Most people would just about rather be repeatedly poked in the eye socket with a fork than to listen to an insurance agent go over the benefits of a whole life insurance policy. They also know, for the most part, that a term life insurance policy is usually better than a whole life policy, if only for the fact that you get a whole lot more coverage for a whole lot less money. As investments go, whole life insurance is at the bottom of the list in terms of what you earn.
Let’s take a closer look at why this is. Get familiar with the math of life insurance and you’ll be more equipped to make the right decisions for you and your family.
First of all, it’s important to understand the difference between what your life insurance agent tells you and what is reality. The agent will want to show you a bunch of charts that show how well the mutual funds that back your whole life policy perform. This is, in itself, probably pretty accurate. If the agent shows you a fund that has consistently earned 12 percent, you can count on it.
Unfortunately, not all of the money you put into the policy goes toward the mutual fund. A good amount of it goes to managing the policy.
Let’s assume you have $100 a month to spend on life insurance. You might find two policies: a $100 per month whole life policy and a $7 per month term life insurance policy. Each have a face value of around $125,000, but the whole life policy builds a cash value.
So, to start with, the whole life policy costs $7 for the actual insurance. You’re left now with $93 to be invested, right? Nope.
On average, it takes three years of that $93 per month to cover the expenses and commissions on the policy. After those three years, even the best policies get about a 7.4 percent return.
If, instead, you were to buy a term life insurance policy and invest the other $93 in mutual funds yourself, you would be looking at more like a 12 percent return.
There’s one last number you need to consider about buying a cash policy. If you pass away, your beneficiaries get the face value of the policy. That means even if the policy has a cash value, if that value is less than the face amount, they still only get the face amount.
Unless you’re into throwing your money away, you’re better off with a term policy and just investing the rest of your available money.
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