Whole life insurance is based on a simple idea... the idea of life insurance with the extra amount that you pay for going to a savings/investment account that will build a cash reserve. The idea starts out right but as most of you know companies make them complicated... its human nature. Lets look at a simple graph so you can get a better idea of the way it works.
As the graph shows... Whole life can start at a bargain. If you start early enough a whole life policy can, price wise, compete with most policies. The premiums are level and will never change as long as you keep it going. The price may be a little more expensive then say.. term insurance but the extra you're paying should be going to a Cash Value account that has some interest on it. The savings side is, according to the government, suppose to be invested. Most insurance companies will invest it in high rated bonds, this will give them safe growth. The problem and upside, depending on how you look at it, is that its a fixed rate. So for example... you may receive, depending on the insurance company and rates, anywhere from 1%-6%. This is a way better return then a bank that's for sure. Lets get a better feel for what that 1%-6% is really doing for you. A simple way to get a ruff estimate of how long it takes money to double is called the rule of 72. This rule is simple... if you take the constant number 72 and divide it by the interest rate you are receiving, you will get the approximate years it will take your money to double. Lets look at an example, if you have $1 in the bank and according to CNN Money (http://money.cnn.com/2013/10/01/pf/savings-account-yields/) the average yield is 0.06%. What that means is at that interest rate will double your money in 1200 years... LOL WOW.. you might as well assume that you're not getting any interest. If you're lucky enough to get 1% then it will take 72 years for your money to double. Even at 6%, which is a world of a lot better, it will double every 12 years. The great thing is that the interest rate is guaranteed, no chance of up and downs from month to month. As long as you make the payment you get the interest on the amount that goes to the Cash Value.
The amount in the "savings" side grows tax-deferred which for some people is a great thing. That means that as long as you have the policy in-force your money gets the 1%-6% with no tax implications. The policies have an added "feature" of being able to borrow a portion of the cash value to use it in a tight situation. There are a few things you must know about doing this though. Money that is borrowed from banks, insurance companies or maybe even a friend comes with the understanding that you will repay it with.... interest. That interest amount can very from policy to policy but usually is higher then the interest they are giving you on the actual cash value. That interest they charge you is not added to your cash value... the insurance company keeps it. It's almost like having a line of credit opened up to you, and if you ever cancel/surrender the policy the full value of the Cash Value and any loans taken will become taxable. Lets not forget that the insurance company will take what you owe them out of the cash value, reducing what you actually get. OH, lets not forget if there are any surrender charges on your policy still.... that could eat up any cash value. That is not an exclusive feature of just whole life policies but most all policies that have a cash savings attached to it.
Most Whole life policies will mature at the age of 120 now a days. What that means is your policy is good till your 120th birthday. You will make payments till your 120th birthday and should you pass anytime before that, your beneficiaries will receive the death benefit. So far most of the benefits sound great, the issue comes up when you look at the little over looked stuff.
Every Policy also has fees/administration cost and what not. These fees take away from the total amount that you are suppose to be accumulating in the cash value. So if your total premium that you are paying is... $100, some of it will go to the cost of insurance, some to the fees and administration charges. The left over will then be added to the cash value. You must ask, after all expenses how much will be credited to my cash value. Many a person will make the mistake of assuming that 1/3, 1/2 will go towards their cash value. Don't be afraid to ask the corporate line how much of your premium is reaching the cash value. You can calculate the amount if you know what to look for in the policy, but easier to just ask. I stress, ask the insurance company customer service line. I stated above, the contract is between you and the company not you and the agent.
When you have a whole life insurance policy you must take into account that in the event of something happening to the insured, your family is faced with the option of either the cash value that has been saved up to that point or the death benefit. This keeps the insurance companies liability low since they take the cash value. An example would be... lets take someone who has had their policy for 25 years... faithfully paying, never missing a premium payment and has not taken a loan out of it. They have a $100,000 worth of coverage and have saved up... $30,000 in cash value. The unforeseen happens and they pass away, The beneficiary will face the simple yet unfair choice of receiving the $100K death benefit or the $30k cash value. Any person will take the 100K over the 30K, what they fail to take into calculation is that the insurance company now only has to come up with $70K to pay out. So you as the policy owner were paying the same premium payment the whole time but the value of the death benefit in a way was decreasing as you build up your savings. So your premium for the coverage, to the insurance company, has increased in a sense. Some insurance companies have added the option to have both if you ask for it, but at an added cost.
The another draw back of this type of policy is the guarantee that people love to have. You see the average return of the S&P500 if you take the CAGR rate which is the true return or annualized return since 1871 to the end of 2013 was a hair over 9% (Some may say that's not fair because its a huge time frame but in a realistic time frame say 50 years ago.. its 10.22%). So if you are locked in at a 1%-6% return you're in essence leaving 3% on the table. While 3% may not sound like a lot, a 30 year old who has this policy till he passes at say 80 will leave ruffly $130,000-$690,000 on the table if you were investing $100 in a fund that mirrored the S&P500, depending on the fixed rate you're getting. The question arises, but were do I find the other 3% but all in good time.
I believe that you should ask a few questions in this type of policy... #1 What is the interest that my money will be earning in the cash value after all fees and administration charges? #2 How much of my monthly premium is going into my cash value? #3 Are there surrender charges and if so how much and for how long are they in place? #4 If I had to take a loan out, how much interest would I be charged? #5 Are there any exclusions/suicide clauses that I need to know about? #6 In the event that I pass, does my family/beneficiaries get the death benefit and the cash value? If you ask these questions, you will get a much better picture of what you have and what to expect. IF you're one of the many people that do not have life insurance and are reading this, do not rush into buying one. Especially after just reading this one blog, there are another 3 to come. Next blog we will cover the Life insurance know as Variable Life, till then and like always... if you have any questions or clarifications you may have.. Just ask. Till then Web World....
AXI C.
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