Written by: Jon Luskin
Before I tell you about whole life insurance, imagine for a moment: You’re going shopping for a new dishwasher. A salesmen approaches you and tells you about a FANTASTIC new product: the dishwashing car!
The dish-washing car is a car with a built-in dishwasher! Just think of the possibilities: You can do your dishes while driving your car!
Now, because this product is so ground-breaking, there are a few catches. This dishwashing car is very expensive (at least compared to buying a car and a dishwasher separately). The maintenance and repairs on this new technology is also very expensive. And lastly, it doesn’t drive very well for a car. Oh, and it also doesn’t clean dishes very well for a dishwasher.
But, think of the upside: You can do your dishes while driving your car!
If you think a dish-washing car is a terrible idea, don’t fret. Most people would find the idea of a dishwashing-car ridiculous. Why? Because there is absolutely no reason to combine a dishwasher and a car. You’re much better off buying the two separately.
PERMANENT LIFE INSURANCE: THE DISH-WASHING CAR
In the world of finance, there is something quite similar to the dish-washing car: it’s called permanent life insurance.
You get permanent life insurance when you combine life insurance and investing into one product.
There are many, many types of permanent life insurance, including:
- Whole Life
- Universal Life
- Variable Life
- Variable Universal Life
In today’s post, we’re doing a case study on permanent life insurance: What happens when you buy a permanent life insurance policy instead of simply purchasing your investments and life insurance separately?
“SAN DIEGO” LIFE INSURANCE COMPANY’S UNIVERSAL LIFE INSURANCE POLICY CASE STUDY
There are two strategies being compared. The first strategy is: purchase a permanent life policy.
For this case study, I have the fortune of using data from a “San Diego” Life Insurance Company universal life policy. (Remember, universal life is a type of permanent life insurance.)
Now, there is no so such company called San Diego Life Insurance. In our litigious society, I can’t name the real life insurance company. But, I’ll let you think about which company I could be referencing. Hint: they sell life insurance, and are named after a big city.
BUY TERM LIFE INSURANCE AND INVEST
Our second strategy is to “buy term life insurance and invest the difference (BTID).” This is our benchmark strategy. Here, we’ll be buying a regular (inexpensive) term life insurance policy.
Term life is simply a life insurance policy. It works just like your homeowner’s or auto insurance policy. If there is an incident covered by the insurance policy (i.e. a death), the insurance policy pays out.
RUNNING THE NUMBERS
Our budget for either strategy is the same: $12,000 per year. We’re spending the same amount of money in each case to:
- buy the “San Diego” Universal Life Policy, or
- buy inexpensive term life insurance and then investing the rest of the money
This post is actually borrowed from an old personal financial planning blog. If you’re interested in getting into the nitty gritty of the numbers, you can check out the original post here. For the cliff notes, read on.
Why the startling difference? Consider that in the first year of this universal life policy, there is no cash (surrender) value. Why? Because that money goes to pay for the salesperson’s commissions. Insurance company fees, and a cap on benefits further limits the final value of the universal life insurance policy.
For certain high net worth or high-income individuals (who have already maxed out every tax-advantaged savings option), a permanent life policy might be the way to go. However, for most people, the case study above shows that it makes more sense to purchase your investments and your life insurance separately.
Given the data, it is not surprising that many fee-only financial planners advocate for buying a term life policy, and then investing separately.
So, the next time a salesperson offers you a life insurance policy that allows you to save money at the same time – make them a counter-offer: see if you can interest them in a dish-washing car.
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