Great Debates: Term or Cash Value?

This is a debate between the confused and the self-interested. Ordinary consumers are typically confused by cash-value life insurance and leery of the steep premiums involved. Meanwhile, insurance salespeople are big proponents—but also biased, because cash-value policies pay them hefty commissions.

In pushing cash-value policies, salespeople tout the investment advantages, forced savings, chance to earn additional dividends and ability to borrow against the policy. But in the end, the case for life insurance rests on two unique advantages. First, it could salvage a family’s financial future if the main breadwinner dies. Second, the proceeds are income-tax-free to the beneficiaries, and potentially also estate-tax-free. That’s a key reason to buy a cash-value policy with the goal of having coverage at the end of your life, even if you die at a ripe old age.

Set against that tax advantage are three drawbacks. First, you probably don’t need lifetime coverage. Instead, your need for life insurance will likely be over by your 50s or 60s because, by then, your kids will have left home and your spouse would have enough money if you died suddenly.

Second, because the premiums on a cash-value policy are so steep, you might skimp on the death benefit and leave your family in the financial lurch if you die prematurely. In fact, because the premiums are so steep, many policyholders drop their policies. The Society of Actuaries estimates that 39% of whole-life policies are terminated within the first 10 years. These folks would have incurred the steep upfront commissions charged by cash-value policies, but managed to accrue precious little cash value.

Third, if you’re looking to invest, there are lower-cost options with better return potential than building up an insurance policy’s cash value. For instance, you could fund a 401(k), with its initial tax deduction, tax-deferred growth and possible matching employer contribution.

What about that income-tax-free legacy for your heirs? If that’s your goal, you could fund a Roth 401(k) or Roth IRA. The bottom line: Instead of paying the large premiums on cash-value life insurance, most folks would likely get better returns by buying low-cost term insurance and investing the money they save.

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