Why Whole Life Insurance Doesn’t Make Sense for Most Military Families

Life insurance is a complex topic.  When you’re trying to find the right policy for your situation, it’s easy to get confused by the different types of polices that are available.  Two of the most common types of policies term and whole life insurance.  This article will attempt to explain:

  • The difference between term and whole life insurance
  • Why term life insurance is usually the right type of policy
  • Three whole life insurance ‘sales pitches’ and why you shouldn’t fall for them
  • Why an insurance salesman might have an incentive to push a more expensive policy

What’s the difference between term insurance and whole life insurance?

While there are many differences between term and whole life insurance, there are three that are pertinent to this article.

First, the premium on a term insurance policy remains level for the duration of that policy’s term.  For example, a 20-year policy has the same premium for year 1 as year 20.  After that, it needs to be renewed.  Since premiums usually increase with age, these renewed policies are generally issued at higher rates.  Whole life insurance, which is considered permanent insurance, has premiums that remain flat for as long as the policyholder keeps paying them.  This could be for five years or for 50 years.  Hence the term, ‘whole life.’

Second, whole life insurance has a cash component.  The cash component is the result of unused premiums, which are set aside as part of the policy.  Technically, this cash belongs to the policyholder.  This is also known as ‘forced savings.’  In essence, a whole life policy is ‘part insurance, part investment.’  Term life insurance, although cheaper, has no cash component.  Unless the covered person dies, there is no benefit paid out under a term policy.  SGLI is an example of a term life insurance policy.

Third, and most importantly, people BUY term life insurance.  However, people are SOLD whole life insurance.  What does this mean?  People generally recognize that they need life insurance, and buy a term policy because it makes sense.  SGLI acts like a term policy in this sense, and everyone understand how important SGLI is.  Term life insurance is so simple, you can shop for quotes online.

However, whole life insurance policies are so complicated, you need a salesman to help you understand the reasons why you would buy it.  In fact, I’ve never met anyone who said, “I need a whole life insurance policy.”  Most people only buy a whole life insurance policy if convinced to do so by an insurance agent.  That agent might have reasons to sell this policy other than the client’s best interests, as we’ll get to below.

Why is term life insurance usually the right type of policy?

We just discussed how you can save up money by buying a whole life policy.  Also, we just discussed how you might end up paying higher rates for term insurance if you have to renew when you get older.  That makes the case for whole life insurance, where you can lock in rates when you’re younger, right?

Not so fast.  There’s a common saying, “Buy term insurance, and invest the difference.”  What this means is that instead of buying whole life insurance, you would be better off buying a term policy (at a much lower premium), then investing the extra money in a low cost savings vehicle like an IRA or Thrift Savings Plan.  Usually, additional fees associated with a whole life policy eat into the savings that you would otherwise put to work.

However, with a term policy, you protect yourself from the sudden loss of income that you might encounter in a post-military career.  Even if you retire in your 40s or 50s, most people can find reasonable rates for a term life insurance policy that protects against this loss of income until you retire in your 60s or 70s.  If planned properly, by the time your term policy expires, you’ll be financially independent, and you’ll have saved enough money so that you and your spouse can live on your retirement assets alone.  If you pass, your spouse will still have enough set aside to be financially stable.

Three common whole life ‘sales pitches’ and why you shouldn’t fall for them.

It is hard to envision a scenario for a military family in which a whole life policy is better for than a term policy.  However, there are several things you might hear, and the counterpoint that you should be aware of.

  • You can start a whole life policy for your children and keep low rates forever.    However, you’re paying a lot in terms of opportunity cost for that policy.  The insurance company will take your money, invest it, then give you a portion of whatever they’ve earned.  However, it’s never been easier to build your own conservative, diversified portfolio and invest the money yourself.  Over time, the power of compounding interest will reward your early investment.  Since anyone can do the math and come up with an answer that supports their position, you should do the math for your situation and make your own decision.
  • You can have ‘permanent’ life insurance for the rest of your life. Two counterpoints to this argument.
    • First of all, you don’t. Most permanent life insurance policies mature when the insured reaches age 100, although some insurance policies have changed to allow for policies to continue until age 120.  At that point, you receive a payout of your policy’s face value.  However, if you’re still alive, you’ll receive a massive tax hit, as you’ll have to pay taxes on the difference between your premiums and the face value.  Not only that, but the taxes are at ordinary income rates, not more favorable capital gains rates.
    • Second, if you’re prudent with your finances, your insurance needs should go down as you age. By the time you retire, you should have very little need for life insurance.  True financial independence means that you don’t have any insurable need, because you don’t have to replace any lost earnings power when someone dies.  Why would you continue to pay for insurance that you don’t need?
  • If you don’t spend your cash balance, you can keep it. While this might be true, don’t expect this to be realistic for the first 10 years of your policy.  First of all, you don’t have much of a cash balance to begin with.  Second, most insurance companies levy heavy fees and surrender charges that will eat into this cash balance.  Additionally, the return you’ll receive from a life insurance policy will far underperform what you would reasonably respect from a diversified portfolio.  Although salesmen might try to sell policies such as variable life (which allows you to dabble in the stock market), or variable universal life (which allows you to dabble in the stock market and figure out how much you want to pay in monthly premiums), you can rest assured that the lion’s share of any profits will go to the insurance company.

Why would an insurance agent try to ‘upsell’ me on an insurance policy? 

The same reason any other salesman would try to upsell you—there’s a larger commission.  It is very difficult to pinpoint exactly how insurance companies compensate their agents, since there are so many variables:  type of policy, number of policies sold, regulations, etc.  However, there’s a general rule of thumb:  insurance agents receive a first year commission, paid immediately after the first insurance premium is paid by the policyholder.  This commission can be upwards of 50% of the first year’s premiums, and many anecdotes indicate that it can be as much (or more than) 100% of the first year’s premium.  However, as the policy matures, the insurance company earns its money back (and then some), because the agent’s commission trails off significantly after the first year.

If you know this fact, then there are two observations that follow:

  • Commissions on a more expensive policy are higher than commissions on a cheaper policy. Some might argue that whole life policies can be cheaper over a ‘whole life.’  This is theoretically true, if you buy a policy for a very young child (like the weird Gerber life insurance flyers that I’ve occasionally seen, where I could buy a whole life policy for my newborn for just pennies per month).  However, for most military families who have had the benefit of using SGLI for most of their career, and are now looking for post-military options, this argument doesn’t make sense.  Shopping for life insurance in your 30s, 40s, and 50s, means that a whole life policy will usually be a LOT more expensive than a comparable term policy, even a 30-year term.
  • After an insurance policy is in force, that agent has more of an incentive to find the next new policy, than to service the existing policy. And frankly, how much ‘service’ does a life insurance policyholder need, especially in the first few years, when there is very little cash balance on a whole life policy?  So, that’s why you might have a policy in force and still have an agent trying to help you figure out another option.

Of course, you won’t see the price of your insurance agent’s commission.  The commission is directly paid by the insurance company, even though you pay the cost of that commission.

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About Forrest Baumhover

Forrest Baumhover is a Certified Financial Planner™ and tax professional. His firm, Westchase Financial Planning, focuses on the unique financial planning needs of servicemembers and families looking to separate or retire from active duty.If you’d like to learn more about Forrest or his services, please check out the About Forrest page at the top of this article.
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