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Myths - Life Insurance as an Investment

The insurance agents will tell you:

  • Death benefits for life insurance policies are non-taxable!
  • You are able to take a loan on your life insurance policy for retirement!
  • You can get a 4% to 8% guaranteed return on your life insurance policy!
  • Typically dividends are paid out that will provide extra savings.

With statements like these, insurance agents are able to make life insurance sound like a better investment vehicle than it actually is.  Yet, there are many factors that they do not tell you about, including:

  • There is a 50% commission paid on average on the first year premium and 4% thereafter (per Society of Actuary survey).
  • There is an additional acquisition expense that averages 27% of the first year premium.
  • There are additional ongoing administration expenses and profit margins that reduce your rate of return.
  • The 4% to 8% guaranteed return does not reflect these expenses.

By the time these expenses are offset from the 4% to 8% guaranteed return, the actual return will be significantly less.  So, the 4% to 8% guaranteed return that they quote may be more like 2% to 6% return (note, the 6% return may be generous, the upper range could be lower).

"Don't buy any life insurance with cash values (i.e., whole life). It's too hard to tell good cash value policies from bad ones, and you lose too much money if you don't hold the policy for 20 years."
- Ralph Nader

Insurance policies are generally used for protection (e.g., making sure your family is taken care of in case of an early death) and should not be used primarily as an investment vehicle.  Thus, many financial advisors have been promoting term insurance which is basic protection in case of death.  If you are looking at a life insurance policy as an investment, you are usually better off by looking at IRAs (including Roth IRA) and 401(k) plans.  These investment vehicles will typically provide a higher rate of return.

Even if an insurance agent tries to sell you a variable life insurance product (life insurance policy where you select your investment, such as an equity investment option) because it has better returns than a standard life insurance, studies have shown that the rate of return is still not as good as other savings vehicles.  For example, James Hunt, an actuary who studies these policies for Consumer Federation of America (James is a former Insurance Commissioner for Vermont), concluded that variable life insurance policies should not be bought if the buyer has not maximized all other tax-deferred options (e.g., 401(k), IRAs, etc.).  In an analysis of a $1 million MET Variable Life Insurance policy assuming a gross investment return of 10%, the expenses (commissions, administrative costs, etc.) significantly affect the policy's net return in a variable life insurance policy:

Holding Period
Linton Yield
5 years
10 years
15 years
20 years

Note, the Linton Yield is the comparable return you would have received if instead of investing in the variable life insurance policy, you had used the same premium to buy term life insurance with the difference in premiums (because term life insurance is cheaper than other life insurance) being invested.  So after 10 years, by having term life insurance and investing the difference in premiums, one would have received 10% return in their investments (which we are using as the assumption of what the market returned).  Yet, the equivalent return in the variable life insurance policy was only 5.5%.  This is because the variable life insurance policy did credit the account for the 10% return that the market received.  Yet, it also deducted the commissions, administration and other fees it charges to reduce the overall return to 5.5%.  Even after 20 years, one would be better off investing in equities (in this example returning 10%) because even with taxes (capital gains) the net return would be better than the 7.4% return from the life insurance policy.  One may wonder what would happen if equities return less than 10%, would the insurance be a better bet?   No, because the 7.4% Linton yield would also be significantly less (the calculation above assumes equities earn 10% - if they don't the return would decrease proportionately). 

So should you get rid of your insurance policy?  Not necessarily, the returns above are low mainly due to the high initial expenses paid.  If you already have an insurance policy, you have already spent that money.   You should consider whether to hold the policy or not by reviewing the future investment return factoring in the expenses already paid.  Consumer Federation of America can do this analysis for $45 to $75.

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