In Shawshank Redemption, Andy Dufresne was sentenced to life in prison for a murder he didn’t commit. He declared his innocence and spent hours digging a hole in his cell wall, so he could eventually escape. On a stormy night he finally escaped through the tunnel he dug to enjoy a life of freedom on a beach in Mexico. In some way, his character explains the life of an “investor” who owns a permanent life insurance policy like universal life or whole life.
In a recent Wall Street Journal article, Universal Life Insurance, a 1980s Sensation, Has Backfired, the author describes a product that delivered less than stellar results.[1]
What is universal life insurance? It’s a permanent form of life insurance that allows you to invest in a fixed rate policy or one that delivers variable rates of return. The variable policy gives you the option to invest your premium in stocks and bonds. Since it’s a permanent form of life insurance you’ll pay your premium for your entire life.
In the article referenced above, a few of the policy holders have seen their premiums increase by 300% to 400% and some have reduced their death benefit to afford their policies. These insurance policies are injected with high fees, and higher redemption charges – a major reason for their underperformance.
One reason people buy permanent life insurance is to build a cash value reserve they can later use it to live on. The cash value can be withdrawn from the policy on a tax-free basis as a loan, a key benefit to the policy holder.
A client of mine once owned a variable universal life insurance policy that was purchased from a large insurance company. She paid a monthly premium of $995 for 14 years. After reviewing her policy, I decided to terminate it because it was not growing. When we cashed in her policy she lost 7.38%, or $11,740. Had she invested $995 per month in the Vanguard S&P 500 index fund, and paid taxes annually, she would’ve enjoyed a positive return on her investment and an extra $52,300!
My stance is to buy term and invest the rest in low-cost mutual funds. The cost of term insurance is cheap because all your doing is buying insurance coverage – no cash value added.
Of course, insurance should be purchased for need. For example, if you’re a young couple with children and a home with a mortgage it’s essential that you own a life insurance policy. When your children are grown, and your debt level has dropped, the need for life insurance declines. A 94-year old living on a fixed income does not need life insurance.
If you want to pass on a larger estate to your children or donate assets to charity, then a life insurance policy may make sense. You can also use life insurance to pay an estate tax if your estate is large enough.
What if you want to own a permanent life insurance policy? What choices are available? Fortunately, you can purchase low-cost life insurance from several carriers like TIAA. These carriers offer policies without a sales commission or back-end sales charge, and the internal expenses are much lower than broker-sold policies.
A meeting with a Certified Financial Planner™ can help you evaluate your life insurance requirements. They can determine the necessary amount of life insurance coverage for you as well as what type of policy to buy.
Before you make a lifetime commitment to an insurance policy, make sure it’s a good one.
Never ask a barber if you need a haircut. ~ Warren Buffett
9/20/2018
Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.
[1] https://www.wsj.com/articles/universal-life-insurance-a-1980s-sensation-has-backfired-1537368656?mod=trending_now_2, by Leslie Scism, 9/19/2018