When you’re young – say during college or in your 20s and 30s – life insurance is the least likely thing on your mind. Seriously, I’ve yet to meet a college student or recent graduate who’s given any thought to life insurance. But there are a lot of reasons why a millennial should consider life insurance:
- Rates are best when you’re young and healthy
- You have private student loans with a cosigner
- You’re getting married and want to protect your spouse or family
- You have children
If you are considering getting life insurance, make sure that you are looking at term life insurance, and not whole or any other type of policy. There are a lot of insurance options out there, and you usually have to go through an insurance broker who has a financial incentive to steer you into something that costs more than it should. You could very well end up with something more expensive than you really need.
If you’re looking for a solid place to get a term life quote, check out Ethos here and get a quote in minutes.
Term vs. Whole Life Insurance
Term life insurance is just like it sounds: it is life insurance for a set term. A term can range anywhere from 1 year up to 30 years, or sometimes even longer. On the death of the insured, as long as it falls within the term, it pays out the amount of the policy to the beneficiary.
Whole life insurance, however, takes everything you get with a term policy and attempts to add an investment component. Some of these investment components are simple money market funds that accrue interest, but others invest in bonds or seek to mimic indexes like the S&P 500. The policy builds a cash value in this investment component which you can borrow against or cash out after a certain time. The most common types of whole life policies are traditional whole life, universal whole life, and variable whole life.
Whole life insurance is more expensive because you’re not only paying for insurance, but you’re also paying for the investment portion. In almost every single scenario, the amount you pay into a whole life insurance policy will never equate to the benefit you receive. No matter how much the investment portion grows, the insurance company will still take their fees. As such, it’s almost always better to keep life insurance as term insurance, and invest the other money in the stock market.
The Life Insurance Math – Why Term Life Insurance Is Better
Let’s look at a 25 year old male, excellent health, and non-smoker. The policy is for $1,000,000 for a 30 year term.
For a term policy, you would pay about $80 per month, or about $960 per year (this, of course, varies based on a lot of factors, but it s good estimate).
For a traditional whole life policy, while rates and accounts vary greatly, you can see a premium payment of around $250 per month, or $3,000 per year. Remember, this is much more expensive than a traditional term life policy.
Let’s just look at the difference between these two policies. The term policy has no cash value, but you get to keep the difference in the premium you would have shelled out for the whole life policy ($2,040 annually).
After 10 years, the cash value of the whole life policy would be roughly $28,000. This money is also after-tax, since this is insurance and not simply an investment.
After 10 years, if you just invested the difference between the policies, you’d have a before-tax investment value of $36,321, assuming a 8% rate of return. Even if you include taxes at the 28% rate, you would still see an after tax return of $31,691. This is over $3,000 more than the cash value of the whole life policy.
This works out in almost every single scenario. Where does that extra money go? Into the pockets of the life insurance company or their salesmen as a commission.
A Look At What Really Bad Whole Life Looks Like
Of course, some policies are worse than others. And we love showing math, so we wanted to share what a really bad whole like policy looks like.
This policy is from a major company in the space. It was issued in 6/2012 – so as of this update, it’s almost 7 years old. The reader is 40, male, healthy, and got the policy then at 33, when he was probably even healthier!
It’s a guaranteed whole life policy until age 99. It has a current death benefit of $1,551,262, with a current face value of $1,549,562.
The monthly premium is $1,982.72.
This reader has been paying his policy for 79 months – so he’s paid a total of $156,634 for this policy.
Guess what the current cash value is in February 2019? Just $88,459.
That’s almost a -40% return of the past 7 years…
The argument of most insurance agents is “well, you’re getting more than life insurance! You’re getting an investment as well!”
So, if you want to separate the two – he has $88,459 in “investments/cash value” and paid $68,175 for a $1,500,000 insurance policy.
Any way you slice this it’s bad. If you wanted to get a $1.5 million term life policy, this reader would probably pay about $115/mo in a worst case. So, in the same 79 months he’s had the policy, he could have had the same insurance coverage for just $9,085. That’s a $59,090 difference!
