2/21/2005
Advice from Nashville's leading Financial Aid Advisor Dave Ramsey
Dave Says
By Dave Ramsey
Author of:
Financial Peace and
The Total Money Makeover
"Why does Dave not like whole life insurance?"
Dear Dave,
I’ve been an advocate of whole life insurance policies and have had one for
several years, but I’ve read that you think these are a bad deal compared to
term insurance.
I’ve been viewing my whole life policy as death insurance and a savings plan all
rolled into one product. I’ve borrowed money from it in the past at a low
interest rate. I just don’t feel as if I’m throwing my money away. I’ve got
about $3,000 cash value in it right now and my beneficiary would get $50,000 if
I die. With a term insurance policy, I don’t have the option of borrowing
against it and there is no return on my money except when I die.
Reggie in Flint, MI.
Dear Reggie,
Have you noticed that your car insurance doesn’t have a savings plan built into
it? You get no money from that insurance unless you wreck your car. Your health
insurance doesn’t have cash value plan in it either. You get no money from that
insurance policy unless you get sick.
Insurance, in its purest form, is transferring to someone else the risk that you
cannot afford to take. I cannot afford to take the risk that I’ll need a triple
bypass surgery that will cost $50,000-$100,000. Therefore, I carry health
insurance and the risk of incurring those costs is transferred to the health
insurer. Whole life policies, as you said, combine an insurance policy with a
savings program.
You and I know that insurance companies, no matter what kind of insurance they
provide, are in business to make money. If they’re offering you both a death
policy and a savings program, you’re paying a fee for both products.
Recently, we conducted a study that I’ll use as an example. We asked eight of
the top insurance companies for their best whole life rates. If a 30-year-old
pays $100 a month in whole life insurance policy premiums, he could buy a policy
worth about $125,000, on average. Some of the $100 goes toward the insurance
policy and some of it funds a savings account. Then we looked at how much that
same 30-year-old could buy if he got a 20 year level term insurance policy worth
$125,000. The cost is about $8 a month. So, $92 a month funds the savings plan
in the whole life policy. Studies tell us that whole life policies pay between
1.2% and 2.3% interest on the savings after a couple of years. The first year or
two they actually pay no interest. Keep in mind, inflation averages 4%, so
you’re losing money every year if you only average 2% interest.
There’s another problem with whole life insurance, in addition to paying ten
times more for it than term insurance. You’ve got $3,000 cash value in the
savings portion of your policy. If you die tomorrow, they’ll pay your
beneficiary the insured amount, but the insurance company gets to keep your
$3,000 savings.
So, your investment program for your $92 a month is zero return for the first
few years, 1%-2% return after that – which doesn’t keep up with inflation – and
when you die, they keep your money. You could invest that $92 a month in a good
mutual fund and average a 12% return – which is what the insurance company is
doing. They give you 1%-2% and keep the other 10%.
There is a valid concern with term insurance – that it will get more expensive
as you age. If your 20 year level term policy comes up for renewal when you’re
50, it’s going to be pretty expensive. That is why I also push people to get out
of debt and invest in a good Roth IRA. If you follow that plan, you can have
$750,000 saved up in your Roth IRA by the time your term renewal comes up. With
that much money set aside, zero debt and a paid-for house, your family is secure
because you've become self-insured.
-Dave
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