Low-cost life insurance is one of the top five investments recommended by Michael Edesess et. al. in their excellent book, The 3 Simple Rules of Investing: Why Everything You’ve Heard About Investing Is Wrong — And What To Do Instead. Here are the five recommendations in this book.
- Invest in TIPs (TIP)
- Invest in a low-cost total U.S. domestic equity fund. (VTI)
- Invest in a low-cost total international equity fund. (VEU or VEU)
- Invest in a single-premium income annuities.
- Invest in a low-cost life insurance plan.
The first three recommendations are ones I support. The fourth and fifth, less so. Annuities are expensive, but they do guarantee (with some risk) a source of income. In this blog I will tell my experience with life insurance.
In the late 1950s I took out a $10,000 life insurance policy with TIAA-CREF. The policy was worth five times my annual teaching salary that year. TIAA-CREF policies at that time were only available to college and university professors and teachers in private high schools. Each year TIAA-CREF sent me a dividend check that was quite small for the first few years. The annual cost of the policy, as I recall, was a little under $150 a year and it was known as an Ordinary or Whole Life Policy. At that time TIAA-CREF offered four policies. 1) Decreasing Term, which I will describe later. 2) Term, which I will describe later. 3) Ordinary or Whole Life, and 4) Endowment. The Endowment policy was a very expensive life insurance and saving plan type of policy. Not one I would recommend unless you are in a particularly high tax bracket.
One year the dividend closely matched the premium cost of the policy. Great, was my original thought. Here I am, getting a $10,000 insurance policy for next to nothing. What could be better? The following year, the dividend amounted to a little over $150.00. That large dividend peaked my interest. How could a company pay a dividend that exceeded the cost of the policy? Something was going on that I failed to understand. So I began to investigate Whole Life Insurance and found out that the premiums I was paying into TIAA-CREF were adding up and that the insurance company was not really insuring me for $10,000. Instead, they were insuring me for $10,000 minus my premiums. When I called TIAA-CREF, and keep in mind this is a great insurance company, I found out that my policy had a cash value of $2,300. Therefore, they were insuring me for $10,000 – $2,300 or $7,700. $2,300 of that $10,000 policy was really my money – known as the cash value.
About this same time I heard of a course being offered in our area: Inflation, Insurance, and Investments. This was a time when inflation was just beginning to ramp up and I had this dividend insurance question. Further, investing was an interest, but I knew little more about it other than to invest in no-load mutual funds. So I signed up for the course and the thesis of the three-week class was simply, Buy Term and Invest the Difference. With this advice I began to look into term insurance offered by TIAA-CREF and found this startling information. If I withdrew the $2,300 cash value from the $10,000 Whole Life Insurance policy, put it in the bank, I could purchase a $10,000 term insurance policy with the earned interest and have money left over. Amazing. This would not be possible today at current interest rates.
But I did not buy term insurance. By this time we were buying our first house and we had a loan that now would be considered peanuts. Instead of purchasing term insurance, I took out an even cheaper policy, decreasing term. This is a type of insurance that starts high and over the years decreases in value. For example, a $100,000 policy may only cover $50,000 ten years into the life of the policy. The concept behind decreasing term is this. As the value of the policy decreases, the principle in the house increases. In case of death the insurance will cover the remaining portion of the house loan. When the value of the house exceeds the remaining value of the decreasing term plan, drop the insurance. It is no longer needed. Or it may not be needed. Each person needs to make these decisions based on their own situation.
There you have my life insurance story. Conclusion: If you need life insurance, take out the least expensive plan possible and save the difference in low-cost index ETFs.