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September 28, 2009

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I don't view insurance as an investment, but Mr. Ed Slott, the nationally recognized expert on IRAs, says life insurance is a good way for people with large estates to pass money to their beneficiaries tax-free upon the insured's death. It also can be used to pay estate taxes upon death.

You should read the several books Ed Slott has written to understand the value of life insurance in estate planning.

OK, here's a comment & a question re life insurance:

What do you need life insurance for if you have children, but you're divorced and both you & your ex have professional, high-paying careers?

If I died, the kids would go live with their Dad. Obviously, our house would be sold. The equity & all my other assets (including the $400K life insurance that I do have) would go to my kids in a trust administered by my sister.

So my question is: why would I need more life insurance? I've got college costs & 8 yrs child support covered, plus significantly more.

I find the online life insurance calculators confusing, since they all seem to be based on the nowadays rare model of a 2-parent family with only one parent working at a career. If both parents have good jobs as well as own their own homes, and both are healthy and relatively young, why pay for it?

MC: what if you and your ex die in rapid succession? It's not incredibly likely, but it does happen (and as long as you're in contact with one another, the odds are higher--a car could smash into the coffee shop where you're meeting to discuss Sally's college plans or whatever). You want to make sure your kids are taken care of even if both parents are unable to support them. You'll probably also want some cushion in case, say, you're in a car accident with the kids, you're killed, and one or more of your kids requires expensive treatment or, worse, becomes disabled. For some parents, this may just be out of their reach, but it sounds like you are in a financial position to make such arrangements. And, by the way, since it sounds like you haven't considered the possibility of near-simultaneous deaths, you need to get together with your spouse to choose guardians in case that should come to pass!

That said, there's an upper limit to life insurance's usefulness. Once you've replaced all that money described above, I don't see a reason to go further.

It seems the return rates on cash value insurance is generally pretty poor. You'd be lucky to get 4% return with insurance.

If you're happy with a safe 4% return then buy treasury bonds or put money in a stable value fund.

I don't advocate cash-value life insurance as an investment although it can be useful in certain tax planning scenarios. As for your assertion that our recent economic meltdown is a "once in a generation or longer" event, I hope you are correct but I don't think you are. The severe hangover from all of the government borrowing and spending hasn't even started. Asset allocation is a fine defensive strategy in normal times but I am afraid that our belief in what is or will be "normal" is no longer valid.

MC --

My two cents is that you need life insurance to replace vital income/savings that will be needed for your dependents to get on their feet/to an age where they can take care of themselves. If you have enough savings and don't have an income that's not vital to provide for them, then you probably don't need life insurance.

@ Sarah, I like you response to MCs question. I agreed with MC at first but you never know, it is possible for both parents to go at the same time.

Great blog here, love the articles!

Although whole life / universal life insurance in some instances can be part of a good portfolio of investments, I would rather use term life for my insurance needs, save or invest the difference in cost between the two in an index fund of my choosing. Another point the article indirectly mentioned is that you need to choose a company that is is likely to be around in order to collect. Good luck trying to guess which one that well be!

Most good personal money management experts (including many fee-only financial advisors, Suze Orman, Jane Bryant Quinn, and Humberto Cruz) recommend term life, not cash value life, for the majority of individuals who need life insurance protection. Term life is pure insurance protection; it offers no investment component. Cash value policies are generally significantly more expensive than term life. And the returns on cash value life are generally low for a given level of risk, and once commissions and fees are factored in, the returns are usually miserable. An alternative strategy is to buy a good term life policy. Then invest the premium difference between this policy and good cash value policy yourself in a well-allocated portfolio.

In general, life insurance is not a good investment as such. But, of course, there are circumstances where cash value life may be called for.

Thanks for the advice, everyone!

In the (extremely rare) event of my ex's and my simultaneous deaths, his life insurance (that pays out to the children) will add onto the benefit they get from my life insurance. (These particular life insurance policies are mandated by our divorce decree). So I still don't see why I would need to buy more life insurance myself.

But considering using life insurance to ameliorate estate taxes is a great idea--I'll that into account.

"ameliorate estate taxes is a great idea"

If your estate is big enough to worry about estate taxes then you wouldn't really need life insurance because the estate itself would support your kids.

Current exemption to estate taxes is $3.5M so anything less then that is free of estate taxes. Estate tax laws are in flux and the top exemption may drop again but the old exemption was $1M.

Jim, your statement isn't very well thought-out in my estimation... Have you considered large families? Kids with special needs? Disabilities? $3.5 Million may take care of my home(s), student loans, etc, but will it take care of a paraplegic son for the rest of his natural life?

