Term Life vs. Whole Life and Other Trash Value Life Insurance.

Term Life vs. Whole Life and Other Trash Value Life Insurance.


Term Life vs. Whole Life and Other Trash Value Life Insurance.

Hello to all of the readers of this hub. By simply looking at the title of this hub you can see that I have an unfavorable, to put it softly, view of whole life and other “permanent” life insurances out there on the market also known as cash value life insurance because they have a cash part. Having researched the issue and having personally examined many whole life policies as a financial advisor I became a staunch supporter of the “buy term and invest the difference” philosophy.

But let’s start with the basics shall we?

Why would anyone need life insurance in the first place?

If there is anyone in your life that depends on you, especially financially for example your spouse and children, if you die and are now gone your dependants will most likely suffer a financial tragedy following a family tragedy. The financial stress makes the suffering more unbearably painful. The goal of life insurance planning should be to replace the income of the bread winner in the family.

The Underlying Premises

Term insurance like the name implies is for a term, for example 10, 20, or 30 years and it is sold on the premise that the need for life insurance is NOT a permanent need. This is especially true if you are financially disciplined and work on getting out of debt and building wealth. For example if your kids are ages 2 and 3 in twenty years they will be 22 and 23, theoretically out of college, and fully capable of taking care of themselves. If you have avoided debt or worked your way out of it and also make wise decisions by investing long-term there is no reason why you couldn’t become self-insured by the time your term insurance expires.

Whole life insurance or any other type of “permanent” insurance operates on the premise that you need life insurance your whole life, or forever; especially when you get old. That of course is a very profitable side to be on for the insurance company because they can then have a steady stream of payments coming from people for a very long time. This of course is where the salesmen would point out that whole life insurance companies pay the actual death benefit because the insured person kept the contract all of his or her life whereas the term life contract would expire. Watch the video at the end.

How do these contracts work?

As with all life insurance the insured has to die in order for the family to receive the full coverage amount, some contracts have what is known as a terminal illness rider which means if an insured becomes terminally ill the family can get a portion of that money before a death. Otherwise a term insurance contract would simply pay the death benefit. Cash value life insurance will also pay the death benefit but in certain situations you may not get the full amount, more on that later.

Ok let's look at some nuts and bolts of why I hate Whole Life insurance and the other trash value garbage.

First of all cash value life insurance has two major components to the contract. There is the life insurance component and then there is the “savings” or “investment” component which has cash value, hence the term. Usually the life insurance component is essentially an annually increasing term policy, which means that the cost of the life insurance is going up every year within the policy. That alone is a bad deal, by-the-way don’t buy an increasing term policy either, stick to a fixed 20 year level-term.

Next, let’s talk about the other component, the cash value. The money that you overpay in cash value life insurance is either put in a savings program or investment program depending on the insurance type. Listed below are some of the selling points of buying and building up this cash value, my comments, and what the salespeople don’t know themselves or simply do not tell the client.

  • Having a forced savings plan, adding discipline to saving

Big deal, why not buy term insurance for a lot cheaper and have the difference be automatically drafted from the same bank account and deposited into a savings account or a REAL investment account, and not have to pay ridiculous fees? This is commonly known as a PAC or a pre-authorized check.

  • Can be used at retirement

So can the money invested in the Roth IRA, IRA, 401(k), or even the money in a non- qualified investment account. Not that impressive of a sales point.

  • Cash Value Grows Tax-Advantaged

Again, so can the money in a Roth IRA, IRA, 401(k), and also a good variable annuity.

  • Send the kids to college

Really? Are you serious? Why not use a Coverdell ESA or a 529 plan, maybe an UTMA or UGMA? Believe it or not your kids can get scholarships to go to school too. Insurance salespeople really try to press on an emotional button with this one when a potential client has children. Don’t fall for it.

  • Premium Cost is Guaranteed

Sure, right. The total dollar amount taken automatically out of the bank account might not change, however as I mentioned the insurance component inside the policy usually does increase every year because the insured person is getting older.

  • Policy Pays a Dividend

A policy dividend is not the same as when a company declares a dividend to their stockholders. An insurance policy dividend is paid when the company took extra money and then gives it back because not all of it was used for expenses. So you first overpaid and got some of it back, that is not growth. There is nothing great about these dividends.

