An easy-to-understand article about all the Math involved in Whole Life Insurance.
Many people want to get permanent insurance, because it sounds great.
Having financial protection for your whole life and even after you die sounds like a plan. But it might not be all rainbows and butterflies in the end.
Let’s see why, but before that, let’s start with the basics.
A whole life insurance policy is a permanent protection policy that gives lifelong coverage to policyholders. There are two major components: a guaranteed death benefit and a cash value.
The death benefit is given out to beneficiaries only when the policyholder dies.
The cash value (which accumulates over time) can also be used by the policyholder while he is alive. Of course, for this to happen premiums need to be paid on time.
Most people are concerned about what rate of return they will be getting on their policies. And frankly speaking, that is the only attraction people have for opting for life insurance plans.
What is the Rate of Return on Insurance?
When you purchase a life insurance policy, you opt for a death benefit AND the cash value component which is also the savings account (or could be reinvested).
There is somewhat confusion when it comes to whole life insurance, because it has two important components: life insurance and an investment component.
But, when you opted for the policy, your financial situation was very different. Let’s say it worsens in the next 10 years or so and you are forced to surrender your policy because you are unable to pay the premiums anymore to keep the policy in force.
In such a scenario, the return on your whole life insurance could decrease.
Let’s fill in a situation with numbers for better explanation.
Randall is a 35 year old male, who opts for a whole life insurance.
Let’s talk about the first 30 years of the plan. He buys the plan for $1,000 each year and invests $13,000 in the stock market. We’ll accept a liberal 8% yearly pace of return, throughout each and every year, wherein Randall altogether outflanks the normal financial in value reserves, earning a yearly ROR of 3.69% in the course of the most recent 30 years.
This move is applicable to so many taxes!
Instead, if he allocates these $13,000 in the savings component, he flattens out all of his taxes.
What average do people get?
The absolute average that people get as a return on their whole life insurance is usually 1.5% for the whole life guaranteed cash value, 2.2%for the Treasuries, and 3.5% for the whole life possible cash value which is adjusted for inflation, right now at 2.2% per year.
Is Whole Life Insurance a Smart Investment?
It all rounds up to this question.
One we have the math out of the equation (pun intended), the only question that surfaces is whether whole life insurance is a good investment or not.
Whole life insurance gives you longlife protection, which means you’re insured for however long you live. And when you die, there is guaranteed tax-free death benefit. The cash value component grows over time when you pay your premiums regularly, and a portion of said cash value can be used during the life of the insured as well.
Sounds good so far.
But, let’s not forget HIGHER PREMIUMS.
This major feature of whole life insurance keeps people from opting for it, because you have to pay higher premiums (than term life policy) for the rest of your life to keep the policy in force.
To compare the two, let’s take an example.
Miranda is a non-smoker 30 year old woman who purchases a term life policy of 20 years. The death benefit is decided on $1 million for $480 per year. Let’s assume she dies at age 53 after paying premiums for 23 years. Her beneficiaries will receive a tax-free amount of $1 million even though Miranda only paid $11,040 during her life.
This is an excellent return on investment that term life insurance provides if your beneficiaries claim the policy.
What if Miranda had opted for a whole life insurance instead?
Instead of $480 a year, she would have been expected to pay $9,370 a year because of higher premiums!
After 5 years, the guaranteed cash value of the policy is $19,880 while she would have paid $46,850 in premiums.
After 20 years, the cash value accounts to $181,630 and premiums would be $187,400.
But, if she had again bought term life insurance after 20 years for $480 a year and invested the remaining $8,890 at an annual average return of 8%, she would have secured a complete $480,806 before taxes!
So there is guaranteed return on whole life insurance, that’s for sure.
There is another option though. What if Miranda had put the remaining $8,890 in a savings account with an interest of 1% even? She would have had $208,671 after 20 years which is a lot more than what the policy originally guaranteed at $181,630.
So if you really come to think of it keeping all the math in mind, do you think buying whole life insurance is a good idea? Yes, the average return is guaranteed, but wouldn’t someone be better off investing that money or putting it in a savings account?