And if your estate ends up being $5 million, how much of it do you want to go to the fed instead of your kids? The answer for me is simple: As little as possible.

@Greg - most of those people you mention as "good" money management experts don't even take their OWN advice. (do a google search of "Suze Orman municipal bonds")

Here's the reason: They're rich.

Their advice applies mainly to the middle class, because that's where they can sell books, give seminars, and find a TV audience. Frankly, most people in the top 5-10% of earners have no business listening to these people, because their advice, while it might be "safe", is not in the best interest of this demographic and I believe also hinders their financial potential.

It scary to me how people become brainwashed to believe what people and businesses tell them. I hope you realize that the people and businesses that advertise or pass on this misinformation are the same ones that benefit the most from it. Do you look at who funds/advertises on Suze Orman? How much would it cost her to go against her advertisers? The problem with cash value life insurance is not the policies it's the people selling them. It's very easy to get 5% or more rates of returns in a cash value policy. If you are in a 25% or more tax bracket that could be equivalent to closer to a 7% rate of return. Remember asset allocation. It's just a piece of the pie.

FMF-

You are constantly touting index funds, while poo-pooing whole life insurance with an emphasis on their "high cost". Motley Fool says that the expenses in a passive index fund is "minimal" at near 1 percent. However, even if I pay 100 percent commission on a whole life policy in the first year, this is a one-time cost. Your index fund providers are going to skim their +/- 1 percent every year, even in years that they lose YOUR money... That means that when your IRA/401k balance reaches $1 million, you are paying almost $10,000 in fees to your mutual fund provider...EVERY YEAR! Does Life Insurance still look so "expensive"?

rxjohnk --

1% per year is not even close for a good index fund. I pay a fraction of that.

So I did my research on your Vanguard and Vanguard Admiral funds, and this is what it says for the 3 you mention in a Nov. 2008 post (the ratio has changed since your post):

Fund Expense 5 yr ann. return
VTSMX 0.09 1.85
VBMFX 0.14 5.09
VGTSX 0.34 7.69

So if you have an equal amount in each fund, you have a blended expense ratio of 0.19%, correct? So for $1 million in funds, you get dinged for $1900 a year. How many years will those funds be there? 10? ($19,000) 20? ($38,000) and for an average return of 4.87%? You can do better than that with CHECKING accounts.

http://www.highyieldcheckingdeals.com/2008/03/high-yield-reward-checking-accounts-by.html

rxjohnk --

1. I don't have an equal amount in all three -- I have much more in the lowest cost one.

2. Every investment costs something (including insurance.)

3. For most people, insurance will return nowhere near what a mutual fund will, so saying mutual funds have more expenses make them bad is nonsense. They also have a much higher return.

For a select few in unusual circumstances (like you), maybe insurance has a higher return because of the way you use it. But for the vast majority of people, this is simply not the case.

FMF-

1. The lowest expense ratio fund also has the lowest return - doesn't even beat inflation over the last 10 years... And you have MOST of your money here?

2. The costs of the investments should justify themselves. I would gladly pay 10 percent for 50 percent annual returns. Low cost doesn't make something a good investment, nor does high cost.

3. A much higher return? Not so fast! In my policy, after 10 years, the "Guaranteed" cash value is equivalent to the 10 year return of VTSMX (0.84 percent annualized). The "non-Guaranteed" values outperform it by about 10% after 10 years. This is without even touching the money, ie - "using it the way I use it".

Oh, AND I don't have to waste any money on term insurance either! Can I add those savings to my annual return compared to your mutual fund? That would add another $11,000 to my column over 10 years ($1 million through MetLife - $92/mo).

I don't think my circumstances are all that unusual.

I'm a 20-something married person in a 2 income household, we live in a smaller home than we could afford, we don't drive new cars, and we invest as much money as we can. Now, having said that, we also eat out too much (6 times this week), drive a lot (just put 250 miles in today alone), and a lot of our money seems to get spent on shoes for my wife!

That's not so unusual is it?

rxjohnk --

1. Do you think that past performance is a predictor of future gains? How about looking at a longer period of time? What happens to returns then? You're picking the best time periods to prove your point. I can do the same. In short, I think the US economy (and thus the stocks that go with them) will do very well over the 20-year investment horizon I have.

2. That's tru. But you were the one arguing about how your investment was such a great, low cost option.

3. See #1 above.

And...your circumstances are very unusual based on your comments left here:

http://www.freemoneyfinance.com/2009/10/which-type-of-life-insurance-is-best-for-you.html

FMF-

What about that is unusual? Can you be specific?

rxjohnk --

It's unusual in that the vast majority of people don't/can't/won't do the things you're doing with it.

