If you ever want to see the veins on Dave Ramsey’s head bulge, ask him about whole life insurance. Ramsey, like most other financial advisors, hates it; he calls it a rip-off with a terrible return. The fact that many insurance agents can still talk their customers into buying whole life makes the matter that much worse. By the time many figure out that they’ve been hoodwinked, it’s too late. They’ve already poured money into a policy with fees so high that much of any potential return is swallowed up.
What is a whole life policy?
There are many types of life insurance products, but most can be categorized as “term” or “permanent.” As the name implies, term life provides death benefit coverage for a particular term — generally up to 30 years. As long as the premium is paid, the policyholder is covered. Once the term is up, the policy expires, and if the policyholder wants to continue with coverage, they must shop for another policy.
Whole life is a type of permanent life insurance. For some, the big selling point is that coverage can last the policyholder’s entire life as long as premiums are paid. The premium is locked in place, meaning it can’t change. And here’s where insurance agents “sweeten” the pot: A whole life policy builds cash value. The longer the policyholder pays a premium, the more cash they can borrow against or leave to their heirs. It’s sold as a financial product that provides a death benefit and guarantees a return on investment.
A guaranteed investment sounds pretty good for anyone skittish about investing their money in the stock market, where values rise and fall. But a deeper look into whole life reveals a whole lot of problems — problems an agent earning a large commission on the sale is unlikely to mention.
Problem #1: Shifting percentages
How much of each premium goes toward paying for the death benefit, and how much goes toward cash value changes through the years. In the early years, a more significant percentage of each premium goes toward cash value. As the policyholder ages, more goes toward the policy, and less cash value is built.
Problem #2: Slow growth
The bad thing about buying into a product with guaranteed growth is that the growth is slow, and the interest rate the policyholder is paid tends to be pathetic, particularly compared to the overall stock market. If a person purchases whole life believing it will fund their retirement, they are likely to be disappointed with their earnings.
Problem #3: Cash value can disappear
For years, a person pays into a whole life policy, waiting until the day they can receive a check for the entirety of the cash value the policy has built. When they purchased the policy, the policyholder was told that they would receive the funds once they reached maturity age. The problem is, for most insurance companies, the maturity age is between 95 and 121 years old. As long as the policyholder lives to that age, they’ll be sent a check for the cash value. If the policyholder does not touch the cash value and dies before the maturity age, the insurance company keeps the entirety of the cash value. The policyholder’s heirs receive the death benefit associated with the policy, but all that cash built up over the years? It belongs to the insurer.
Problem #4: Borrowing against cash value feels like a sick joke
Say the policyholder realizes that they don’t want their cash value to disappear, so they decide to do something with the money built up in their account. Maybe they want to go on a trip or make improvements to their home. They borrow the money and then have to pay it back with interest. That’s right — they pay interest to borrow their own money. And if the policyholder does not pay the loan back in full, the insurance company deducts the difference from their death benefit.
Problem #5: Getting rid of the policy is expensive
Imagine that a person has paid into a whole life policy for years and finally sees the light, deciding that it’s all been a waste of money. They choose to purchase a much less expensive term life insurance policy and tuck the savings away in a bank account or invest it with a broker. They tell their insurance company that they want to surrender or cancel their policy. Depending on the policy, the insurance company cashes the policyholder out by deducting fees and sending what’s left of the cash value. The amount a policyholder receives is likely to be far less than they expected.
Term life is always the best bet
Ramsey tells his followers that their only job is to replace their income when they die. A term life policy is the best, least expensive way to make sure that happens. Further, any insurance agent who tries to convince a customer that permanent life insurance is the way to go is not looking out for the customer’s best interest.
No matter how earnest an agent appears to be, it’s important to remember that they are selling a product for which they will receive a commission. While an agent may be the most ethical person on the planet, it’s still up to the customer to investigate a product before making a purchase and to look for an insurance company that respects their decisions.
Source: The Motley Fool