in taxable investments. That just means that instead of him giving the insurance company $1,761 a year for a Whole Life Policy what would happen if he gave the insurance company $249 a year and invested the rest in the stock market and paid taxes every year -oooh scary!
An Uneven Match
Because many people don’t have the guts to go 100% into stocks – yeah that’s right I said it – I have done this historical simulation as though this 31 year old man bought a 30 year $150,000 death benefit term policy for $249 a year and put half of the remaining $1,512 into the stock market and the other half into one of the most boring investments around, 10 year government bonds. Then I made estimated adjustments for yearly taxes on the earnings. At the end I am assuming the individual doesn’t liquidate the Whole Life Insurance Policy or the Taxable Investment Account, but if he did they would be subject to similar taxes.
Now there are obviously 1,451.59 ways in which the tax scenario could be different. For example, you could contribute part to a Traditonal IRA, a Roth IRA, a 401k, buy no dividend stocks, buy only dividend stocks, have high turnover mutual funds, making policy loans, and 1,444.59 more ways. Despite what you may be told these are not going to drastically change the concept of these findings. Which is that if you gamble more at a casino you lose money and if you buy more insurance than you need you lose money. If you want to address any particular scenario just use ask me.
As you can see I have condensed the table to match the age of the insured and set the start year to 1954 so the end year would be 2018. Now if I did a different set of years there may be some rows to the table where the Whole Life policy did better but there are not many and again doesn’t change the concept that if you buy more insurance than you need it is like investing your money at a casino.
Just like a casino, insurance companies have to charge the average person enough so that when they have to make a big payout to a few individuals they can do it and still be profitable. So, it is in your best interest to only give insurance companies as little money as you need to in order to get your financial risk to an acceptable level. Whole Life policies are often like being forced to gamble at a casino over and over again. That is why I almost always recommend Term Life Insurance. There are a few exception when permanent policies are good to get or keep, but they are very very rare.
As a part time job I actually do sell Term Life Insurance for Primerica. If you know you need to get life insurance or have been presented with a whole life, universal life, or any other type of permanent life insurance I strongly encourage you to reach out to me and share some of the details like the reader who supplied this example. I would be more than happy to help you go through the numbers on any illustration. I can also give you a quote for Term with some tips on other places you can shop for Term that may or may not be cheaper than what I can sell you.
Just Not Enough Time
I like to keep my posts short since I know you all have things to do, but because of that I have to leave lots of details out. For example, what would happen if the great depression had occurred during this simulation. Well you can check it! Below is a link the the excel sheet I made to do the calculations and you can use it to change the stock allocation and the start year.
I also want to give a shout out to NYU.edu whose simplified stock market data I have referenced multiple times.
That’s it! Leave a comment or a like!