There are many excuses that people can make for failing to make the choices (and follow through on them) that will lead to their own prosperity.

To respond to your previous response:

1. This system will have predictable returns regardless of what the stock market does. Regardless of the time frame you choose with a properly designed whole life policy, after about 3 years, the return is positive. You can't say that for the stock market. You may be right about the 20 year horizon, but that is tantamount to speculation.

2. My point is that whole life is not "high-cost" compared to an index fund, as you argue repeatedly that it is. I think I made that point very well, thank you.

3. Again, for all the don't/can't/won't-ers, you "don't/can't/won't" have to use it the way I do to get these returns. You have not made a valid argument against this point.

AND, still no argument against the extra $10k I save by NOT buying term!

How much do you think your closed-minded approach to finances keeps your net worth from growing each year?

rxjohnk --

You haven't made any points at all except that you have an ax to grind and will keep grinding it until someone listens. Well, no one is listening.

Come back in 20 years and you can compare your net worth with mine now and we'll see who ends up on top.

I have to respectfully disagree. When I was looking for information on this about 3 years ago, there was very little information available, and now, there is considerably more information. Internet searches for "Bank on yourself" or "infinite banking" now bring up a wealth of information on this system, which indicates to me that many people are interested.

I will gladly accept your challenge, though. Let's get a baseline....

I turn 29 next week, October 22nd. Where were you at 29?

rxjohnk --

I was probably around $50k in net worth at that point.

By the way, if you'd like to write a post on how you use life insurance for investing (and why you think it's better than other alternatives), I'd be glad to look at it for a guest post. I think it would generate some interesting discussion.

Insurance as an investment works for some people, but I can’t say it should be recommended as a panacea, a must-have in diversified investment portfolios. Investment-linked life insurance makes sense for people who are due to retire and have completed all their financial obligations like putting the kids through college, and paying off mortgage and loan amounts; people who are rich and are looking at investment as an estate planning vehicle, etc. But take the average American. With very high monthly premiums, investment-linked life insurance will drain out monthly budgets. The economy is still in recession, and even keeping up with food bills is tough. How can high investment-linked life insurance premiums be met? Yet, everyone needs life insurance. The only way then is by buying term life policies. Reliable and affordable, with the right planning it will cover the ‘term’ when you are most vulnerable – the middle years when you are bringing up kids, investing in professional growth, paying off mortgages and loans, etc. Term life insurance even comes with attractive options such as Convertibility, Return on Premiums, etc these days. When you buy term life policies online from reputed companies, you can even get a term life policy from a top-rated insurance company at upto 70 percent off. There is no denying that the free online life insurance quotes that reputed term life agencies offer today has brought down term life quotes even more, and has truly made life insurance a very affordable necessity.

Denise at AccuQuote
Disclaimer: I work for AccuQuote and this is my personal opinion.

Don't talk to anyone who wants to invest your cash in mutual funds. These con-men are the biggest crooks in the "trusted" financial advise seller world and they often don't understand that whole life insurance is a savings account with many benefits besides like tax-free money and internal cumulative growth rates of about 5-6% also tax-free. Did I mention the death benefit as well. All large banks have at least 20% of their tier one asset class in permanent whole file insurance. BTW get it from a strong mutual insurance company.

"Investments" in stocks and mutual funds is nothing but gambling which the rich should only do with their extra disposable assets not their income. Everyone else, save your money in safe savings vehicles like whole life insurance, borrow money from your own bank like in the "infinite banking concept" & stop living beyond your means in debt because you'll end up eating dog food in retirement and dying miserable. It happened before and all bets are on that it will happen now again. Most of all, don't bother with "trusted" financial advisors, independent or not they are 99.9% of the time fucking crooks or diluted.

Good luck because in all seriousness your going to need it. I wish it was going to be different.

You are missing the point. The true value of life insurance is in the fed tax free death benefit. Term is great only if you die unusually young. Do the math for a decent permanent policy if you die at 70 or older.

You need to relax.

Market Speculation and More Market Speculation. Folks do not know where they stand in the food chain. Weak Managers have run stock companies in the ground, and "Career Savers" - people w/ net worths from $500k to $5 mil. have invested for years that these greedy fools will have their best interest in mind, as the "shareholder". Do your family a favor. Get w/ someone who understands permanent whole life insurance w/ a mutual company - and walk away from the market. The market is rigged for the elite wealthy. If a man w/ a $75 mil net worth loses $50 mil in the market, he is still rich. If a man w/ $600k loses $450k in the market at age 57, his retirement dream is over. If the " savings plan" end in a number or letter, remember it is a plan that is to the tax advantage of Uncle Sam, not the "saver."

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