Sunday, October 28, 2012

Whole Life Versus Buy Term and Invest the Difference

Age

Premium

Value

Death

Premium

Investment

Value

Death

33

4800

0

403081

552

4248

4432.309

504432.3

34

4800

0

406376

552

4248

9211.224

509211.2

35

12000

10250

416972

552

11448

21876.24

521876.2

36

12000

22016

428221

552

11448

35531.66

535531.7

37

12000

34850

440538

552

11448

50254.93

550254.9

38

12000

48445

453615

552

11448

66129.56

566129.6

39

12000

63227

467881

552

11448

83245.59

583245.6

40

12000

78955

483092

552

11448

101700.1

601700.1

41

12000

95934

499553

552

11448

121597.7

621597.7

42

12000

114949

518051

552

11448

143051.4

643051.4

43

11223

135690

538275

552

10671

165372

665372

44

10620

157664

559732

552

10068

188808.9

688808.9

45

10620

181318

582869

552

10068

214078.6

714078.6

46

10620

206950

607984

552

10068

241324.3

741324.3

47

10620

234770

635287

552

10068

270700.7

770700.7

48

10620

264864

664864

552

10068

302374.3

802374.3

49

10620

296943

696943

552

10068

336524.8

836524.8

50

10620

331612

731612

552

10068

373345.9

873345.9

51

10620

369133

769133

552

10068

413046.3

913046.3

52

10620

409863

809863

552

10068

455851.4

955851.4

53

10620

453985

853985

1575

9045

500936.4

1000936

54

10620

501782

901782

1575

9045

549547.1

1049547

55

10620

553473

953473

1575

9045

601959.1

1101959

56

10620

609358

1009358

1575

9045

658469.7

1158470

57

10620

669919

1069919

1575

9045

719399.5

1219399

58

10620

735505

1135505

1575

9045

785094

1285094

59

10620

806558

1206558

1575

9045

855925.8

1355926

60

10620

883446

1283446

1575

9045

932296.6

1432297

61

10620

966576

1366576

1575

9045

1014640

1514640

62

10620

1056580

1456580

1575

9045

1103422

1603422

63

0

1143823

1456580

0

0

1189709

1189709

64

0

1238855

1511403

0

0

1282745

1282745

65

0

1341551

1609861

0

0

1383055

1383055

66

0

1304978

1581027

0

0

1337013

1337013

67

0

1267837

1550996

0

0

1287369

1287369

68

0

1230983

1520603

0

0

1233844

1233844

69

0

1194144

1489327

0

0

1176133

1176133

70

0

1157463

1457112

0

0

1113909

1113909

71

0

1121188

1402368

0

0

1046819

1046819

72

0

1085612

1343205

0

0

974482.2

974482.2

These tables are based on a whole life insurance policy illustration given to me on June 24th, 2012. The first Premium, Value and Death columns represent the Premium, Cash Value and Death Benefit of the $400,000 Whole Life Insurance policy with an increasing death benefit. The second Premium, Investment, Value and Death columns represent the effect of purchasing a 20 Year $500,000 Term Life Insurance policy with Primerica and investing the difference into an investment account.

  • Assumes a 7.82% Interest Rate
  • Whole Life Premium = Term Life Premium + Investment
  • At age 66, annual withdrawls of $143,014 are made
  • LV(M) = LV(M-1) * 1.0782 + sum (n=1,12) [ (LI(M)/12)*(1+.0782/12)^n ]

LV(M) stands for LifeValue and represents the value in the investment account after the Mth year for the "Buy Term and Invest the Difference" strategy. LI(M) stands for LifeInvestment and represents the value being invested during the Mth year. The term "sum(n=1,12)" is usually written using a capital sigma and is a shorthand notation which represents adding all the terms as n ranges from 1 to 12.

Renewable Term versus Convertible Term

Here, I assume that at age 53, I will use the guaranteed renewal aspect to purchase a new 20 year term. Then, at age 63, I will let the policy lapse. The reason I did this is to try to compare with the policy illustration which assumed no more payments would be made at age 63.

It is important to note that Primerica Life Insurance is renewable term (no need for new medical exams). Most term life insurance is convertible term, which is not good, since you only have the option to convert to whole life after the term is finished. These companies plan to hit you with high renewal rates in the future.

Theory of Decreasing Responsibility

Based on the theory of decreasing responsibility, once the kids are grown and the mortgages are paid off, the need for life insurance goes down dramatically. In general, this means that you would normally stop paying for life insurance as you get older since the rates will start to become extremely high.

Whole Life Cash Value

In a whole life policy (aka universal life, indexed universal life, variable life), the cash value is owned by the life insurance company. There are often more fees and less control than in a normal retirement account. Since premiums are paid with after tax dollars, this is comparable to using a ROTH IRA to accumulate money tax free. One might also compare the wealth transfer ability of various ROTH IRAs to the wealth transfer ability of a whole life policy, in terms of being able to avoid income tax, estate tax and probate.

Unlike using a ROTH IRA, when the "withdrawls" occur, there is a major difference between the whole life policy and the ROTH IRA. In a whole life policy, the withdrawls are loaned from the account. This means that after the withdrawls from age 66 to 72, the cash value loan would be $1,001,098, meaning that you might have to pay $40,000 or so a year to cover interest. This is used to pay for the continued life insurance coverage each year! Most people don't know this and their policy typically implodes on itself as they get older and coverage becomes more expensive. This is why I have not run the numbers out to age 121. My illustration was run out to age 121 to imply that I would have a 9.6 million cash value and 11.2 million death benefit.

Even worse is that the assumed rate of 7.82% may not even be achieved in which case keeping the whole life policy is even more difficult. The increased cost given here along with the analysis is why over 25% of people lapse their whole life policy within the first three years, after paying a lot of money in commissions and fees.

Conclusion

The conclusion is that you might wait 30 or 40 years for your whole life policy to catch up to the alternative. After that time, you will then realize that your policy can no longer handle the high cost of insurance coverage. My advice would be to do some research or ask a professional since many times these contracts may be quite complex.

Dedicated to Jerry Izu.

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