Blast from the past

Kiplinger's Personal Finance Magazine, May, 1998 by Kimberly Lankford

Imagine you're part of an earlier generation--maybe when America used to gather round the TV to watch I Love Lucy or Father Knows Best. You've recently married, and you're planning a family. You need life insurance. You get a call from Mr. Jones, an agent you know from Kiwanis. Mr. Jones comes over one night after supper and sits with you at the kitchen table. Okay, says Mr. Jones, you could buy term insurance, but you'll have to pay higher premiums when you renew the policy. And what if your health deteriorates? Oh, and by the way, how are you going to make your money grow if it's in a 4% passbook savings account?

Mr. Jones suggests a much safer bet: Combine your need for insurance with a sure-thing investment. He pulls out whole-life policy illustrations and explains the intricacies of surrender charges and policy loans. You consider the fact that the premiums will stay level, the policy will stay in force for as long as you live, the cash-value portion will grow tax-deferred, and you can borrow from it whenever you like. Then you pick the biggest whole-fife policy you can afford.

Fast forward to 1998. Never mind that you don't have time to have an agent over after supper. For most people, cash-value insurance is an anachronism, rendered obsolete by new life insurance choices and new investing options. It still makes sense for a few people in special situations (to see if you fit the profile, see the box below). But under the new rules, you're more likely to be a loser than a winner if you buy cash-value insurance.

YOU CAN BUY A 30-YEAR TERM POLICY--CHEAP

Under the old rules, buying cash-value insurance was the only way to lock in coverage long term with predictable premiums. Initial premiums for term insurance were much lower than for cash-value, but they'd rise at the end of the term, often every year. Eventually they would become more expensive than cash-value premiums--so expensive, went the cash-value sales pitch, that you might have to drop your coverage.

Now you can buy a 20-year or 30-year level-term policy and lock in premiums until you retire, or your children graduate from college, or you pay off your mortgage. "That takes a lot of steam out of the argument for cash-value," says John Ryan, a financial planner in Denver.

Because cash-value insurance is so much more expensive than term due to the investment component, buyers sometimes skimp on the death benefit. Ryan has also seen people spend such a large percentage of their income on cash-value life insurance that they can't afford other coverage they need, such as disability insurance.

Meanwhile, intense competition has lowered the price you'll pay for term coverage. A 35-year-old man who qualified for preferred rates could recently lock in a 30-year level-term policy from Transamerica with a $250,000 death benefit for as little as $360 a year. A 45-year-old man could get preferred rates on a 20-year level-term $250,000 policy for as little as $493.

Bonus: You can shop for term insurance from a quote service over the phone or the Internet--at, say, 2 A.M.--and spend the time after supper doing the dishes.

YOU HAVE OTHER TAX-DEFERRED SAVINGS OPTIONS

Buying cash-value insurance used to be one of the few ways to shelter savings from taxes until the money was withdrawn. Now there are a slew of tax-deferred savings options. You can invest up to $4,000 a year per couple in tax-deferred IRAs--and maybe even deduct the contributions. As an alternative, most couples are eligible to invest $4,000 per year in Roth IRAs, which let you take your money out at retirement tax-free (see "Taxes"). You may be able to invest up to $10,000 each, pretax, in a 401 (k) retirement plan offered by your employer--your boss may even match your contributions--or $6,000 pretax in a SIMPLE retirement plan. If you're self-employed, you may also get tax deferral through a SEP, SIMPLE or Keogh plan.

With two IRAs and two 401(k)s, a couple can sock away as much as $24,000 a year to appreciate without the drag of taxes. But the maximum level premium for a $250,000 Ameritas policy, for example, is $3,125 a year for a 35-year-old man (about $2,650 is invested in the cash value). You can raise the investment amount (and the premium) if you raise the death benefit.

YOU CAN DO BETTER INVESTING ELSEWHERE

You've heard it over and over: Buy term and invest the difference. It wasn't always easy to do that, but now with almost 6,000 mutual funds to choose from and online-broker commissions as low as $8 per trade, do-it-yourself investing has become a national pastime.

The main problem with cash-value insurance is that high up-front commissions and fees drain your returns in the early years. The Consumer Federation of America recently calculated the rate of return on more than 4,000 whole-life and universal-life policies, in which cash-value gains are based primarily on the company's fixed-income investments. (Universal life has a flexible premium and death benefit; whole life usually does not.) After subtracting a typical term-insurance cost from the premium, the consumer group found that most policies didn't have a positive rate of return until the fifth year, when they averaged 5.6%. (Low-load policies, which don't pay agent commissions, had positive returns earlier.)