Buy term and invest the difference?

[Peaceful_Warrior]

Background:
- A year and a half ago, I bought a Whole Life policy. Current cash value is maybe a few hundred bucks at most.
- I intend to retire in my 40's (I'm 29 now).
- I contribute heavily to 401k, Roth IRA, and also to Vanguard Total Stock Market Index fund, as well as some other bond-like investments returning about 9-11%.

Present situation:
- I'm trying to decide whether I should drop the policy, then buy term and invest the difference. My instincts tell me to drop it, but my logical mind wants to see the numbers that justify the decision.

Challenge:
- Does anybody have a worksheet that they've used to calculate exactly which solution will have more assets? (at say, 5 years, 10 years, 15 years, and 20 years)

Without looking at concrete numbers, it's near impossible to compare these two strategies since they seem to fit different needs for people... I'm just trying to figure out which one makes the most sense for me.

 

[2B]

You don't need a worksheet. The interest rate you were led to believe you would get when you bought your policy was way too high. I know from personal experience. It hasn't been very long but compare your current cash value with what you were given when you decided to buy the policy. I held my Northwestern Mutual policy for about 5 years before I did that and it was not even close. I could have grown the money faster in money market.

I hate to link this to annuities but the same person that sold you the whole life policy would love to sell you one. That tells me all I need to know.

2B

 

[LOL!]

We have never bought life insurance even with two kids. By the time we had kids, we were practically self-insured. Our jobs provided some life insurance and now in our 40's, if either one or both of us died, it would have no financial impact on the living. Don't forget that social security provides survivor's benefits that can be significant.

I'm not recommending that you go without life insurance, but you might be surprised if you are an uber-saver (i.e. can retire in your 40s) how you can become self-insured.

 

[Peaceful_Warrior]

The rate on the policy comes out to around 4%-5%. As the policy matures, the dividends get re-invested to purchase paid-up additions, which then increase the death benefit and the cash surrender value.

So it's not exactly black and white. Also, have to take into consideration the fact that loans can be taken from the cash value tax-free (and then the death benefit is reduced by the amount loaned), whereas anything I invest will be subject to the capital gains taxes (since I already max my 401k).

Then there's also to be factored in the present value of the future cash value. And then two numbers also need to be compared -- the guaranteed cash value, and what I believe the expected cash value to be (which will be less than what they show on their projections).

And I'm guessing there are other things as well that I haven't considered, but I have yet to find a complete worksheet on this and was hoping maybe somebody on here had already done this math or would point out additional things I need to consider in the bare-bones one I've already started.

You don't need a worksheet. The interest rate you were led to believe you would get when you bought your policy was way too high. I know from personal experience. It hasn't been very long but compare your current cash value with what you were given when you decided to buy the policy. I held my Northwestern Mutual policy for about 5 years before I did that and it was not even close. I could have grown the money faster in money market.

I hate to link this to annuities but the same person that sold you the whole life policy would love to sell you one. That tells me all I need to know.

2B

 

[2B]

PW,

Your answer confused me. What I read was full of promises and hopes. You can probably get a 20 year term policy for a small fraction of what you are paying for your whole life. The "left over money" can either finance a great vacation this year (which I suggest if all of your other tax deferred savings routes are fully funded) or increase you savings into a tax friendly investment like an index fund.

Whole life is not a good investment.

I have to admit my son in law bought a whole life poicy. I gritted my teeth and didn't say a thing since my daughter told me about it and said she told him that I would not recommend it. When my former valley-girl daughter listens to what I've said, that in its self is a victory.

 

[73ss454]

2B is right on the money.

18 years ago I bought a whole life policy. The agent said if I paid 7K a year for 10 years I would never have to make another payment. (500K) When the 10 years ended I thought I was paid up. Surprise, the policy didn't make enough interest and I paid for another 4 years. Then 2 years ago I got another bill for a lesser amount and last year I paid 4K. At 58 I will cash it in this year and invest the cash value.

For me anything that has anything to do with an insurance company is a rip off.

Keep banging away about the annuities also 2B. I'm sure most of the folks on this board see the danger with insurance companies but maybe you'll save a few. Others will never get it.