  • Option to Have the Insurance Company Pay Premiums if You Become Disabled

Why not have disability insurance and have that pay for everything like your house, your food, and your utilities also? And why not have an emergency fund to pay for disabilities that are short term? Why pay extra in fees to the insurance company? By-the-way term insurance policies can have the same option too. I do not recommend that option even on term policies.

  • Provides Wide Flexibility

The money you do not overpay for life insurance has even more flexibility. You can spend it, save it, or invest it. Isn’t that neat?

  • Cash Value Can Be Used as Collateral

Don’t go into debt, bad idea. Besides you can usually use other assets as collateral anyways.

  • Cash Value is Exempt from Creditors

Not if you used it as collateral. The previous bullet point seems to contradict this one, not being a lawyer I am not sure how this would work out in court. But if you wouldn’t have gone into debt in the first place and instead worked your way out of it or had a good financial plan in place with a solid emergency fund you probably would never have to deal with creditors after.

  • Can Borrow From Your Policy, Especially in Case of an Emergency

Now this is where it gets very stupid, fast. What many agents fail to tell the client if he or she wants to use the money that is sitting in the cash value the client has to borrow their own money and pay interest to the insurance company. How bizarre is that? Also often insurance companies have the option to not give that money for “up to six months”, according the contracts that I have read. Better plan your emergencies ahead then. This is a really a dumb plan. Always have your own solid emergency fund of three to six months of expenses saved in a money market account or savings account.

I know a family that had a cash value policy that they had for many years and the cash value grew to a considerable amount. The oldest daughter decided to get married and the parents wanted to help out with the wedding using their cash that they have accumulated in that policy. They contacted the company and requested the total amount to be sent to them. That is when they found out, amongst other things, that in order for them to keep the life insurance,

  • they would have to take out a loan against their cash value at six to eight percent (6-8%) interest and pay it all back to the insurance company within a certain period of time
  • they would not be able to take the full amount of the cash value but only seventy five percent (75%) of the cash value

After some drama, they had to cancel that policy; they took their money that they accumulated minus the fees that they also did not know about, and bought an increasing term policy from the same company after their agent convinced them to do it. Not surprising, that term policy had a feature called guaranteed convertibly, which meant that they could convert that term policy back to a trash value life insurance plan.

Now what would have happened if the father, who was the policy owner, did take that loan and died shortly? Answer, the family would have gotten the death benefit amount minus the outstanding loan amount and interest due. WHAT?! Yep, that is right. Remember in the “How do these contracts work” section, I told you that cash value life insurance might not pay the whole amount? This is when that would happen, because you see the poor insurance company was hoping that you would not die for a long time and that you would “save” your money with them for a long time as well. And while you are doing so they would use your money for their benefit and give you a lousy “guaranteed” return in exchange. But when you take your money and use it for YOUR benefit, they want to charge you because they feel like they lost an opportunity to use your money and therefore they feel justified in sending your grieving family less.

On the other hand, did you know that if the insured person died without touching the cash value, in most cases, the insurance company would just send the death benefit and keep the cash value? THAT IS A RIP OFF!!! Having bought insurance and an investment plan all-in-one, paying extra money monthly all that time, and in the end just getting one thing is a BAD IDEA. The family would have been better off buying term insurance and saving/investing elsewhere and then getting the benefits of both because one plan is not being held hostage by the other.

Still think cash value life insurance can be a good thing in certain circumstances? I didn’t even mention yet that savings/investing component only starts to build up only after 2-3 years.

Huh? You mean that I am not getting my guaranteed 3% rate of return?

Nope you are not; matter-of-fact you are getting a 100% loss on that money. All of the money that you pay into your “savings” goes to fees and the agent’s commission. That means you will have a zero balance for a few years, the money that you start putting in after starts to grow at whatever rate promised or the pace that the investment is bringing inside the policy, again minus the fees. So basically it will take you many years just to break even, when instead you could have invested that money in a real investment account and started to build wealth then, from day one.

Good luck.

Here is a great video to watch…


Comments 10 comments

LandmarkWealth profile image

LandmarkWealth 4 years ago from Melville NY

While your article is accurate for the majority of middle class Americans, I wouldn't completely discount permanent insurance. It is vital in cases of buy sell agreements for small business partners and even more so for a life insurance trust to avoid or minimize estate taxes. Unfortunately term coverage can't be used to address those needs. Depending on the tax law changes in 2013, this may be necessary fro a much larger group of Americans.


dennis.cherenkov profile image

dennis.cherenkov 4 years ago from Sacramento, CA Author

Thank you Landmark Wealth, yes my article is accurate for the majority of Americans. However even for estate taxes permanent life insurance is not much of a saver. Keep in mind, insurance is not free, the companies do not give away life insurance. If the beneficiaries of on an estate can't pay an estate tax, if there is one, is usually because the assets are illiquid family farms, other real estate, small family business etc. For such cases a good term insurance policy can still do well, while you invest and have money allocated for possible future taxes.

