Can I interest you in a car that has a built-in dishwasher? It’s just like a regular car, but unwieldy to drive, and more expensive to purchase and maintain. Because of the machine-vehicle’s larger size and increased weight, it gets poor gas mileage. The part-car, part-dishwasher has labor intensive upkeep; each time you park the vehicle, you’re required to add soap, as well as drain any waste water. All this is in addition to the usual responsibilities of filling up for gas, changing the oil, and rotating the tires. It’s expensive; you’ll be paying bills from both the auto mechanic and the appliance technician.
It is undeniable; the automobile-dishwasher has huge downsides:
- high sticker price
- high maintenance costs
- poor performance
But, just think of the upside: you can do your dishes while driving your car!
If you’re not sold on this inane invention, don’t worry; that’s a perfectly normal reaction. Given all the downsides of owning a car-dishwasher hybrid, it makes more sense not to own this ridiculous machine. Keep your car and your dishwasher separate. This will:
- lower your cost of ownership
- enable each machine to do its own job most efficiently
Whole Life Insurance (Permanent Life Insurance) is Akin to Owning a Car That Doubles as a Dishwasher
You may not have heard the term “permanent life insurance” before. However, you’ve likely heard the names of the various types of permanent life insurance:
- Whole Life Insurance (AKA Ordinary Life Insurance)
- Universal Life Insurance (AKA Adjustable Life Insurance)
- Variable Life Insurance
- Variable Universal Life Insurance
- Indexed Universal Life Insurance
You can infer from the opening analogy that owning a whole life insurance policy (or any variation of a permanent life insurance policy) is akin to owning a car that doubles as a dishwasher, because of:
- high cost, and
- poor performance
The High Cost of Permanent Life Insurance Premiums: Whole Life Insurance vs. Term Life Insurance
Any whole life insurance, variable life insurance, or universal life insurance policy is far and away substantially more expensive than a plain vanilla term life policy. While whole life insurance, etc., can be used to care for dependents and/or manage liabilities in your absence, it is not the most cost effective option; each dollar paid into a whole life insurance policy gets you less life insurance coverage relative to term life insurance.
Of course, comparing term life insurance and whole life insurance (or variable life insurance, universal life insurance, etc.) is unfair. (Whole life insurance and its cousins offer a cash value component while term life insurance does not.) However, if pure life insurance is all you need, it does not make sense to pay the outsized premiums of whole life insurance policy (or variable life insurance policy, universal life insurance policy, etc).
Why You Should Not Choose a Whole Life Insurance Policy for Life Insurance
With term life insurance, if you die, the policy pays your beneficiaries. That’s all there is to it. And frankly, that’s all you need life insurance for. Unlike an whole life insurance policy (or indexed universal life insurance policy, etc.), term life insurance provides coverage at an extremely reasonable price: just a few hundred dollars can purchase over a million dollars in coverage for an entire year.
At the other end of the spectrum is permanent life insurance. Whole life insurance, variable life insurance, universal life insurance and their variations often end up being a better deal for the insurance company (and the insurance agent) than for the policy holders.
While the above comment may ruffle some feathers (of insurance salesmen), is it our professional opinion (as fee-only financial planners held to a fiduciary standard) that whole life insurance and its variations are rarely appropriate.
In fact, we work to get our clients out of their whole life insurance, variable life insurance, and universal life insurance policies
Life Insurance in Financial Planning with a Fee-Only Financial Planner
When we create financial planning models for our clients, we calculate a life insurance needs analysis. Or said in plain English, we run some numbers to figure out how much life insurance a client needs. Usually, clients need a lot of coverage. Fortunately, this is easily accomplished by purchasing a term-life insurance policy. Were a whole life insurance policy (or indexed universal life policy, etc.) used instead, the price tag of the policy would be prohibitive.
Rarely in financial planning do we reach the conclusion that a client should buy an expensive whole life insurance, universal life insurance, or an indexed life insurance policy. Permanent life insurance usually cannot not add value. (In rare circumstances, a permanent life policy can be appropriate – but mostly for extremely high net worth clients with particular estate planning and tax planning considerations.)
The High Cost of Permanent Life Insurance Premiums Fees
The agent selling you a variable life insurance policy will pitch these expensive products as savings vehicles; they’ll point to the tax-preferential treatment available to your ‘investment.’ (The agent does this because he makes a large commission. Term life insurance policies offer little commission.) However, know that this special tax treatment offered by permanent life insurance is no greater than can be had with:
- Individual Retirement Arrange (IRA) accounts
- Traditional IRA
- Roth IRA
- Employer-Provided Retirement Plans
- Simple IRA
- Simplified Employee Pension (SEP) IRA
What’s more, a Roth IRA account gives you supreme liquidity – allowing you to remove your principal at any time – without tax consequences. An additional distribution of $10,000 is even available to first-time home buyers. We think that this flexibility is far superior to anything offered by a universal, or adjust life insurance policy.
Further, while permanent life insurance can offer tax-deferred growth, it usually cannot do so on a cost-competitive basis. That is, while you may be able to grow your investment with a permanent life policy, you can do so much more cost-effectively via a fund in an investment account, be it a mutual fund or an exchange-traded fund (ETF).
There are many costs associated with a permanent life policy, including:
- Loading Fees
- Rider Costs
- State Premium Taxes
- Internal Insurance Company Mortality Charges
- Insurance Company Upcharges
When you avoid these charges by using low-cost investment products, you get to keep more money for yourself! Said another way, it does not make sense to purchase a permanent life insurance policy as an investment vehicle unless you have already maxed out your existing retirement accounts, like your IRA, 401(k), etc. You’re almost always best served by saving or investing with traditional savings and investment accounts.
[subtitle3] Risk Management (Life Insurance) and Investment with a Fee-Only Financial Planner[/subtitle3]
When it comes to financial planning, we recommended keeping your car completely separate from your dishwasher. We advocate for a simple term life policy. We also recommend any number of savings vehicles to achieve financial goals:
- A cash savings account with six months of living expenses
- A college savings account (529)
- A retirement savings account, like a 401(k) or an IRA
- A Health Savings Account (HSA)
- A taxable investment account
Choose simple, inexpensive term life insurance, and low-cost investment products over the variations of expensive, complex of permanent life insurance.
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If you’re unsure if a permanent life insurance policy is right for you, work with a fee-only financial planner to determine your insurance and investment needs. Without the conflict of interest stemming from the desire to earn a commission, the fee-only financial planner can work for you as your fiduciary. Alternatively, if you’re currently the policy holder of a whole life (ordinary life), variable life, universal life (adjustable life), or variable universal life policy, work with a fee-only financial planner to determine if it makes sense for you to continue paying your premiums, or walk away with your cash surrender value.
Internal Revenue Service. (n.d.). Publication 590 (2013), Individual Retirement Arrangements (IRAs). Retrieved from Internal Revenue Service: https://www.wealthanalytics.com/wp-content/uploads/2019/05/p590-2013.pdf