Cash Value vs. Term Life Insurance

There are a lot of people out there who are eager to sell life insurance to you, and they’ll be happy to tell you anything you want to hear. One of the most common “can’t-lose” products they will offer you is Cash Value life insurance, also marketed as Whole Life, Universal Life, or Variable Life. What these products have in common is an offer to put some of the premiums you pay into an investment account, so that you don’t feel like your money is just vanishing into the air.

But is that what you really need?
Who really benefits when insurance and investments are mixed together?

Most consumer advocates (Motley Fool, Yahoo!Money, Suze Orman, etc.) advocate buying Term Insurance, rather than Cash Value, based on the cost-benefit ratio. Term Insurance costs less per thousand dollars of protection. This means that the same $80 per month can be used to pay for $500,000 dollars of face amount, versus maybe one third of that if you chose Cash Value. If you die, your family would be much better off if you had term protection in place.

However, a great many insurance agents will tell you that if you don’t die within the policy’s term, that money has gone to waste and you’ll never see it again. Why not save and invest some of it, and be able to access it later in life?

Well, there are a few disadvantages to investing through your insurance company. First of all, the internal rate of return of a Whole Life policy rarely exceeds 3% over the life of the policy, and is usually a good deal less.

Universal Life has a higher guaranteed rate of return, but the fees built in will eat into your earnings over the life of the policy. Variable Life will let you invest in the market (usually in mutual funds) and get much better returns, but it can have pretty steep fees too. You have many better options, in both rate of return and fee structure, if you can shop around on the market, without being tied to your insurance policy.

One important detail that’s often buried in the fine print: with Cash Value, your survivors will receive the face amount of the policy OR the accumulated savings, but not both (unless you pay extra for a rider that allows that). In essence, you’re paying triple the cost to have two benefits, but only receiving one. You’re better off using a separate investment account which your survivors can inherent cleanly, in addition to any insurance monies they are entitled to.

Also, don’t forget the fact that if you choose to “withdraw” your savings, the insurance company will actually be giving you a loan against your account, which you have to repay - with interest! - or they will reduce the amount paid out upon death.

So why do insurance companies push this form of insurance, if it’s rarely in the best interest of the consumer?

Let’s look at their bottom line. The insurance company is going to receive your $80 dollars per month and they have two choices. They can insure you for $500,000 and if you die pay out that amount, or they could arrange to pay out one third that amount, and also earn the fees you pay to them on the investment side. In addition, while your money is in their coffers during the life of your policy, they can invest it and earn money on it themselves, AND if you should die, they pay only the face amount and get to keep your investment earnings. It’s a pretty good deal for them, isn’t it?

The lesson here is to always look at where your best interests lie while looking at the vested interests of the people you do business with. What’s best for you will generally be to find the most comprehensive term policy you can, and then use the savings in the cost of insurance to build a separate investment account for your future and that of your heirs.