I read a lot of personal finance blogs, as part of my journey to get my financial life in order. I’ve read Dave Ramsey‘s Total Money Makeover. One piece of advice I see over and over again is that whole life insurance is a waste of money and everyone should have term life insurance instead.
Personally, I think that advice is horse-poop.
A guy in debt up to his eyeballs just called the biggest names in personal finance idiots. Riiiight. Actually, I didn’t call anyone an idiot. I’ll let Suze Orman do that. I’m just saying that the standard advice ignores some very important aspects of psychology that Dave Ramsey utilizes in other chapters of his book.
The Standard Advice:
Everyone has heard of the debt snowball. It’s the idea that you pay off your smallest debt first, while paying minimums on other debts. Once that’s paid off, put that money towards the next smallest debt. From a financial standpoint, this is wrong; you should pay off the highest interest debt first. But from a psychological standpoint, it’s absolutely right. You get the “win” of paying off a debt sooner and are more likely to stick with it.
On the topic of savings and insurance, you aren’t supposed to mix the two. Term life is cheaper and the money you would have spent on whole life, but now aren’t, you invest. Investing in the stock market “historically” earns a higher rate of return than what a cash-value life insurance policy pays.
What’s Wrong with the Standard Advice:
Will you really invest it?
The idea of the debt snowball is that the psychological win that provides a greater likelihood of overall success is more important than saving a couple hundred dollars. The standard advice on life insurance assumes you don’t need any psychological boost to succeed and instead chases after the extra money. I think we all know the definition of ass-u-me. It seems rather backwards that a person is going to be more disciplined at saving for tomorrow than in paying off debts you see today.
Sure you can set up an automatic withdrawal, but when the new shiny whatever comes out, the temptation will be there to cancel the withdrawal and buy the shiny. If you’re investing through a vehicle like life insurance, then your investment becomes a bill that you have to pay.
Will you really earn more?
I’m a worrier. I try not to, but it comes naturally. As such, I have a pretty low risk tolerance. According to e*trade, my retirement account is more than 1/3 fixed income mutual funds. I like the idea of guaranteed return. I sleep better at night with it than I do thinking about the fact that a downgrade of US Treasuries caused $1.4 trillion to disappear from the stock market. A cash value life insurance policy won’t loose value in a recession.
I recently talked about this issue with an actual insurance agent, Patrick Soukup*. When I brought up this issue with him, he also brought up the issue of pre-tax gains vs. after-tax gains. I’m not going to pretend I’m remotely knowledgeable on tax issues aside from filing a simple 1040 every year. But apparently, your stock market investment would need to gain 7-8% to match the after-tax value of cash-value life insurance’s current 3-4% returns.
*He wasn’t sure of compliance issues with me providing contact info in this post, but if you are in the northern Colorado area and want to talk to him, contact me on twitter and I can get you in touch.
Disclaimer: I am not a certified anything, except flagger (the guy who stops traffic in a construction zone). The information above is my opinion based on readings and conversation and should not be construed as advice.
- What Type of Life Insurance Should I Purchase? (aptusinsurance.com)
- Types of Life Insurance (aptusinsurance.com)
- Slow and Steady Wins the Life-Insurance Race (money.usnews.com)
- More Than Half of Financial Advisors Miss Opportunity to Incorporate Life Insurance into Planning (dworkinassociates.wordpress.com)