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"The basic difference between term and whole life insurance is this: A term policy
is life coverage only. On the death of the insured it pays the face amount of the
policy to the named beneficiary. You can buy term for periods of one year to 30
years. Whole life insurance, on the other hand, combines a term policy with an
investment component. The investment could be in bonds and money-market
instruments or stocks. The policy builds cash value that you can borrow against.
The three most common types of whole life insurance are traditional whole life
policies, universal and variable. With both whole life and term, you can lock in the
same monthly payment over the life of the policy.
Whole life insurance is expensive: You're paying not only for insurance but also
for the investment portion. That extra cost might almost be worth it if these
policies were a good investment vehicle. But usually they aren't. Insurance agents
like to call these policies retirement plans, emphasizing the "forced savings"
inherent in forking over the premiums each month "for retirement."
Premiums for term insurance are downright cheap for people in good health up to
about age 50. After that age, premiums start to get progressively more expensive.
The same holds true for whole life policies, though people who need coverage
starting in their 60s and beyond may have no alternative but to buy whole life.
Most companies simply won't sell term policies to people over about age 65.
Term: Where the Value Is
To get a real sense of the value of term, let's compare a term policy and a
universal life policy. Say a 40-year-old nonsmoking male has a choice between a
$250,000 Met Life universal policy with a $3,000 annual premium and a same
amount of renewable term coverage with a 20-year fixed premium of $350. At the
end of one year, the universal policy, assuming it paid 5.7% per year,
tax-deferred, would have a cash value of exactly zero (cash value is the amount
you would get back if you canceled the policy). But say he had instead invested
$2,650 (the difference between $3,000 and $350) in a no-load mutual fund that
averaged a total return of 10% annually. At the end of the first year, he'd have
$2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10
years, he would have accumulated more than $46,000 in after-tax savings in the
mutual fund. Over the same period, the cash value of the policy would have
climbed only to $31,819.
That's not to say that whole life insurance is always a bad idea. Wealthy people
can use whole life in their estate planning by setting up an insurance trust that will
pay their estate taxes from the proceeds of the policy. And for the growing number
of people in their late 40s or early 50s who are just starting families, whole life is
at least worth a look.
Sizing Up a Whole Life Policy
One of the great problems with whole life is only an expert can tell if a policy you
own or are considering will ever become a decent investment. James Hunt,
actuary for the Consumer Federation of America, who has analyzed thousands of
policies, notes that whole life policies hardly ever yield a reasonable return unless
held for 20 years or more. So if you buy one be prepared to pay into it for the very
long haul.
The key to a whole life policy is its internal rate of return -- the yield on the policy
after all fees and charges are subtracted. A competent analysis can determine at
a minimum whether the weight of the fees and charges built into one of these
policies will ever allow a worthwhile return. Such an analysis will also pinpoint the
minimum amount of cash value that you can derive from a policy at any given time
interval."
-smartmoney.com
is life coverage only. On the death of the insured it pays the face amount of the
policy to the named beneficiary. You can buy term for periods of one year to 30
years. Whole life insurance, on the other hand, combines a term policy with an
investment component. The investment could be in bonds and money-market
instruments or stocks. The policy builds cash value that you can borrow against.
The three most common types of whole life insurance are traditional whole life
policies, universal and variable. With both whole life and term, you can lock in the
same monthly payment over the life of the policy.
Whole life insurance is expensive: You're paying not only for insurance but also
for the investment portion. That extra cost might almost be worth it if these
policies were a good investment vehicle. But usually they aren't. Insurance agents
like to call these policies retirement plans, emphasizing the "forced savings"
inherent in forking over the premiums each month "for retirement."
Premiums for term insurance are downright cheap for people in good health up to
about age 50. After that age, premiums start to get progressively more expensive.
The same holds true for whole life policies, though people who need coverage
starting in their 60s and beyond may have no alternative but to buy whole life.
Most companies simply won't sell term policies to people over about age 65.
Term: Where the Value Is
To get a real sense of the value of term, let's compare a term policy and a
universal life policy. Say a 40-year-old nonsmoking male has a choice between a
$250,000 Met Life universal policy with a $3,000 annual premium and a same
amount of renewable term coverage with a 20-year fixed premium of $350. At the
end of one year, the universal policy, assuming it paid 5.7% per year,
tax-deferred, would have a cash value of exactly zero (cash value is the amount
you would get back if you canceled the policy). But say he had instead invested
$2,650 (the difference between $3,000 and $350) in a no-load mutual fund that
averaged a total return of 10% annually. At the end of the first year, he'd have
$2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10
years, he would have accumulated more than $46,000 in after-tax savings in the
mutual fund. Over the same period, the cash value of the policy would have
climbed only to $31,819.
That's not to say that whole life insurance is always a bad idea. Wealthy people
can use whole life in their estate planning by setting up an insurance trust that will
pay their estate taxes from the proceeds of the policy. And for the growing number
of people in their late 40s or early 50s who are just starting families, whole life is
at least worth a look.
Sizing Up a Whole Life Policy
One of the great problems with whole life is only an expert can tell if a policy you
own or are considering will ever become a decent investment. James Hunt,
actuary for the Consumer Federation of America, who has analyzed thousands of
policies, notes that whole life policies hardly ever yield a reasonable return unless
held for 20 years or more. So if you buy one be prepared to pay into it for the very
long haul.
The key to a whole life policy is its internal rate of return -- the yield on the policy
after all fees and charges are subtracted. A competent analysis can determine at
a minimum whether the weight of the fees and charges built into one of these
policies will ever allow a worthwhile return. Such an analysis will also pinpoint the
minimum amount of cash value that you can derive from a policy at any given time
interval."
-smartmoney.com
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