I’m also assuming that he got a 0% return on his investments – because if you start changing the math on the life insurance portion, the return goes negative quickly!
And remember, we’re talking about the stock market from 2012 to 2019 – on of the longest bull markets in history! And a 0% return at best (likely negative though). I just shake my head here.
What You Need To Know About Whole Life Insurance
It is also essential that you keep this is mind: term life is simple – a straight term, nothing fancy. But whole life is a complex instrument that is designed to return more than a term life policy to the insurance company. Our friend Todd at Financial Mentor wrote an amazing guide to try to highlight the complexities of whole life insurance. It’s 10,000 words long (because whole life is so complex), and it basically sums up why whole life is a bad deal.
Since it is complex, you also have to speak to an insurance representative to even get a quote, and policies vary widely from insurer to insurer. The most easily compared metric on whole life policies is the internal rate of return (the yield on the policy minus fees). With a little analysis, you can figure out if the policy will provide a decent return, and you may even be able to figure out the minimum cash value at any given time.
For warning, a whole life policy usually doesn’t even yield a worthwhile return unless you hold it for over 20 years. Then it starts to be a little better, but still not usually on par with outside investments. Second, whole life policies usually have surrender charges, so if you accidentally bought one and now want to switch to a term, make sure you read the fine print. You could see large fees required to get out of your whole life policy.
Finally, since 30 years is a long time, you want to make sure that the insurance company you are insured with will be around. Insurance companies are rated by two main companies – S&P and AM Best – who look at the company’s ability to pay claims. Most financially sound insurers are rated AAA, so make sure that you go with the best.
Want to know more more about why whole life is not a good choice? Check out the Whole Life Rebellion to see how almost every other personal finance blogger in the world agrees (okay, not everyone, but the vast majority).
Conclusion – Only Purchase Term Life Insurance
The bottom line is that, for young adults, term life insurance makes the most financial sense. The purpose of insurance is to be a backstop against major financial loss in the case of an unexpected event – death. It’s not an investment vehicle. It’s not sexy. It’s not a retirement savings account. No matter how you paint it, insurance is designed to be insurance.
Want to see how affordable term life insurance is? Check out a free quote from Ethos Life Insurance. It’s quick, free, and you can make sure your family is protected.
Or, see our list of the best online term life insurance companies.
Readers, what are your thoughts on the term vs. whole life insurance debate?
Tushar@EverythingFinance says
Totally agree with you on the Term Life Insurance. I got a 15 year , $1 millon term life insurance policy for a few dollars a month. I firmly believe that insurance and investments should be kept separate.
Robert says
Totally agree – and don’t let the salesman sell you otherwise!
Kris @ Everyday Tips says
I have never been interested in whole life policies. To me, life insurance and mutual funds have two different purposes, therefore, I don’t see the reason to use life insurance as an investment.
Great post.
Brent Pittman says
We’ve gone with term. Only reason I would ever get a whole life policy is if I maxed out my IRA, 401K, SEP, HSA, mutual funds,….and then finally if I still had money I think I’d give it away before I bought whole life. Great article
My Money Talk Online says
I couldn’t agree with you more on the fact that term life insurance is the way to go. We want to make sure our loved ones are taken care of in the case of our early death and term life is the most cost effective way to make sure of this. When researching insurance costs I was surprised at the reasonableness in price for the amount of insurance I was looking for on a term policy. Even if you believe you can’t afford it, it’s worth researching. Alot of times it is lower priced then you think and sometimes for our loved ones the truth is we can’t afford not to be covered.
Ashley @ Money Talks says
Amen on the Term Insurance. I truly don’t understand why people argue that whole life is better. It only makes sense to me that term would win out every single time.
MyMoneyDesign says
I use to have a variable policy that I was promised would turn into a great investment someday. A few years after wising up, we switch to a 30-Year term policy. My only regret is not doing it sooner!
