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[A Note From The Author: This is the most visited post on this blog. If this is your first time here, welcome! This post has generated more hate mail and hate comments than all of my other ones combined. There are over 700 comments on it, which may take you over 4 hours to read. However, after two years of arguing with whole life insurance salesmen in the comments section of this post, I did a series of posts called Debunking The Myths Of Whole Life Insurance that quite frankly is better written than this post. I suggest you read that series instead of this post as it includes all the useful information in this post as well as in the lengthy comments below it. ]

Whole life insurance has been a pillar of income to life insurance salesmen for years. It is often recommended, particularly to high earners, as a guaranteed investment with some wonderful tax benefits. Alas, its flaws generally outweigh it’s advantages. Here’s why:

1) The insurance costs too much.

When a whole life insurance policy is sold (and they’re always sold, never bought), the buyer and seller generally focus on the investment portion of the policy, not the insurance policy. The silly buyer just naturally assumes he’s getting the insurance portion at the going rate (such as what he would pay for term insurance.) Fool. Like any business, they charge what they can get away with. If you’re not paying attention, you’d better believe the price gets jacked up. A bigger problem is that young people can’t afford enough whole life insurance to cover their actual need for insurance, so they end up buying a separate term policy anyway, or worse, they don’t and walk around under-insured.

2) The fees are too high.

You don’t pay the fees directly, but you do pay them with lower returns. For example, the commission on a whole life insurance policy is generally 100% of the first year’s premiums then 6% of premiums every year after that. That’s money that doesn’t get invested on your behalf. By comparison, the commission on a term policy is about 50% of the first year’s premiums, then 4% of premiums after that. It’s pretty easy to see what the financial incentive is. Sell whole life instead of term, and upgrade the policy at every opportunity. 100% of a new policy is far better than 6% of an old one. “But you don’t pay the commissions, the company does” argues the salesman. Where do you suppose the company gets the money from?

3) You don’t need a middleman for your investments.

Consider what the insurance company does. It takes your premium each month, pockets its profit, puts a certain percentage of the premium into a pool to pay the benefits of those who die, and then invests the rest in a relatively conservative portfolio, such as bonds. You can invest in bonds directly. Which return do you expect to be higher- the one where they shave off some profit before investing, or the one where you invest your entire lump sum? It’s like buying a load mutual fund. In fact, some cash value life insurance policies actually DO HAVE A LOAD. Can you imagine? Not only do you have to pay for an expensive insurance portion, you then have to pay just for the privilege of investing your money with them.

4) Complexity favors the issuer.

After a while, people figured out that whole life insurance was a rip-off. So to disguise that fact, the companies just made the products so complex that only their actuaries could figure them out. Even those who have spent a great deal of time trying to figure these policies out don’t understand them. Even the guys selling them don’t completely understand them, but you better believe they understand the commission structure. Suffice to say, the more complex it gets, the worse a deal it is for you.

5) Even when it works out okay, it takes a long, long time to do so.

Most whole life policies, if you hold them long enough, actually have an okay return. The returns often even beat inflation. Unfortunately, that usually doesn’t happen for a while. Take a look at this chart of the actual returns of a policy:

This chart, from the (great site by the way) illustrates 4 lines demonstrating the actual performance of the site author’s whole life policy. The solid green line is the cash value of the policy. The thin line is the total of the premiums paid into the policy. The reddish orange dashed line is the effect of inflation on out of pocket dollars, or the real total of the premiums paid into the policy. The blue dotted line is the total cash value of an investor who bought a cheap term policy, and then invested the difference between the whole life insurance and term life insurance into a good bond fund. The left axis is in dollars, the bottom indicates the policy holder’s age.

There are several things to notice. First, it took this particular policy owner 8 years just to break even, 12 if you actually consider inflation. 12 years is a long time to have a negative return. This was particularly true for me. The policy I once owned was still in the red after 7 years when I cashed it out after realizing the error of my ways. It should be noted that this policy owner has done all he could to minimize the effects of the fees. He bought a good size policy ($100K), he pays annually instead of monthly, and he bought it from a mutual life insurance company. And still, after 14 years in the policy, he is barely beating the total of the inflation-adjusted premiums and cannot even keep up with the guy who bought term and invested the difference in lowly bonds. I’m a pretty patient guy, but that’s a long time.

Now, these policies eventually do give you an okay return after 30-40 years, especially when considering that the proceeds are tax-free. Unfortunately, almost no one sticks with them that long. But if you’ve had one for many years (say, more than 10), think twice before cashing it in.

Interesting facts

  • American Financial Services Association (AFSA) is a trade association for the U.S. consumer credit industry headquartered in Washington, D.C.. AFSA’s 350 members include consumer and commercial finance companies, vehicle finance/leasing companies, mortgage lenders, credit card issuers, industrial banks and industry suppliers. AFSA is a founding...

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