Have I got a deal for you! What if you could own a combination electric can opener/wi-fi hotspot? You can use it to open cans, of course, but in an emergency you could also use it as a wi-fi hotspot. Why settle for just an electric can opener or just a wi-fi hotspot when you can have both!
Now, it’s true that it costs about 20% more than if you just got a can opener and a wi-fi hotspot separately. And if you did purchase those separately, the can opener would work a little bit better and the wi-fi hotspot would work a whole lot better. But think of the simplicity and convenience of having them combined! And what if you stop using cans and no longer need a can opener? Well, then you’d still be able to use it as a wi-fi hotspot! It’s a win-win!
As you have probably intuited, I’m not talking about can openers and wi-fi hotspots. I’m talking about whole life insurance. Many folks are convinced (often by their insurance salesperson) that whole life insurance is the best of both worlds. If you purchase term life insurance, all you get is life insurance, and it only has value to you if you die (well, value to your beneficiaries). But if you purchase whole life, not only do you get life insurance, but you get an investment; it’s building value as you go along. It’s life insurance and an investment and you get all the simplicity and convenience by having them combined!
The problem is that, just like a can opener and a wi-fi hotspot, insurance and investments are two very different things. They serve different purposes and have different considerations when deciding what to purchase. And, like the mythical combination above, when you purchase whole life insurance it costs more than purchasing the equivalent term life insurance and investments separately, and doesn’t work as well. It tries to do two very different things and does both of them sub-optimally. If you need life insurance, purchase term life insurance. And if you have money to invest, invest it in a brokerage account. Don’t try to combine two things that shouldn’t be combined.
So why do so many people have whole life insurance? Because they’ve been convinced (again, often by a salesperson who gets a high commission when they sell you a whole life policy) that it’s a better value than term-life insurance, because term-life only pays out when you die. So you don’t get any “value” for the premiums you pay along the way until you die. But, as is often true with health insurance, people never do the math so don’t realize that if they simply invested the extra premiums they are paying for whole life insurance (over the cost of term-life) separately, they would come out ahead.
The salesperson plays on (knowingly or not) our (rational) objection to paying for insurance that we hope we’ll never need (or at least not cash in on for a very long time). They try to convince us that you can turn life insurance into an investment instead of just insurance but, in the end, you get both subpar insurance and subpar investments. And they also play on many folks’ basic misunderstanding of the purpose of insurance, which is to protect against catastrophe, not to “pay for things.” By design, when you purchase insurance you are expecting to lose money. The expected value of the insurance is always going to be less than the expected value of your premiums invested over time. Because that’s the only way the insurance company can make money and stay in business. Do some people “win” and get more than they paid for? Sure, just like some people win the lottery and some people leave Vegas with more than they came with. But, just like in the Hunger Games, the odds are not in your favor.
There are a few very, very, very rare situations where whole life can make sense, but it’s very unlikely that your situation is one of them (much lower than 1% of people should have whole life insurance). So don’t purchase it. And, if you already have purchased it, stop paying for it and cash out the current value and invest that money elsewhere (and purchase term life insurance if you are still in a life-stage where you need life insurance).
As always, the details of your individual policy and situation matter, so there may be instances where you have a whole life policy that you won’t want to cash out. For example, if the policy holder is likely to die fairly soon and the value of the life insurance is significantly more than the cash value. Or perhaps you no longer can qualify for a term-life policy and you are still in a life-stage where you need life insurance.
Fisch Financial 