Life insurance not an investment

Life-insurance agents extol the virtues of cash-value life insurance with all the fervour of the evangelist. These policies will, they claim, provide money for your kid’s university, protect your family in case you die, cut your income-tax bill, help you retire, bail you out in an emergency, save your heirs a fortune in estate taxes and help bring about world peace. Okay, maybe not world peace. But agents do promise everything else, and more, if you purchase a cash-value life insurance policy. Can these policies really achieve all that’s claimed for them? As they say on  Ajax Street, if it sounds like too much of a good thing, it probably is. Cash-value life insurance is, regrettably, no exception.

Where We Go Wrong

While there are bewildering variations, life-insurance policies fall into one of two broad camps, term insurance and cash-value life insurance. As insurance agents are quick to note, term insurance provides a death benefit and nothing more. You pay an annual premium, in return for which your heirs will get a fistful of money should you die within the next year. What if you don’t die? Your premiums are gone and you have nothing to show for them.

Insurance agents will also point out that you often can’t renew a term policy after age 70 and, even if you can, these policies grow increasingly costly. With some term insurance, you may need to take a medical exam periodically to keep the policy in force. Depending on the policy, the premiums you pay may adjust upward every year or they may only increase every five or ten years. As you grow older and your chances of dying rise, term insurance can become prohibitively expensive. All of these drawbacks are pounded home by an army of life-insurance agents, who will then contrast these flaws with the voluminous virtues of cash-value life insurance. Cash-value policies, which are sometimes also called “permanent” insurance, come in three varieties, whole life, universal life and variable life. The policies can be continued past age 70 and they are designed so that the annual premium shouldn’t ever go up.

How do these policies manage this feat? Every year, part of your premium goes into an investment account, so that the policy gradually builds up cash value. With variable life, you can even control how the money is invested and you might opt to put part of your premiums in the stock market. Because more and more of a cash-value policy’s promised death benefit comes to be represented by cash value, the pure insurance you buy each year gradually decreases. As a result, premiums on cash-value policies don’t shoot up in the later years, as they do with term insurance. Moreover, the cash value grows on a tax-deferred basis, so there are no income taxes to be paid each year. As the cash value climbs, you can borrow against the policy and you may be able to withdraw your accumulated premiums tax-free, which could prove helpful as you grapple with university costs. You can even cancel the policy, get back the cash value and then use it to help pay for retirement. But if you do keep the policy in force, it can provide substantial estate-tax savings. If you arrange for the policy to be owned by, say, an irrevocable life-insurance trust, rather than by yourself, the proceeds from the policy won’t be subject to estate taxes.

Alternatives?

Sound attractive? Life-insurance agents, who happen to earn fat commissions for selling these policies, certainly believe so. But there are, unfortunately, a few minor problems. Like the fact that cash-value policies are horribly expensive, that you have plenty of better ways to borrow, that you probably don’t need life insurance past age 70, that you can get tax-deferred growth better and cheaper elsewhere and that you will probably never be rich enough to need the estate-tax savings, just another oversold contraption? You better believe it. Insurance agents pitch cash-value life insurance as the universal panacea, solving every problem from taxes to university funding to retirement. But while these pitches can indeed be used to achieve multiple goals, they don’t achieve any of their objectives particularly well.

The principal reason to buy life insurance isn’t to save on taxes or earn fat investment returns. Instead, the reason you buy life insurance is to protect your family in the event of your death. On that score, term insurance is a much better bet than cash-value life insurance because it’s so much cheaper. A cash-value policy might cost eight times as much as a term-insurance policy with the same death benefit. The danger is, if you plunk for a cash-value policy, you might skimp on coverage because the premiums are so steep. What about the escalating premiums on a term policy? What about the fact that you may not even be able to keep your term insurance in force beyond age 70? Big deal. By the time you reach 70, you may not  have anybody who is financially dependent on you. Your spouse shouldn’t be dependent on your income anymore, because by age 70 the two of you together should have accumulated a substantial nest egg to carry you through retirement. Very few people need “permanent” insurance. Most folks are much better off buying cheap term insurance, which after the initial medical exam, can be kept in force for as long as the policy is needed without taking any more medical tests.