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The Truth About Term and Whole Life Insurance

By Edited Feb 13, 2014 0 0

Life insurance is one of the most misunderstood financial products in existence. Even with complicated offerings on the market like stock options, warrants, and futures contracts, life insurance remains a complete mystery to some. Some investors will even choose to invest in FOREX before they'll consider a life insurance policy as an investment. This may be largely due to several common misconceptions about the nature of life insurance.

Myth: Cash value life insurance is one of the worst financial products available.

Truth: Cash value life insurance is one of the most stable investments you can buy. If you choose the right kind of cash value policy, you will be well rewarded until the day you die. High cash value contracts are less common these days, but they're still out there. 10-pay, 20-pay, and custom whole life policies allow you to rapidly build a savings that is guaranteed for life.

Universal life insurance offers you a way to minimize the death benefit of the policy while maximizing the cash value potential of the contract. While it lacks the explicit guarantees of a whole life, universal life insurance gives you the opportunity to earn more than a whole life policy over time. Like a whole life policy, the cash value of a universal life contract is accessible for any reason during your lifetime.

The direct access to the cash value makes cash value insurance one of the most flexible products in existence. What's more, some whole life, and many universal life, policies offer non-direct recognition loans. This means that any money you borrow from the policy doesn't actually leave the policy. It continues to grow as though you never took a loan out at all.

For example, if you had $10,000 in cash value in a whole life offering a non-direct recognition loan feature, you could take out a loan for the full $10,000. The insurer would give you a loan for the $10,000 and charge interest on the loan. They would secure this loan with $10,000 in your policy. None of this requires a loan application or any sort of formal approval process. Since the insurer continues paying interest on the $10,000 it secured for the loan, your net interest on the loan is often zero percent. This means that, when you pay back the loan, you'll have the same amount of money in the policy as if you had never taken out a loan.

Myth: Cash value life insurance is overpriced for what you get.

Truth: Cash value insurance appears to be overpriced due to the high premiums relative to the death benefit you receive. This is often perceived as being an "expensive" policy type. However, the truth is that most of the premium you pay goes towards investments that will eventually become part of the cash value of the policy.

The insurer has to do this by design. A common misconception is that the insurer keeps your cash value when you die and only pays out the death benefit. This is impossible for the insurer to do. Since the cash value is contractually guaranteed to equal the death benefit at your age 100, the insurer must build a cash value that replaces the death benefit over time. The amount of insurance you purchase in a whole life policy is constantly decreasing each year. The difference between the total cash value and the remaining death benefit amount is called the "net amount at risk." This is the amount of money the insurer stands to lose if you die in any given year. This cash value isn't a cost, it's a benefit that you get to keep as long as you live. When you die, the insurer is contractually obligated to pay out the cash value and any remaining insurance (death benefit) to your beneficiaries. Marketing divisions of life insurance companies are sometimes responsible for this confusion, since they actively promote the idea of whole life as "a death benefit with a savings component." Actuarially, this is inaccurate, and individuals responsible for designing life insurance policies do not incorporate any actual separation of cash value and death benefit into the policy.

Myth: Term life is cheaper than whole life

Truth: The actual lifetime cost is the same for both policy types. Term life insurance is based on the same cost structure as whole life. Both policies use the Commissioner's Standard Ordinary Mortality Table, also called the CSO Mortality Table, to price policies. Both term and whole life have what are called "guaranteed mortality charges." These charges represent the cost of the death benefit, and will work out to be the same over time. The reason the premium for whole life is higher is two-fold:

1) The whole life policy is generating investment interest which requires higher initial premium outlays (premium payments). These higher premiums in the early years of the policy help to hold down the cost of insurance in the latter years of your life resulting in a lower lifetime premium outlay than term life and;

2) Whole life front-loads its costs. This means that you pay a higher cost per thousand dollars of death benefit in the early years of the policy. In the latter years, your cost is very low. In some cases, it's practically non-existent.



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