Investing in a pricey life insurance policy
Equity indexed universal life is costly, and full of high fees. But is it worth it?
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| Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005). |
NEW YORK (Money) -- Question: I'm 36 and make about $130,000 a year. My wife stays at home and cares for our three young boys. For about nine years, we have been paying into a variable universal life insurance policy that has a $250,000 death benefit and a cash value of about $3,000. My agent now wants me to move into an index universal life policy with a death benefit of $500,000, which would increase my payment by $200 a month. I have read that this type of insurance may not be right for my family. What do you recommend? ---Eric, Pleasanton, Calif.
Answer: I recommend that you talk to another adviser.
Granted, I don't have the details of the policy you already own or the one that your agent wants to switch you into. But on the basis of what you've told me, I have serious doubts about whether you should be plowing money into either of them.
The theory behind such policies is that they provide life insurance protection as well as an investing component, known as the cash value. With a variable universal life policy, a portion of your premium pays for insurance protection -a death benefit for your family if you die - while the rest is invested in stock and/or bond mutual fund-like accounts.
The policy your agent is now recommending, which is known in insurance circles as EIUL, or equity indexed universal life, is similar to variable universal life in that some of your premium pays for insurance protection and the rest is invested. In the case of EIUL, however, the policy's cash value is tied to the performance of an index such as the Standard & Poor's 500-stock index. Typically, you earn a portion (as opposed to all) of the index's gain when it goes up; if the index declines, the policy usually guarantees that you will receive at least some minimum return, say, 2% or so.
I wouldn't be surprised if one reason your agent is recommending the switch to EIUL now is because the stock market has performed so dismally in recent years. Witness the fact that you have just $3,000 in cash value after paying premiums for nine years.
I'm not going to get into the issue of whether switching to a more conservative approach after the market has already crashed is a good or a lousy move. The more important issue, it seems to me, is whether you should own this type of insurance at all.
At first glance, these policies may seem like a wonderful idea, taking care of your insurance and investing needs in one efficient and convenient policy. Problem is, I don't think they fill either of these needs very well.
These policies are typically loaded with a variety of lofty investment expenses that drag down your long-term return potential. The expenses of variable life policies are detailed in the prospectus, although unless you're a forensic accountant, you'll likely have a hard time figuring them out. The costs aren't explicitly broken out in EIUL policies, but you can bet they're in there.
On the life insurance side, there are two issues. One is whether, after allowing for the investment component and the policy's expenses, you have enough premium left over to give you the amount of insurance coverage you need. In your case, $500,000 may sound like a lot. But given your earnings and the fact that you've got a wife and three kids depending on your income, that amount may not be enough.
The other issue is whether you're getting a good deal on the cost of the insurance protection itself. That's hard to know unless your agent has explained that cost in a way you can understand - such as breaking out the cost for each thousand dollars of insurance coverage - and then told you how that cost stacks up versus what you might pay for other policies.
Frankly, I think there's a much easier and more cost effective way to go: buy your insurance protection and do your investing separately.
As far as insurance goes, a young person like you should be focusing on getting sufficient coverage to assure your family won't suffer a steep drop in its living standard should you die, while at the same time not shelling out so much in premiums that you can't enjoy life now and save for the future. (To figure out how much insurance you need, you can consult a life insurance needs calculator.)
Your best shot at getting sufficient coverage at an affordable price is to buy bare-bones insurance protection - i.e., a term insurance policy. You can get quotes on term policies at several insurance sites online.
On the investing side, your aim should be to put together a portfolio of low-cost stock and bond mutual funds such as those that have made our Money 70 list of recommended funds.
If you can do that while investing through a tax-advantaged savings plan - a 401(k) plan at work, an IRA, a SEP-IRA for the self-employed or some combination of these - so much the better. The tax benefits will effectively leverage your savings and investing efforts. But if you can't, you can always stick to tax-efficient investments like index funds or tax-managed funds in taxable accounts.
So I suggest you consult an adviser who can help you figure out the best way to get you the life insurance protection you need, assure that you're saving and investing appropriately and also help you decide what to do with the policy you already own.
Preferably, that adviser should be one who know his way around insurance, but doesn't make his living primarily from selling the types of policies your agent is pushing.
You can begin your search for such an adviser by going to the Financial Planning Association's planner search tool. For assistance deciding whether it's worthwhile to hold onto your current policy, you might check out the life insurance evaluation service offered by the Consumer Federation of America.
All this will require more time and effort from you than simply going along with your agent's recommendation. But I think the payoff in greater financial security for you and your family in both the short- and long-term will be well worth it. 
