I still remember the day I took out my permanent life insurance policy (sometimes referred to as a whole life policy.) I was a junior in college and a friend of mine provided my name to his buddy who was a sales agent at one of the large insurance companies.
Being the money moron I was back then, which I am still working to improve upon, I was sold on the guaranteed returns (5%) the policy would provide in addition to the insurance coverage the policy provided. I thought I was so cool and responsible for thinking about my future.
In this post, I will review how I received a NEGATIVE 19% RETURN on the money I put into my whole life policy, and what I could have earned if I had instead invested the money.
If you don’t know the difference between permanent life insurance and term life insurance check out this post. Because I understand my perspective is not always right, check out this book I read and reviewed that proposes the advantages of permanent life insurance policies.
Thinking back, why did I really need the permanent life insurance policy? I was single and my debt was mainly federal student loans, which are forgiven if you die. Therefore, my parents, who co-signed on my loans, wouldn’t be stuck with the student loan bill. I didn’t have any other debts at the time; therefore, I didn’t need coverage from a life insurance policy.
Last month (January 2017), I finally stopped paying into my permanent life policy. I cashed out the cash value of the policy, which was $12,160. That is A LOT of money. However, when you consider I paid a little over $19,000 into the policy over seven years well, yeah – OOPS…
That is a negative 19% return on my money. This gets me fired up and I hope by sharing this with my readers that they don’t make the same mistake I made. The companies that sell these policies are well-known to you and I because they are constantly advertising their services.
They are able to spend an excessive amount of money advertising because they are raking folks (like me) over the coals with the fat commissions they make. These companies then roll some of that money back into advertising to target even more people. In addition to selling insurance policies, companies often sell their investment services at high fees (>1%) – much higher fees compared to low-cost index funds.
After cashing out my permanent policy, I took out a term life policy that costs SIGNIFICANTLY less. I took out this policy to cover things for my family (i.e. college for my future little one, income replacement, etc.)
Buy term insurance and invest the difference
I often see financial advisors and personal finance bloggers address questions by running a simple calculation – what if you invested the money instead of paying down debt. Or, in this specific instance, what if I bought term coverage (which is cheaper) and invested the difference? Would I come out ahead?
I did get quotes for the same amount of coverage on a term policy. The term policy over the same period of seven years would have cost a total of $1,185. I was paying double that each year in premiums for the permanent life insurance policy!!!
What could have been…
I want to share these numbers so you can see how much money this permanent life insurance policy cost me. This calculation also shows the importance of starting to invest at a young age. Finally, I knew the numbers wouldn’t be pretty. But I had no idea they would be downright discouraging.
For the calculation, I went back and compared the whole life policy and the so-called guaranteed returns the insurance company provided in their analysis to the return I would have had if I invested my money into a Roth IRA.
Why? Because a Roth IRA is funded with post-tax contributions, just like the whole life policy. I funded the whole life policy for over seven years. I even added more to my monthly contribution after graduating college!
For simplicity, I used my average monthly contribution over the seven years of $240/month to calculate my Roth return. The first row, Present Value (2017), is after seven years of investing and I am currently 29. The subsequent rows assume an additional 10 years of investment time.
For those of you diminishing the ability to get a 7% return, even with a modest 3% return, I would have had over $21,000. Like I mentioned earlier, these numbers are frustrating for me to see.
But, I am also a strong believer in learning from my mistakes. In addition, I believe in continuing education. I study finance topics by reading books, checking out blogs, and listening to podcasts – I’ve armed myself with more knowledge, which has helped me make fewer mistakes.
I hope you haven’t fallen victim to this type of insurance policy. Or maybe you have a different perspective?