Corey @ Passive Income to Retire says
I politely disagree. There’s no reason why you can’t have a conservative investment that is joined with life insurance. The major disadvantage to term life is that if you live past the term of the coverage, you have lost all of that money. At least with whole life insurance, at least my plan, you never lose your money and you still have a death benefit. A commenter on my whole life insurance post (from last week) mentioned he has a 5% return on just the cash value aspect of his whole life insurance plan. That’s not bad when you consider the sharp decline in the stock market over the past few years.
Robert says
Corey, remember what insurance is about – it’s not savings, it’s there for emergencies. If you are 30, and get a 30 year term, by the time the term ends at 60, you should have you kid’s done with school, and you should already have a great savings for retirement, and your house should be paid off, if not close. If you don’t mind sharing specifics, how much is your premium for whole vs. premium for term, and in the terms, what is the minimum return you are guaranteed?
Jeff says
Thank you Corey. The problem is they are sold incorrectly. Whole life has it’s advantages. It should be used to supplement a large term policy, so you don’t have to buy another term later in life.
Chris Huntley says
Awesome post Robert! Buy term and invest the rest is a better option for most. Thanks for joining the #wholeliferebellion. We built a great Term vs Whole Life Insurance Comparison Calculator if you want to crunch some numbers: http://www.insuranceblogbychris.com/term-vs-whole-life-insurance-comparison-calculator/
Ed says
Most young people just outlive their term life insurance. So, you get nothing out of it. Have you heard of life insurance with living benefits? Please,do a little more research before saying that term insurance is better than whole life, or universal life insurance.
Robert Farrington says
It’s always better. I’m happy to do any math you need to prove it. Let’s break it down if you want! Bring the numbers!!
The goal of insurance is to protect your family – it’s not an investment vehicle. If you outlive your term, you win! Over those 20 or 30 years, you should have accrued enough assets and paid off your debt so there is no need for a massive payout to protect your family.
Why pay huge fees to get the same insurance with worse investment options? The math always skews in favor of term except in a few very rare cases where there is no risk for loss in a short term.
Brad says
I want the same example with ROP…
Robert Farrington says
Same example applies – Return of Premium (ROP) is typically about 30% more expensive than a baseline policy. Plus, you need to read the riders – while you get your base premium back, you may not get the riders your paid back, or if you do, it’s even more expensive.
Then, you can still do the math on the spread – what you’re paying, tied up for X years, compared to what you save, invested for X years. In the end, going with term, you are basically pocketing the insurance company’s profit and probably a little more with compound interest over time.
Even if the policy has some cash value/investing component, the math always works.
The reason? Insurance companies have to make a profit. The more complex, the more profit. By avoiding the complex instruments, you are basically DIYing what the insurance company does, and saving all that money.
Robert P says
Robert,
I disagree with Term better than Permanent or Whole Life insurance.
Especially at the younger ages mentioned. With Permanent or Whole Life after about twelve or so years, you have cash value equal to the premium paid. Also, tax free money. When children grow up and home is paid off why not leave a legacy for your Grandchildren. Term insurance can be used to lock in insurability or take the risk out if one cannot afford the extra cash to buy Permanent or WL insurance. Used with Permanent, WL as a blend. Unless they want to use that extra money to pay for an iPhone or drive a luxury car. Both non proforming assets.
Robert Farrington says
My guess is you sell life insurance, or were sold a policy by someone who sells life insurance. I’ve learned a few things over time, and one of them is you’re never going to convince the life insurance salesmen they are wrong.
But, alas, bring the math. If you have a permanent or whole policy, let’s see the costs. Let’s see the actual tables. Let’s see how it grows, when you could potentially break even, and look at the cost of an equivalent dollar value term policy. If you want, email it to me and we can discuss. I know I won’t change your opinion, but I love real world examples much better than the sales pitch!
And if you want to leave a legacy for your grandchildren, insurance is definitely not the best way to do it!
