2

Long time browser, first time poster in "the stacks." Please forgive and inform me of any mistakes I make.

I recently graduated college (23 years old) in the US and have started my first salaried position. I have $50000 in cds that I'm planning on saving for a house. I have about $3800 per month after rent and food. I have $1000 in a Roth IRA. No college debt.

In speaking with a financial adviser who is sort of a friend/good acquaintance, he recommended I save using a Roth and buying whole insurance. I did some googling and found the Roth to be a reasonable deal, but the insurance seemed a little sketchy (please explain to me why I'm wrong here if I am, I do have a wife if that's relevant, but no debt, and she's a smart cookie who'd manage fine financially if I kick the bucket on my way home from work tomorrow).

My mother, who admittedly claims to have no "real" knowledge about investing/money, recommended that I keep my cash in an easily liquidatable form so as to purchase a house without huge loans as the interest rates I would pay on those will be higher than the interest rates I would gain from investing (outside of the potential from something "riskier").

In general what are the pros and cons of each of these scenarios? (And again, I'll be happy to provide additional information/change anything upon request, and I'll also make sure to accept an answer in a few days/whatever time-frame seems reasonable)

  • See other answers for discussion of whole-life. Majority consensus is that it is indeec a little sketchy; you'll do better buying insurance and investments separately, unless you really need someone to force you to invest. Most other investments are liquid enough to permit buying a house, though depending on rates you may want to borrow even if you could pay cash. IRA -- roth or otherwise -- is an excellent idea if your employer doesn't offer 401(k) or equivalent (roth or otherwise), but that's saving for retirement, not shorter term. – keshlam Oct 5 '15 at 22:14
2

Cash/CD's for a house downpayment = Good. Resist the urge to invest this money unless you're not planning on the house for at least 5 years.

Roth IRA - Good. Amounts contributed are able to be withdrawn without tax penalties, though you would really need to be in a crisis for this to be a good idea. It's your long-term, retirement money. The earlier you start, the better. Use your 401K at work, if it's offered. Contribute to the Roth as much as you can, as well.

Whole life ("Cash value") life insurance: Be careful...

Cash-value life insurance (Whole, Universal, Variable Universal) must be watched more closely as you age. Once they reach that "magical" point of being self-sustaining, you cannot relax. The annual cost of insurance is taken from the cash value, which your premium payments replenish. If you stop making premium payments, eventually the cost of insurance (which goes up every year) will erode your cash value down to nothing, at which point more premium must be paid to keep the policy in force. This often happens in your old age, when you can least afford the surprise, and costs are highest.

Some advisors get messed up in their priorities when they start depending on the 8-10% commissions they are paid on insurance policies. Since premiums for cash-value policies are far higher than for term policies, you might get some insight into your advisor if they ignore your attempts to consider a term policy.

Because of the insurance costs' effects on your cash value, these types of policies are some of the most inefficient and expensive ways to invest. You are better off not investing via a life insurance policy.

You don't need life insurance unless someone depends on your financial contribution to their life (spouse and children, for example). Some people just like the peace of mind it brings, and some people want a lump sum to leave as a gift to their loved ones (which is an expensive way to leave a gift). You can have these "feel-good" benefits with a term policy for much less money, if you must have them.

Unless you expect to become uninsurable at some point in the future, you should consider using term insurance to meet your life insurance needs until it is no longer needed.

3

Week after week, I make remarks regarding expenses within retirement accounts. A 401(k) with a 1% or greater fee is criminal, in my opinion.

Whole life insurance usually starts with fees north of 2%, and I've seen as high as 3.5% per year. Compare that to my own 401(k) with charges .02% for its S&P fund.

When pressed to say something nice about whole life insurance, I offer "whole life has sent tens of thousands of children to college, the children of the people selling it." A good friend would never suggest whole life, a great friend will physically restrain you from buying such a product.

1

You're extremely fortunate to have $50k in CDs, no debt, and $3800 disposable after food and rent. Congrats.

