Many times after I complete an insurance analysis for a client and it’s time for them to purchase a policy, they will ask me, “Can we just buy the policy from you?” The answer is always, “Sorry, no.” I could go out and get my insurance license to sell insurance products, but then I wouldn’t be considered a “Fee-Only” advisor anymore since I’d be making a commission on the sale. The reason I want to remain fee-only is so that my clients know I am only recommending what’s truly in their best interest; I don’t benefit monetarily from them purchasing their insurance. This scenario happens most often when it involves life insurance. Typically, clients come to me having been sold a cash value life insurance plan that they don’t need, and it’s up to me to break the news to them that all they really need is a term life policy. This article will discuss some of the differences that your insurance agent may not tell you between cash value policies and term life policies.
First, let me clarify that cash value life insurance includes whole life, universal life, variable life, and return of premium life. Term life insurance can be issued for 10, 15, 20, 25, or 30 years with guaranteed level premiums. Term life policies are much less expensive than cash value policies since they are solely for the purpose of insuring the policyholder during a certain time period. Cash value policies are much more expensive since they provide coverage for those who want insurance coverage their whole life.
Problem #1 – If the term life policyholder saves the extra money they no longer have to pay in premiums for the whole life policy, and uses that money to become debt-free (or for investing if already debt-free), they won’t need insurance for their whole life. Life insurance is only needed for as long as a premature death would put a financial strain on the policyholder’s family. The only reason someone would need life insurance for their whole life is if they plan to always be in debt and unable to meet the obligations of their family.
Problem #2 – Insurance agents are quick to point out that cash value plans provide flexibility and forced savings for retirement, education, and emergencies. The problem with that is there are better investment options for all of the above scenarios. It is very easy to setup automatic contributions into a 401k or IRA. You’re most likely also getting “free money” (company match) by contributing to your 401k. By using a 529 to save for college expenses, most states allow you to deduct your contributions up to a certain amount. And finally, it is extremely easy to setup a taxable account with unlimited investment choices to save for emergencies, where as your investment choices are limited within the cash value plan. In summary, better investment options, tax benefits, and rates of return can all be accomplished by investing in traditional investment vehicles. A life insurance policy should be just that – an insurance policy – not an investment vehicle.
Problem #3 – If you’ve been sold a cash value plan, chances are you were given data that shows why a cash value plan makes sense as an investment. However, there are a couple issues that the agent usually “forgets” to tell you. First, the returns they present won’t take into account the added interest that you are continuing to pay on your debt since you’re unable to pay it off more quickly due to the more expensive premiums. Second, if you ever need to borrow from the cash value, you are required to pay interest to the insurance company. Why would anyone pay interest to borrow their own money?! If you withdraw the money instead of taking a loan, and you don’t repay it back to the policy, your death benefit is reduced. And now for the most disturbing fact that hardly anyone ever knows – When you die, only the policy’s death benefit is paid to your beneficiary. The cash value savings that you have built-up is used to pay your death benefit; your beneficiary doesn’t get it in addition to the benefit. Here’s an example: A cash value policy has a death benefit of $500,000, with a cash value savings balance of $100,000. When the policyholder dies, the beneficiary doesn’t get $600,000. The insurance company only pays the death benefit of $500,000, essentially pocketing the cash value savings and using it to pay the death benefit. Doesn’t exactly seem fair, does it?
The problems above all underscore why it is my philosophy that everyone work to become debt-free, have an emergency fund, and use high quality investment vehicles to build their wealth. So what can you do if you have already bought a cash value plan? Everyone’s situation is different, so it’s important to have an analysis done by an unbiased professional. However, more often than not, it makes sense to “stop the bleeding” by terminating the policy (even if there is a surrender charge) and get into a term life policy.
If you or someone you know would like an analysis of your current life insurance policy, please call me to schedule your free consultation – 913.402.6099.
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John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.