 

[samclem]

There's a guy selling a calculator that is supposed to do this comparison. I costs $20. I don't know if it is any good, but he has a demo you can look at.

http://toolsformoney.com/buy_term_invest_difference_calculator.htm


Or, you can send me just $10 then read the next line.
*******************************************************
Term insurance is a better deal. Buy term and invest the difference--you'll save a lot of money.
*******************************************************

I paid premiums on a Universal Life policy for about 8 years because I thought the tax benefits would make the relatively low return worthwhile. Nope. When you consider the relatively low return, the relatively high cost of the actual insurance coverage offered, and the available ways of reducing taxes on the money you'll invest, it was clear that term insurance was a much better way to go.

 

[sgeeeee]

. . .
Or, you can send me just $10 then read the next line.
*******************************************************
Term insurance is a better deal. Buy term and invest the difference--you'll save a lot of money.
*******************************************************
. . .

I'm willing to sell you this advice for only $9.

 

[Peaceful_Warrior]

I already have the advice.... I want to see the actual numbers.

The link to that calculator below was pretty much exactly what I'm looking for. Dunno if I can put that together myself or not with where I've started. Though the $20 is probably worth the time I'll spend trying to figure out the #'s myself.

I'm willing to sell you this advice for only $9.

 

[2B]

I already have the advice.... I want to see the actual numbers.

The link to that calculator below was pretty much exactly what I'm looking for. Dunno if I can put that together myself or not with where I've started. Though the $20 is probably worth the time I'll spend trying to figure out the #'s myself.

The problem with the calculator is that the numbers you put in will be based on what the salesman gave or told you. You will not achieve what you think you will get in buildup of cash value.

My advice is so sage-like I want $30.

 

[Peaceful_Warrior]

I'm not sure it matters what the salesman told me actually... when I look at the numbers (so far).

Here's the first run-through on the spreadsheet... I'm curious about anything I'm missing in the calculations or if my logic is wrong.

http://www.Spiritual-Short-Stories.com/misc/BTID_PW_v1.xls

The problem with the calculator is that the numbers you put in will be based on what the salesman gave or told you. You will not achieve what you think you will get in buildup of cash value.

My advice is so sage-like I want $30.

 

[rmark]

Whole life is really nothing more than term insurance + an investment account. So yes, buy term life and invest the rest yourself, cutting out the insurance company middleman. A noted above, the amount credited to your account often doesn't offset future insurance costs as intended.

 

[ERD50]

I'm not sure these posts are addressing the OPs question. Yes, term makes sense over whole life.

But the question is (as I read it) if you *already* bought the whole life, how do you decide if you should cash it in or not. Is the answer the same, or do you need to take other variables into account? Or, are they all just 'sunk assets' at this point?

I'd bet many of us are in this boat. We bought whole-life policies before becoming educated (count me in). Mine is small enough, I don't worry about it too much, I've let the dividends pay the premium for the past 15 years or so.

-ERD50

 

[ats5g]

Peace,

Peter Katt has some articles that may help with the modeling or decision.

- Alec

 

[brewer12345]

Get policy illustration, stick t he numbers into a spreadsheet and model an alternative investment with your money. Its not hard. When I did it about 5 years ago, there was no way an attractively priced UL policy could keep even with a CD.

 

[samclem]

. I'm curious about anything I'm missing in the calculations or if my logic is wrong.

http://www.Spiritual-Short-Stories.com/misc/BTID_PW_v1.xls

PeacefulWarrior,
The calcs and assumptions in your spreadsheet look good to me. I have only a couple of observations/questions:
1) Obviously, the "buy term" option leaves you with less overall death benefit for the window of approx illustration years 20-31. I'm assuming you picked a 20 yr policy because your major need for insurance will have passed by then and/or you expect growth of other assets to provide for your family. If things don't work out that way, you might find yourself needing to buy another term policy under less favorable conditions (older, possible medical conditions). This is probably a risk well worth taking (as the bottom line in your spreadsheets illustrate), but it is a risk.
2) I would have selected a more conservative assumed pre-tax rate of return--10% is probably optimistic, especially as you'll likely not be using 100% stocks in this account intended to provide for the basic needs of your family.
3) Will your estate taxes really be 50%? I think if your assets grow to this extent, you'll use trusts, gifting, etc to reduce the hit.
4) Hey, now you've got a spreadsheet to sell on the Internet! Add some colors, special data-entry examples, and graphs to spiff it up and you're in business. Cha-ching!

