Retirement Savings vs. Life Insurance

Question: I'm 56 and my wife and I together make around $80k and both contribute to our company matched 401Ks. I plan to retire at age 70. My insurance agent is suggesting I stop contributing to my 401K and instead buy a "Permanent Life" policy of $250k which he says will pay out better than if I stayed in the 401K (the company matches 50 cents on the dollar up to 6%)by spending down what I already have and spending down the dividends in the insurance policy. Is this possible? Is buying Permanent Life Insurance considered a good investment? Dennis, Silverthorne, CO.

Answer: I have a very simple point of view toward questions like this: When a company matches half of your contribution into a retirement savings plan you are outperforming over the long-haul Warren Buffett, George Soros, William Gross, and any other legendary investor of the past half-century. Why would you give up such a superior investment track record?

Financial planners disagree on many things, such as the cost and benefits of actively managed investment funds versus passively managed index funds. But most if not all would agree with me that everyone should take full advantage of their retirement savings plan at work--as well as IRA, Roth-IRA, SEP-IRA, or comparable products if you qualify--before even considering putting money into a cash-value life insurance product. Cash value life insurance, such as whole life, universal life, and variable life is not a retirement plan.

I'd stick with your 401(k).

That said, you should evaluate your need for permanent life insurance as a distinct financial planning question. For instance, at your age do you still need life insurance? If so, how much? Does your company offer a group policy? Is it enough, and if it isn't, how much more insurance do you need? Compared to permament life insurance, would it be better for you to invest the potential life insurance premiums in a low-cost tax-efficient taxable account, such as in the S&P 500--or not? These are the kinds of questions I'd pursue before buying a policy.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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For starters, Whole Life Insurance, Universal Life Insurance, and Index Universal Life, are not investment vehicles, they are life insurance contracts with a savings component attached to it.. Therefore, any comparison of these contracts to a mutual fund or stocks is akin to comparing an orange to an apple. The latter are most certainly in the fruit family, but they are not the same. For a more appropriate comparison, it is best to compare these contracts to the performance of a 10-Year or longer note in a best case scenario, or savings rate at a bank in a worst case scenario.

So, one way to evaluate the profitability of a life insurance strategy, is to determine whether the capital expenditure and internal costs of the policy are greater than the capital expenditures, taxes or investment fees of an alternative solution.

At the end of the day, insurance, investment, or annuity contracts are not inherently bad for everyone. the key for each individual is to find a solution that is suitable for him or her. What may be suitable for one person, may not be suitable for another.

- Tom from http://www.lifeant.com

A permanent policy will not work out well unless you stick with it for a long time and most people aren’t able to do that because it’s cost prohibitive. I prefer term life insurance for most people because it is affordable. With a permanent policy, most people can’t afford the face amount of insurance they need to protect their family. Not to mention that the surrender values on a permanent policy add up to abysmal results on the ‘investment’ side of the transaction.

To get a real sense of the value of term, let's compare a term policy and a universal life policy. Currently, the annual premium for a 40-year-old male (non-smoker) in good health for a $500,000, 20-year term level term life insurance policy is only about $350. That same person would have to pay about $3,000 per year to acquire a $500,000 universal policy. For the first few years, most of these policies have zero surrender value. But say he had instead invested $2,650 (the difference between $3,000, the cost of the universal policy, and $350, the cost of a term policy) in a mutual fund that averaged a total return of 10% annually. At the end of the first year, he'd have $2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10 years, he would have accumulated more than $46,000 in after-tax savings in the mutual fund. Over the same period, the cash value of the policy would likely only have climbed only to about $21,558 (assuming a 4.4% non guaranteed rate).

Do you think that financial decisions should be made on economics or on peoples opinions of how they think things work, in other words does it really matter where the money goes if one works better than the other. Where is the proof?

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