Here's how I would approach it. If you see yourself getting into a home in the next couple of years, stay safe and liquid. CDs (depending on the duration) fit that description. Because you have disposable income and you're young, you should be contributing to a Roth IRA. This will build in value and compound over your lifetime, so that when you're in your 70s you'll actually have a retirement.

Financial planners love life insurance because that's how they make all their money. I have whole life insurance because its cash value will be part of my retirement. It may also cover my wife if I ever decide to get married. It may or may not make sense for you now depending on how soon you want to buy a home and home expensive they are in your zip code.

Higher risk, higher reward- you can count on that. Keep the funds in the United States and don't try to get into any slick financial moves.

If you have a school in town, see if you can take an Intro to Financial Planning class. It's extremely helpful for anyone with these kinds of questions.

  • 2
    Note that almost everyone other than life insurance salespeople will point out that whole life policies are almost always worse than term life and investing the difference. Term life policies are bought, whole life policies are sold. – ChrisInEdmonton Oct 5 '15 at 23:24
0

Advantage of cash: You can spend the money without having to pay any fees or taxes to get it out. Disadvantage: When inflation is greater than zero, which it has been for many decades, your cash is continually losing value.

Advantages of an IRA (Roth or classic): Your money will usually grow as the investments return a profit. You get special tax benefits. Disadvantages: There's risk -- you may lose money. There are tax penalties for withdrawing the money before retirement. In general, you should only put money in an IRA if you expect to leave it there until you retire. Or at least, for a long time.

Whole life is a combination of a life insurance policy and an investment. Advantages: Combines insurance and investment into one convenient monthly payment. Disadvantages: The investment portion typically has lower returns than you could get elsewhere.

If you have no need for life insurance -- if you're not supporting anyone or you're confidant they could get along without you or you don't like them and don't care what happens to them when you're gone or whatever -- then there's no point buying life insurance, whole or term. You're paying for a product that you don't need.

It's pretty common advice to tell people that instead of buying a whole life policy, they should buy a term policy with the same coverage, and then invest the difference in the premium. For example, if you were considering getting a $100,000 whole life policy that costs $50 per month (just making up numbers, of course it depends on your age, health, etc), and you see you could get a $100,000 term life policy for $30 per month, you will almost certainly do better in the long run to buy the $30 term policy and put the other $20 into investments. The catch to this plan is that there are usually transaction costs to investing. Even a discount broker like Ameritrade or Scott Trade charges around $10 per transaction. So if you tried to invest $20 each month, you'd lose half of it to transaction fees. Which means that in practice, you'd have to save that money up until you had at least a few hundred. And at that point many people find other things always seem to come up to spend the money on, so that while they start out with every intention of investing this money, they don't.

  • "There's risk -- you may lose money." The same risk with the same type of investment outside IRA. IRA is just a type of account. It is not a type of investment. You can put your money in IRA CDs and it will gain or lose money like outside CDs. You can put it in mutual funds, bonds, stocks, etc. just like you can do with outside money. – user102008 Oct 10 '15 at 6:00
  • "There are tax penalties for withdrawing the money before retirement." Not for withdrawing contributed amounts of a Roth IRA. – user102008 Oct 10 '15 at 6:01
  • @user102008 RE "same risk with the same type of investment outside IRA" Yes, absolutely true. The question asked about cash vs IRA vs whole life, so I didn't get into other types of investments. In retrospect, this may have been misleading. – Jay Oct 12 '15 at 15:03
  • @user102008 Okay, key word here is "contributed". If you put, say, $1000 into a Roth IRA, and that investment then grows to $1500, and you then withdraw the entire amount before reaching age 59 1/2, you don't pay taxes or penalties on the $1000 you originally put in -- because you already paid taxes on that -- but you DO pay taxes plus a 10% penalty on the $500 in profits. If you wait until after 59 1/2, then all withdrawals are tax free. Note there are some other details and special cases, consult your financial planner or tax advisor, etc. – Jay Oct 12 '15 at 15:10

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

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