 

[ats5g]

fyi - cost of $250,000 term life insurance for a healthy 27 year old is b/w $150-200, not $610. See quickquote.com

Also, the way I thought whole life worked is that every year the insurance company takes your premium and kicks back some of that premium to you and puts it in a "cash value" account. Also, isn't the "return" the cash value "earns" based on the profits [return - policy payouts] of the insurance companies general account?

If so, then a rate of return closer to fixed income return would be more appropriate, wouldn't it?

- Alec

 

[FinanceDude]

fyi - cost of $250,000 term life insurance for a healthy 27 year old is b/w $150-200, not $610. See quickquote.com

Also, the way I thought whole life worked is that every year the insurance company takes your premium and kicks back some of that premium to you and puts it in a "cash value" account. Also, isn't the "return" the cash value "earns" based on the profits [return - policy payouts] of the insurance companies general account?

If so, then a rate of return closer to fixed income return would be more appropriate, wouldn't it?

- Alec

They're called "dividends", and are based upon how favorable the "loss ratio" was to the insurance company. Mutual companies like NML and New YorK Life typically pay much higher dividends than Prudential and John Hancock, because they don't have outside shareholders that have a say in how they run things............

Dividends are really a "return of premium" to the contract. NML has the highest dividends in the world of insurance, (almost 8% for 2007-2008 policy year), but it is due to two main reasons:

1)NML rates the HECK out of folks, sometimes for no real reason
2)Their policies cost on average about 15% MORE than other insurance companie's policies...........sort of makes it easy to pay a high dividend..........

So............imagine how GOOD a policy illustration on a whole life policy will look when the NML rep used an 8% return........... Of course, the "guaranteed" CV amount is also shown, but unless the agent points it out (unlikely), you will start drooling over the FUTURE VALUE of your contract............ : :

The SCARIEST thing I ever overheard at a Starbucks was an insurance rep telling a prospect to think of the return on his while life policy as the "fixed income portion of your portfolio"...................

 

[bright eyed]

my dad sells insurance and has said the possible scenarios include

1) if the policy doesn't attain the interest/earnings "assumed" the insurance company will "correct" it by asking you for more money - your monthly premium in fact increases or you lose the policy...as an agent he has had to call people once in a while to warn them ahead of time that this may be coming down for them (think of the bad market years) - other agents might not do that for you-

2) in those bad years, the fees of the company are not covered by the earnings so they will just charge you...

the scenarios they show you "assume" an avg % over the life of the policy - but if there are serious dips in the market you will have to pay to keep it - if you don't want to do that - you might be aging yourself out of getting a cheap term policy - so there is a risk there.

unless this is one of the policies that "guarantee" a minimum return (equity index or something like that) - which includes a maximum too - then you are just paying high fees for a poor return...

why do you feel you need whole life?

 

[Peaceful_Warrior]

Answers follow...

But first a thought: I feel like something is OFF... that I'm missing something in the spreadsheet.... but I just don't know what it is.

2) I would have selected a more conservative assumed pre-tax rate of return--10% is probably optimistic, especially as you'll likely not be using 100% stocks in this account intended to provide for the basic needs of your family.
3) Will your estate taxes really be 50%? I think if your assets grow to this extent, you'll use trusts, gifting, etc to reduce the hit.
4) Hey, now you've got a spreadsheet to sell on the Internet! Add some colors, special data-entry examples, and graphs to spiff it up and you're in business. Cha-ching!

I left the tax rate and estate taxes variable (just modify the values), so I wanted to base it on two things:
2) An investment I know brings 9-10% relatively risk free and consistently. I should probably lower this to 8% or even 7% to simulate worser-case scenario.
3) Assuming worst-case scenario on estate taxes. Realistically, I expect to shelter well, gift, and other things to transfer the wealth.
4) Not a bad idea. Though knowing me, I'll just give it away for free and let people here use it as a resource. This question comes up enough and people always give the verbal answer but don't have numbers to back it up. Now we can tell people, "Go plug your actuals in". I can write some documentation/instructions on the spreadsheet if it turns out others here think it would be used/referenced.

fyi - cost of $250,000 term life insurance for a healthy 27 year old is b/w $150-200, not $610. See quickquote.com

Also, the way I thought whole life worked is that every year the insurance company takes your premium and kicks back some of that premium to you and puts it in a "cash value" account. Also, isn't the "return" the cash value "earns" based on the profits [return - policy payouts] of the insurance companies general account?

