20

What makes CVLI either good or bad? If you get it while young (~23 years old) and have a respectable starting salary then what are some benefits or detriments to having it?

The specific policy I'm talking about is from Northwestern Mutual.

Is it a bad idea to think of this as an investment? If so, is it a good or poor life insurance policy?

If thought of as an investment, is there a benefit to having this type of policy in a poor economy?

11

The standard answer I have heard is that if you were to purchase term life insurance and invest the difference between the cost of the policies, your investments would grow larger than the cash value of the insurance. Also when you take cash out of CVLI the insurance value drops by a like amount. So you can't have your cake and leave it to your heirs too. Either you get the cash value OR they get the insurance value. Hopefully, there could be some of both.

Although I believe the philosophy of that answer I have two issues with it. First, you must be dedicated enough to invest the difference every month. I can imagine that might be tough to do consistently and if you take breaks from the investing will you still accumulate more than you would have with the insurance? Second, for the past couple of years all of my investments in mutual funds have lost value. My life insurance has continued to grow cash value over the same time period. Hmm, maybe there isn't a one size fits all solution.

If you need a large amount of insurance, term life will certainly be more affordable. However, considering this as an investment I would not expect that to be a deciding factor.

Good luck with your decision. It is great that at such a young age you are concerned about investments.

  • The whole life insurance is like term life insurance plus a very conservative investment. That's why it didn't lose value, but it's also why the returns are very low. It isn't reasonable to compare the "savings account" embedded in an insurance policy to mutual funds that invest in risky assets. You could compare to a money market fund, perhaps. – Havoc P May 2 '11 at 15:16
  • 1
    @Havoc P - Your comment captured the essence of the problems with whole life -- you're paying a premium in fees for an investment account that is only marginally better than a money market fund. – duffbeer703 May 2 '11 at 16:51
14

Here's what I'd consider:

  • Most people need on the order of a million dollars in life insurance at least. (Say you make 50K per year; for your surviving spouse to withdraw 4% annually from insurance proceeds to replace that income, 50K/.04=1.25 million. Just a rough rule of thumb, but it shows roughly how much you might need.)
  • A million dollars in cash value insurance is probably not affordable. So cash value insurance probably does not accomplish the goal of protecting your surviving family members.
  • Cash value insurance obfuscates the cost and benefit of the investment and the insurance portion by lumping them together. You can't tell your investment returns or your insurance cost, since they are combined. It's at least simpler than something like a variable annuity, but it's still obfuscated. The opacity here is probably not working in your favor.
  • The main legitimate uses of non-term life insurance have to do with tax and estate planning. Unless you're wealthy and working on your estate plan, you probably don't need these products.
  • If 50K is the only household income, probably the spouse could live with 25K, the insurance amount shall be 750K instead of 1.25M. – Xingang Huang Nov 27 '18 at 19:13
7

"Buy term and invest the difference" is certainly the standard recommendation, and for good reason. When you start looking at some sample numbers the "buy term and invest the difference" strategy starts to look very good. Here are the rates I found (27 yr old in Texas with good health, non-smoker, etc):

$200k term life: $21/month
$200k whole life: $177/month

If you were to invest the difference in a retirement account for 40 years, assuming a 7% rate of return (many retirement planning estimates use 10%) you would have $411,859 at the end of that period. (If you use 10% that figure jumps to over $994k.) Needless to say, $400k in a retirement account is better than a $200k death benefit. Especially since you can't get the death benefit AND the cash value.

Certainly one big difficulty is making sure you invest that difference. The best way to handle that is to set up a direct deposit that goes straight from your paycheck to the retirement account before it even touches your bank account. The next best thing would be an automatic transfer from your bank account. You may wonder 'What if I can no longer afford to invest that money?' First off, take a second and third look at your finances before you start eating into that. But if financial crisis comes and you truly can't afford to fund your own life insurance / retirement account then perhaps it will be a good thing you're not locked into a life insurance policy that forces you to pay those premiums. That extra freedom is another benefit of the "buy term and invest the difference" strategy.

It is great that you are asking this question now while you are young. Because it is much easier to put this strategy into play now while you are young.

As far as using a cash value policy to help diversify your portfolio: I am no expert in how to allocate long term investments after maxing out my IRA and 401k. (My IRA maxes out at $5k/year, another $5k for my wife's, another $16.5k for my 401k.) Before I maxed that out I would have my house paid for and kid's education saved for. And by then it would make sense to pay a financial adviser to help you manage all those investments. They would be the one to ask about using a cash value policy similar to @lux lux's description.

I believe you should NEVER PUT YOUR MONEY INTO SOMETHING YOU DON'T UNDERSTAND. Cash value policies are complex and I don't fully understand them.

I should add that of course my calculations are subject to the standard disclaimer that those investment returns aren't guaranteed. As with any financial decision you must be willing to accept some level of risk and the question is not whether to accept risk, but how much is acceptable. That's why I used 7% in my calculation instead of just 10%. I wanted to demonstrate that you could still beat out whole life if you wanted to reduce your risk and/or if the stock market performs poorly.

5

Buy term and invest the rest is something you will hear all the time, but actually cash value life insurance is a very misunderstood, useful financial product.

Cash value life insurance makes sense if:

  1. You have a need for it or will have a need for it: ie you have dependents.
  2. You are already fully maxing out your IRA and 401k.

If you you aren't maxing out your retirement accounts, just stick with term insurance, and save as much as you can for retirement.

Otherwise, if you have at least 5 or 10k extra after you've funded retirement (for at least 7 years), one financial strategy is to buy a whole life policy from one of the big three mutual insurance firms.

You buy a low face value policy, for example, say 50k face value; the goal is to build cash value in the policy. Overload the policy by buying additional paid up insurance in the first 7 years of the policy, using a paid-up addition rider of the policy.

This policy will then grow its cash value at around 2% to 4% over the life of the policy....similar perhaps to the part of your portfolio that would would be in muni bonds; basically you are beating inflation by a small margin. Further, as you dump money into the policy, the death benefit grows. After 7 or 8 years, the cash value of the policy should equal the money you've put into it, and your death benefit will have grown substantially maybe somewhere around $250k in this example. You can access the cash value by taking a policy loan; you should only do this when it makes sense financially or in an emergency; but the important thing to realize is that your cash is there, if you need it. So now you have insurance, you have your cash reserves.

Why should you do this?

You save up your cash and have access to it, and you get the insurance for "free" while still getting a small return on your investment. You are diversifying your financial portfolio, pushing some of your money into conservative investments.

  • After 7 or 8 years, the policy is worth what I put in. But at be same time you suggest the insurance is free? Hardly. Nothing is free. – JTP - Apologise to Monica Jul 3 '13 at 1:06

Not the answer you're looking for? Browse other questions tagged or ask your own question.