Now lets assume if there is a $20 million estate, the first $10 million, if married, can be sheltered with a simple AB trust, today. And then about $3-4 million will be the tax on $20 million which needs to be kept liquid to pay estate taxes.

Currently, estate taxes are only after $5 million, which means about 99% of the American population does not have to worry about it. And with a simply AB trust that bring it up to $10 million that can be passed down to heirs without estate taxes.

As for buy sell agreements, term insurance is still best. The business can buy term insurance on the business partners and even the other partners can buy insurance on the other partners, called key man insurance.


LandmarkWealth profile image

LandmarkWealth 4 years ago from Melville NY

An ILIT cannot be satisfied with with a term ticket. 75% of americans that reach age 65 live beyond the maximum term benefit. Statistically nearly all of these ILIT would default. I have been a Financial Planner for 15 years and never seen an ILIT funded by a term ticket. Plus you need to include the state Estate tax liability. In NY state for example that can be as much as 12% of any estate in excess of 1 mill. While an ILIT is less common with some of the recent changes to the tax code, that may be reverted in a few short months. The cost of the insurance on a 3 million dollar estate pales in comparison to the tax liability. I don't think it's about whether you can pay the tax as much as it is about do you want to pay it. None of my clients do. The same is true with Buy Sell agreements. I have various clients well past the age of max term coverage. If they had been written with term tickets 15 years ago the entire buy/sell would have defaulted by now and they'd be too old to apply for new coverage. That would destroy the entire succession plan of the business entity. Lastly don't forget the new long term care riders many permanent coverage policies offer now. buying straight LTC typically guarantees nothing. If there is a rider for a draw on the death benefit this can be vital protection that guarantees at least some kind of return rather than 20 years of LTC premiums that may payback nothing. Self insuring is fine for those with substantial enough assets. But couples often go bankrupt without this protection particulary when their is a sizeable age disparity in an income plan.


LandmarkWealth profile image

LandmarkWealth 4 years ago from Melville NY

Also keep in mind that the AB Trust doesn't work well in cases where there was one spouse whom was the primary earner and most of the assets are qualified in one spouses name. Also simply retitling assets can eliminate the 1.3 mill that is left in stepped up basis in cases of a non qualified asset with a sizeable cap gain. All of this should weighed and done on an ad hoc basis. I am not sure how many years you've been in the business, but if I where you I would not discount the permanent insurance option for your larger net worth clients. Permanent coverage is a terrible vehicle for accumulating wealth. But it is often vital later in life when it comes to high net worth asset protection. I was referred a case several years ago that was hit with a combined 2.5 mill estate tax bill from NY and the Fed's. A simple retitling of some real estate and 500k ILIT would have at the time brought that tax hit down to nearly nothing. The prior advisor was taken to arbitration as a result of some poor advice. The reality is each plan is unique and often times it's a combination of multiple solutions. If you are newer to the industry be careful of the Dave Ramseys. His advice is very simplistic and great for a client with a net worth of 200k, but doesn't work effectively with those of sizeable resources.


dennis.cherenkov profile image

dennis.cherenkov 4 years ago from Sacramento, CA Author

LandmarkWealth, just because historically ILITs used whole life policies doesn't mean you can't use a term policy especially a term policy that has a guaranteed renewable feature. Besides that fact still stands, insurance companies don't work for free, having a term policy while you make sure to get enough assets that are liquid to pay the estate tax is still the best way to go. If you have money you do not need the insurance company, term insurance or not. It is always better to buy term, the earlier the better of course, and avoid the ridiculous fees on permanent contracts and invest that money instead. Actuarialy, mathematically, insurance companies usually win big with permanent insurance, no question about it, they take your clients money and invest themselves. The only way for the client or his estate to "win" would be to die a lot earlier than the actuarial period predicts.

As for Dave Ramsey, sorry bud, every time he has proven to be a lot smarter than me and any arguments I had on any point. He is also very successful and does have a lot of experience, and wealth. If he said something that I disagreed with, it always turned out to be best for the consumer in any situation rich or poor, so far.