Insurance is insurance – investments are investments. Don’t commingle the two, you just are worst off in both.
Tommy says
Great post. As a life insurance agent, I am now a firm believer in term insurance. To me it is just better than permanent. Like you said, insurance is designed to be insurance. I think before when I just started in the life industry I was blind to not see the ramifications that whole life has. Yes, the idea of building cash value sounds great, but there are problems that go with it. I wonder how many insurance agents tell their clients that if the client dies with cash still left in their account, that the insurance company keeps it and the beneficiary just gets the death benefit?
Dave says
My biggest issue with this article is that it is incredibly short-sighted. Your term life policy is not likely to last past 75 or 80. At 75 it will be very expensive to replace, and at 80 it will be just about impossible. You’re left with your “invest the difference” of course, but you’ve lost the insurance component, the vehicle to put money into the hands of your family once you die. Surrender fees also do not apply to a regular whole life policy. I think you need to expand your perspective.
Robert Farrington says
Except for the rare circumstances where estate plans exceed the inheritance tax levels and you want to avoid this, under very few circumstances should a 75 or 80 year old have life insurance!
Life insurance is designed to protect – at that age, your kids should be grown (even your grandkids should be grown). If you don’t have any assets, you’re on Social Security and Medicare/Medicaid. If you didn’t save any money during your life to have a nest egg, the last thing you should do is use the income you have to pay premiums on a life insurance policy.
This is why term works – get it when you’re 20-50 (even 50 is pushing it). Get a 10-30 year term – just what you need to cover people depending on your income. By 60 years old, you should be debt free (even a mortgage), your kids should be grown, and you should be eyeing retirement. You don’t need to be spending any money on a life insurance policy because the payout (death benefit) should no longer serve a purpose. Even if you don’t invest the difference, most people shouldn’t have a need for any type of life insurance.
Going back to the first line though – there are some exceptions. But they are exceedingly rare.
Dave says
So much of your response depends entirely on that word “should”. Retirement savings are falling on average, many people had their retirement plans completely derailed in 2008, and their grown children are having difficulty finding jobs to take care of themselves and their own families, while they attempt to tackle their own mounting student loan debt. The last thing a retiree needs is to leave the burden of a funeral, travel expenses, work time lost, to their families once they pass. Life is uncertain, and insurance is guaranteed. Whole life is there your entire life.
Robert Farrington says
If you really need a policy for your whole entire life (which in 99% of cases you don’t), then you should probably consider Guaranteed Universal Life before a whole life policy. It will be about 50% of the cost of whole life, and pick an age – 100? 110? You keep paying your premiums every month (which can be level), and the insurance is there for you…
Dave says
And then of course there’s no safety net or cash value to keep the policy afloat in case of disruption of payment. In what world does one’s family not need money immediately when they die? If you’re so against the life-pay option, why not put $15k up front to guarantee a payout of $25-30K to your loved ones or a charity of your choice immediately after you die with no tax liabilities? Or with a limited-pay whole life you could end up in a product you pay a total of $18K over 20 years for $25K in coverage? Both of those examples would still include a cash value element, neither of which give you even the slightest opportunity to put more in than is paid out. I just feel like your position comes from a severely limited perspective as far as not only life insurance goes, but the real situations real people are in.
Chris S says
Robert,
You are 1,000% accurate in your assessment. I work in the life insurance industry and you couldn’t pay me to take a Whole Life (or any permanent product for that matter).
I don’t know in what world a whole life can be considered a good idea when the insurance company keeps your ‘cash value’ when you die and if you borrow from your ‘savings’ while living, you have to pay it back with interest or face repercussions (lapse, reduced death benefit, etc).
Spend a few dollars on Term insurance, live a debt free life, save 15% of your income and by the time your retire, you will have a very healthy nest egg that will far surpass a life policy. You’ll certainly have $5-15,000 for a funeral.
Building a solid nest egg is how you leave a legacy.