By Taylor Schulte | Finance News
Before I tell you about whole life insurance, imagine for a moment that you’re going shopping for a new dishwasher. A salesman approaches you and tells you about a fantastic new product: the dishwashing car. The dishwashing car is a car with a built-in dishwasher. Just think of the possibilities: You can do your dishes while driving your car.
Now, because this product is so groundbreaking, there are a few catches. This dishwashing car is very expensive (at least compared to buying a car and a dishwasher separately). The maintenance and repairs on this new technology is also very expensive. And lastly, it doesn’t drive very well for a car. Oh and it also doesn’t clean dishes very well for a dishwasher.
But, think of the upside: You can do your dishes while driving your car!
If you think a dishwashing car is a terrible idea, don’t fret. Most people would find the idea of a dishwashing car ridiculous. Why? Because there is absolutely no reason to combine a dishwasher and a car. You’re much better off buying the two separately.
In the world of finance, there is something quite similar to the dishwashing car: it’s called permanent life insurance. You get permanent life insurance when you combine life insurance and investing into one product.
In today’s post, we’re doing a case study on permanent life insurance. There are many, many types of permanent life insurance, including: whole life, universal life, variable life and variable universal life.
“What happens when you buy a permanent life insurance policy instead of simply purchasing your investments and life insurance separately?”
There are two strategies being compared in our case study. The first is to purchase a permanent life policy. For this study, I will use data from a “San Diego” Life Insurance Company’s universal life policy. (Remember, universal life is a type of permanent life insurance.)
Now, there is no so such company called San Diego Life Insurance. In our litigious society, I can’t name the real life insurance company, but I’ll let you think about which company I could be referencing. Hint: They sell life insurance and are named after a big city.
Our second strategy is to buy term life insurance and invest the difference (also known as BTID). This is our benchmark strategy. Here, we’ll be buying a regular (inexpensive) term life insurance policy.
Term life is simply a life insurance policy. It works just like your homeowners or auto insurance policy. If there is an incident covered by the insurance policy (i.e. a death), the insurance policy pays out.
Running the numbers
Our budget for either strategy is the same: $12,000 per year. We’re spending the same amount of money in each case to either buy the “San Diego” universal life policy, or buy inexpensive term life insurance and then invest the rest of the money (BTID). However, the 20-year difference in a universal life vs. BTID strategy is over $380,000.
Why the startling difference? Consider that in the first year of this universal life policy, there is no cash (surrender) value.
Why? Because that money goes to pay for the salesperson’s commissions; insurance company fees and a cap on benefits further limit the final value of the universal life insurance policy.
For certain high net worth or high-income individuals (who have already maxed out every tax-advantaged savings option), a permanent life policy might be the way to go. However, for most people, the case study above shows that it makes more sense to purchase your investments and your life insurance separately.
Given the data, it is not surprising that many fee-only financial planners advocate for buying a term life policy, and then investing separately.
So the next time a salesperson offers you a life insurance policy that allows you to save money at the same time — make them a counteroffer — see if you can interest them in a dishwashing car.
To see the original version of this article, visit tinyurl.com/hmsx3bm.
—Taylor Schulte, CFP, is the CEO of Define Financial and the founder of StayWealthySanDiego.com and is passionate about helping people make smart decisions with their money. He can be reached at 619-577-4002 or firstname.lastname@example.org.