Wish you the best. Good luck.


Assuretyinc 4 years ago

Dennis, I have to strongly disagree with alot of your comments. While you are absolutely right about term insurance, whole life insurance has its place. The problem is that people don't understand how the policy works because they were dealing with commission hungry agents who were dishonest in how they presented the policy. The other reason is that most people don't understand or bother to read the contracts. Whole life insurance is not meant to be a savings vehicle, but one that protects you from taxes and guarantees cash to people who are otherwise unhealthy for a term policy. And the younger you get the policy, the cheaper the whole life will be. Heart disease, cancer, strokes, diabetes, obesity, etc are rampant in this country, and as we all progress in age, its not getting any better. And it costs to insure people that are a greater risk than others, which is the basic premise behind what insurance is.


Assuretyinc 4 years ago

I wanted to finish my earlier post. Each situation and case is different from the next, and every company is different from the next in what they offer. If you're in your 20s or 30s with hardly an assets, then you need term, plain and simple! And insurance policies have changed a great deal with the bad economy that we're in.

Alot of advisors don't design policies properly because they're focused on commissions, but if done right, a person will not have to worry about taxes, being able to use the cash value in cases of emergencies, or lifetime income in their old age. As LandmarkWealth said, insurance is a terrible investment vehicle. However, its far superior than IRAs and Roths when it comes to tax free retirement. And addional riders can be added, so that income is guaranteed for life, which is something IRAs and Roths cannot do. Now I think the promise that income will be guaranteed for life warrants some expense, don't you? You should look more into modified endowment contracts(MECs) and why the government enacted laws to change them in the late 80's, and compare them to term life, IRAs, and Roths. I think you will understand then that tax deferred does not mean tax free. People's retirement funds inside 401ks were cut in half or destroyed by the recession, and home values have been demolished by all the havoc caused by the mega banks. As a result, people are now starting to realize that other options are necessary.


dennis.cherenkov profile image

dennis.cherenkov 4 years ago from Sacramento, CA Author

Assuretyinc, thank you for your feedback. I would like to point out a couple of things. I agree that "most people don't understand or bother to read the contracts" that is true, but even if the client does try to read the contract they probably would not understand much because life insurance contracts are so confusing. Even as an advisor, knowing what to look for, I can't always figure things out on the first attempt, sometimes it takes a long minute. I also agree with you the younger a client buys insurance the cheaper the insurance will be, for whole life AND for term insurance, no one would argue on that point. Its always better to plan early, getting protected and starting to save and invest. If a person does that properly they would never need cash from the whole life policy. If I have a real emergency fund, not only would I never have to worry about taxes but I would also never have to pay interest on the cash value that I would have to BORROW from myself and pay to the insurance company. Next permanent insurance is far more INFERIOR for tax free retirement. Yes I do understand that tax deferred is not the same as tax free. Don't confuse permanent insurance with an annuity. Permanent insurance eats itself up when you stop making payments, and is not intended for investment purposes as the contracts usually say. Annuities are whole different subject.

As far as the economy is concerned, that only goes to show that very diligent planning is needed for the booms and busts. For retirees, it is important to have an even bigger emergency fund, so that they don't have to deplete their retirement assets at an accelerated rate when their investments are going down in the cycle. The havoc was not simply caused by mega banks, everyone had a hand in it, especially the FED.

I wish you the best good luck.


Assuretyinc 4 years ago

Unfortunately, we are in society of consumers that wants everything yesterday, and I doubt that will ever change. Our grandparents generation of saving and paying cash only is long gone. If the 25 year old starts to save until he retires and remains debt free, then he will be in a far superior position to the rest of us. Unfortunately, this is the not the case for the majority of the country. At the end of the day, no solution will be perfect, and will literally cost us because of past mistakes in terms of lifestyle. Anything else is merely a band aid to fix the situation, and it will hurt like hell when you rip it off.


dennis.cherenkov profile image

dennis.cherenkov 4 years ago from Sacramento, CA Author

Assuretyinc, I would have to mostly agree. I have a very wealthy friend who says "the new rich is the old rich, again" the old rich being the generation that lived through or after the great depression and as a result decided that being in debt, overspending, and then being at the mercy of other people is not the way to live. Relying on the benevolence of insurance companies and even banks is the wrong way to go. Investing in the global market as directly as possible without fancy guarantees is still the best way to go. Good luck.

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