If so, then a rate of return closer to fixed income return would be more appropriate, wouldn't it?

Correct, the rate of return is closer to fixed-income because they're just returning the premium (based on profits).

As for the $610 number, you're right. I totally messed that one up because in my tiredness I inadvertently put in what I'm paying for my $1M policy that I recently got to replace my WL.

I should update and use $235 / year instead for my 20 yr Preferred. I don't get the best rates because my dad had to go and have a heart attack before age 60 (fortunately he survived and is now in wonderful health, but still he messed up my life insurance!)

So............imagine how GOOD a policy illustration on a whole life policy will look when the NML rep used an 8% return........... Of course, the "guaranteed" CV amount is also shown, but unless the agent points it out (unlikely), you will start drooling over the FUTURE VALUE of your contract............ : :

The one that is in my spreadsheet, I think looks "good" but even then comparing it to buying term and investing the difference, it doesn't compare (as the numbers tentatively show).

my dad sells insurance and has said the possible scenarios include...

why do you feel you need whole life?

Thanks for the additional insight. I don't feel I "need" whole life. A year and a half ago I was doing financially fine, but not really serious about wealth-building and LBYM (this has been seriously increased since finding this forum).

My Dad had taken out a cheap term policy when I was younger so that I would have coverage and be able to convert to WL. So when I finally decided to take over the policy, I took his advice and got WL. However, it was a small policy, so I got another one from my insurance agent to cover the rest of my insurance needs above and beyond what I got from my company group policy.

First thing I did was drop my group term and buy a hell of a lot more term privately.

Then, as I became wiser I started realizing that maybe I got duped. I looked into it more and more and everybody says "Buy term and invest the difference" but nobody *shows* why. I wanted answers backed up by numbers so that when I go into my insurance agent's office on Friday to drop this off my policy and get a term for my wife (probably through him to keep the multi-line discount we currently get for the Whole Life), I have the background knowledge to understand clearly the decision I am making without question.

My intention is to drop the WL, but I want proof and the spreadsheet.

 

[Gumby]

The SCARIEST thing I ever overheard at a Starbucks was an insurance rep telling a prospect to think of the return on his while life policy as the "fixed income portion of your portfolio"...................

Why is that scary? Isn't the investment part of the premium like a long bond held to maturity, or rather a series of bonds bought over time and held to maturity? You are only subject to changes in the interest rate environment, not equity market volatility. (understanding that the mortality part of the remium is just a cost).

 

[FinanceDude]

Why is that scary? Isn't the investment part of the premium like a long bond held to maturity, or rather a series of bonds bought over time and held to maturity? You are only subject to changes in the interest rate environment, not equity market volatility. (understanding that the mortality part of the remium is just a cost).

I guess the "scary" part is a lecensed rep selling whole life as an INVESTMENT, something that the SEC is not too crazy about.........

 

[bright eyed]

what they also don't show you when you buy these things is how they calculate your risk for your age -

think of it as a steep hill and youth on the left, old age on the right.

as you age, your "risk" of dying increases - so the "death benefit" portion of your policy increases each year - so it eats up more of your principle. The compound interest is supposed to keep up w/ your death % so you don't have to pay more - and in fact (they say) you "should" pay less as your policy increases in value - but that has not in fact been the case in several historical periods and people have had to throw in a lot of money to float the policy or else it is collapsed by the company...

of course - if you live through less volatile markets and don't see a drop like we did before the milennium, you *might be ok...but you are still paying a *load in fees for whatever return you do get.

 

[2soon2tell]

PW

Make sure you are approved for the replacement term policy before you cancel your whole life contract. Just a precaution but you never know with insurance companies.

2soon2tell

 

[Peaceful_Warrior]

No worries there, already have my Term in place and first two-months premiums already paid.

When I drop the WL, I intend to get some 20 yr Term on my wife to cover the other side of the insurance equation.

PW

Make sure you are approved for the replacement term policy before you cancel your whole life contract. Just a precaution but you never know with insurance companies.

2soon2tell