The last couple of weeks I have gone through a process called underwriting - the application for and reception of a life insurance policy. The good news is, my overall health at age 38 is so good that I got a preferred status, which is saving me a ton of money on premiums. The bad news is that I literally had to beg my insurance agent to sell me the product I wanted.
I'm currently in a stage of my life where saving for my own and my wife's retirements has top priority. We didn't do ANYTHING in this regard until about one and a half years ago. Yet I plan to retire on a solid portfolio of dividend-paying stocks like Lockheed-Martin (LMT), McDonald's (MCD), Altria (MO), Target (TGT) and the like. This portfolio is being funded by monthly contributions to our Roth IRAs and is set up to allow us a comfy lifestyle without having to rely on any social security pensions etc. If we will indeed receive such benefits 25 years down the road then we'd consider this the gravy on our silver plates. So what does this all have to do with life insurance?
My agent tried to sell me a permanent cash value life insurance policy. In theory there's a part of your monthly or annual premium going towards the real insurance of a terminal incident (a.k.a. death) and the lion's share is being invested by the insurance company in the market (usually in mutual funds and/or company owned stock portfolios). While this may be a good idea for many people, I don't like this concept at all. I'm not a big fan of Dave Ramsey's "Total Money Makeover" but in regards to cash value life insurance I agree with him: "Cash value life insurance is one of the worst financial products available."
The annual premium I was shown by my agent for the CV policy was $5,000. Now since I convinced him that I only wanted the simple death benefit of a term insurance, my premium has gone down to $600 a year. Let's see what happens if I invest the difference of $4,400 into stocks of dividend-paying companies. For simplicity's sake I'm assuming that the initial yield for the subsequent annual buys as well as the dividend growth rate will stay the same (which is very unlikely) but on the other hand I won't consider stock price appreciation (which is very likely). We're investing the $4,400 every year for the next 20 years (the term of the insurance policy) and reinvest the dividends.
dividend growth rate
portfolio value after 20 years
dividend payout in the 20th year
Not bad, ey? Now let's assume that the insurance company, which kindly invests and manages my money for me takes out 3% in fees each year (in reality they take out like 100% for the first three years to pay the commission to the agent and their own administration costs for the underwriting and then 1-2% for the rest of the term). That leaves $4,268 to be invested. The $600 premium for the death benefits stays the same in both cases. Now what can I write home after a group of professional money managers has taken care of my retirement savings for the return rates they quoted me on that fancy illustration?
cash value after 20 years
interest payout in the 20th year
Cash value life insurance
The customer's net contribution over 20 years is exactly $88,000 in both scenarios ($4,400 x 20). Investing this retirement nest egg with the cash value life insurance gives you total return rates of 3.4-8.5% p.a. The same out-of-pocket amount invested in sound businesses gives you annual return rates of 11.0-29.4% if invested wisely. Warren Buffett became a multi-billionaire … by selling insurance policies! What would you think is the better deal for you?