Calculate the Cost and Return of Whole Life Insurance Plans

Reiterate my point on the indispensable insurance component that we shall put under the whole financial plan umbrella:  the insurance decision is of vital importance. If you deem yourself ultimately worth millions of dollars as a result of your hard work and intellectual capability or want your children to benefit from you materially at your demise, then life insurance is a necessity.

Why there is enormous resistance keeping people from purchasing this important product. I guess we just loathe the idea of paying the premium every year, and a big chunk of which, we think goes to the ‘greedy’ agent. So we feel being ripped off.

However, are you really being ripped off? The best way to answer this question is to dive deep into the excel spreadsheet and crunch the number. Let the mathematical facts tell the truth.

I have obtained two sets of tables illustrating the initial deposition and cumulative assets over the years. In both scenarios, we assume a healthy person at age of 40 in the year of 2016. The first table is provided by Ohio National Financial Services and the other one is cited from page 58/59 of the book – Money.Wealth. Life Insurance. – authored by Jake Thompson.

In the first scenario, a $17,360 annual payment is made continuously for 10 years, and then there is no annual contribution in the rest of your life. The initial death benefit is set to be half a million dollars.

year age deposit balance fees paid(cumulative) dividend
2016 40 17360 0  $                             17,360  $                     1,760
2017 41 17360 9730  $                             24,990  $                     1,858
2018 42 17360 26485  $                             25,595  $                     1,964
2019 43 17360 43870  $                             25,570  $                     2,087
2020 44 17360 61905  $                             24,895  $                     2,259
2021 45 17360 80610  $                             23,550  $                     2,509
2022 46 17360 100015  $                             21,505  $                     2,834
2023 47 17360 120145  $                             18,735  $                     3,270
2024 48 17360 141025  $                             15,215  $                     3,862
2025 49 17360 162690  $                             10,910  $                     4,729

Obviously, by end of the first 10 years, if not counting in the dividend, you lose $10910. This is disturbing. However, in the next 10 years – reaching 60 year old, no annual payment is needed, while the wealth will be grown into $220,485 or $ 306,894 if counting the dividend. The return would be 1.2% and 2.9% respectively.

For another 10 years, the assets would be $2888,555 and $479,618 (with dividend) and return be 2.57% and 3.45% respectively.

Let’s assume keep the money ourselves and put it into a safe account growing with 3% return per year, and to make the result more conservative, we assume the beginning amount is already $173,600. After 30 years, it would be $421,373. Now throwing in some realistic conditions, first, is there such a safe 3% guaranteed financial product? Second, when you withdraw that money, a tax would be imposed, let’s assume 20%, so the final output is likely to be around $300,000. All these are premised on that I can purchase such a safe and stable financial product, I guess it’s likely to be a municipal tax-free bond. (consult practitioner to ensure it’s feasible)

So for me, at this point, I get my head around. It’s about equivalent from the pure standpoint of investment return. The other portion – death benefits- plays an important role to move toward a decision to use insurance.

To be more comfortable, I’d take a look at the other scenario.  Citing from page 58/59 of the book – Money.Wealth. Life Insurance, $750,000 were deposited in two years, in the first year, $2948 would be taken out as a fee paid, the next year, cumulatively, $818 in total is taken away. Then the $150,000 asset keeps growing with varied annual return – 4.2%, 3.6%, 3.0%, 1.75%, 2.3%, …and from the 10th year, the return jumped to 5.68% stable, reaching to $320,835 in the first 10 year end, $320,835 by end of the 20 years, and $551,567 30 years end.

One difference between the two scenarios is the former one grows relatively stable over the full course, while the latter one grow slow in the first 10 years, then rapidly (roughly 2% vs. 5% stark difference). Both look realistic as different companies may take different strategies.

The other difference is the fee taken out from the deposits, the first scenario seems more like real world, while in the second one, only $818 is paid, which I don’t think is realistic.

Lastly and foremost important, I want to understand how the insurance makes money if the laid out schema is really good-looking as in the book. Only when you figure out their profit model, you can be comfortable that you are not in a pyramid-like scam game.

My thought goes to the power of compounding, assuming the insurance company only gets 1% on top of your asset, $150,000 initial input can generate $100,000 or so ($648291.36 – $551,567) after paying us. This is constructed based on reserved 5% annual return. Possibly, this gigantic institutional investor is able to get 7% or 8% as a large arsenal of products are at its disposal, but not available to retail investors.

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