Everyone has their own strategy for how they invest their income to maximize long-term earnings potential. In this post, I want to talk about my experience with a whole life insurance policy. What is whole life insurance, how do the earnings compare, what was my experience, and what did I learn?
If you read my post, finding your happy place with money, you’ll know that I recognized canceling my whole life insurance as a way to improve my financial goals in the future. I was saving close to $100 a month but only building my net worth by about $60 a month through this “investment strategy.”
Full Disclosure, I am not a certified professional, but a mom with experience and interest in personal finance. Learn from me, but check with a professional to understand what will work best for you.
What Is Whole Life Insurance?
First, let’s start with a term life insurance policy that many may be familiar with. A term life insurance policy is typically much cheaper than whole life, however does not accumulate value over time. Once the policy expires, the company is no longer liable to pay out after you pass away. For example, you may pay $20 a month for a policy value such as $500,000. However, after 30 or 40 years it expires and your family won’t receive anything if you outlive the associated term length.
If instead, you invest in a whole life insurance policy, the perceived benefits are that the policy does not have an expiration date and the value of the policy grows as you age because you are investing in it. For example, you may pay $100 per month for only $100,000 in coverage, but the $100,000 increases and as long as you keep paying your premiums. It is also a guaranteed payout that does not expire by a certain age or date. The account accumulates a cash value that you can also choose to take a loan against or cash out later in life for retirement.
Sounds like a good deal huh?
In 2015, a coworker recommended that I meet with his financial advisor. Full disclosure, this financial advisor was not a financial fiduciary, so they do not need to act in my best interest, and were selling products that earn them a commission. I was pretty ignorant to all of that at the time and this guy was probably super excited to meet someone who was recently earning more than they had in the past. I had some extra earnings to buy some of their products, or as they called it, “investments for my future”.
Don’t get me wrong, it’s important to consider things like life insurance, disability insurance, IRA contributions, etc. What I learned through this experience though, was that companies are making a ton of money selling us these products. Many times they earn a commission on specific offerings so they aren’t necessarily selling us products that are in our best interest. Unfortunately, this means we may be missing out on significant earnings potential because they have an incentive to sell a product regardless of how well it will perform.
For example, this guy was all for having me buy as much whole life insurance as I was able to. It was a good investment he told me and it was a guaranteed payout. I was skeptical but still pretty ignorant six years ago. Buying life insurance when you’re young allows you to get it on the cheap, so that was a way to sign me up before I had done all my research. Luckily, I was able to convert from a term policy to a whole life policy and used that to my advantage by limiting how much was tied up buying into the whole life policy. This allowed me to avoid regret if whole life was the way to go, but didn’t suck up my paycheck that was dedicated to paying down student loans at the time.
My decision in April 2015 was to start investing in a whole life insurance policy and supplement the rest with a term policy. At the time I thought (or at least was told), that $100,000 in whole life and $400,000 in term was appropriate to support my future family that I didn’t even have yet. Since that time, my policy has reached $4,285 in cash-out value. I currently contribute about $87 per month because I recognize an annual dividend of $72. Assuming I paid $87 per month over the last 6 years, I have given them over $6,000 for this $4,285 cash-out value. While the net death benefit is slightly higher at $105,416 ($100,000 policy and $5,416 in additional benefits since it builds value over time), it’s disappointing to see how little has accumulated from that “investment.”
Let’s suggest I instead kept only the term life insurance policy, which was significantly cheaper becasue it didn’t have the guaranteed payout. I would have invested $87 per month instead, I would have over $7,700 assuming a 7% interest rate.
Ok, maybe you’re skeptical because at the end of the day you will still get a guaranteed cash payout from the whole life policy. That is what they tell you after all and $100,000 could be a pretty penny to pass down to your future generation. Let’s say that I instead invested that money for 45 years assuming I was to live until 72.
In this scenario, I would theoretically accumulate $307,776, of which $260,796 is interest alone. Considering my track record so far of accumulating less money than I have paid, I’m assuming my net benefit would be closer to $150,000. Maybe this would be higher since theoretically, this should grow with interest, but I’m skeptical that the returns are all being passed on to me. They make these policies difficult to understand for a reason, so taking the time to overanalyze this will only tell me if it’s bad or worse than bad. Let’s be honest, $72 in annual dividends is terrible considering a conservative 4% return on $6,000 would be closer to $240. Given the recent trends in the stock market, a 10% return is more realistic which would net me closer to $600 annually versus a less impressive $72.
What this means is that unless you pass away at a young age, the long-term benefits of a whole life insurance policy are pretty crappy. By covering the short-term with a term policy and investing the delta, you will accumulate significantly more over your lifetime to pass on to your children. Not to mention, you can take a loan from yourself without paying interest (unless you count the interest you won’t earn while borrowing from yourself) – double win!
What I Learned
Forcing myself to write this helped me reflect and reiterate that I need to cancel this whole life insurance policy. It will hurt to walk away with only $4,285 in cash, however, I can instead focus on investing the $87 per month and know the benefits long term will be worth it. To cover any concerns for the short term, I can keep my much cheaper term insurance policy to cover my kids until they are old enough to support themselves. The monthly cost of that policy is less than $14 per month and will cover me until I’m 80 so my husband doesn’t need to worry about my income if I pass. Not to mention the benefit is four times as much because if I live past 80, the insurance company doesn’t have to pay out. Good news for me, maybe not for my husband if he was really looking forward to that extra cash. As the premiums increase with age, I can then decide to cancel the policy when it no longer serves me, and my investments can support my family instead.
Reflecting back, it’s easy to beat myself up over a decision I made without doing all of my research. While I may have $3,000 less to my name because of it, I learned by doing, and I’m wiser because of it. I could have easily used that money for a nicer car, bigger apartment, or spent the money on clothes or other stuff that would not hold value, so my intentions were in a good place. At this stage, I’m still in the habit of putting that money aside each month but can now reallocate that in a way that should give me more long-term earnings potential.
If I was to go back and revisit the decision, I would have instead increased my contributions to my 401k because at the time I was not yet maxing out the full potential. Taking full advantage of that opportunity to invest before paying taxes and lower my taxable income would have been the more valuable decision to make at the time. Paying off my student loans with 7-8% interest would have been a good alternative as well.
Questions to Consider:
- Are you working with a financial fiduciary who has your best interests in mind?
- Are you aware of the fees and commission that you are paying for your investments in the future?
- How much can you earn if you instead invest in an index fund that returned 7% annually? 10% annually?
- Do you have high interest rate debt that could be paid off?
- If you’re risk-averse, what if you instead contribute those dollars to paying off your mortgage early? What is the interest rate on your mortgage?
- How much life insurance do you need and for how long? Will your spouse or children need life insurance if you were to pass away in the next 5, 10, 20, or 30 years?
- If you are investing in accumulating wealth, at what point will your investments replace the need for a life insurance policy?