It’s a natural inclination to compare all of your options when you’re a consumer. We compare products and assets to one another every day. This helps us make informed choices that, hopefully, give us the most bang for our buck. Yet what if you’re making the wrong comparisons? In Daniel Pink’s book, To Sell is Human, he stresses the importance of the question: Compared to what?
When you ask this question, you can more accurately apply your knowledge in a way that gives you helpful data. You’re likely familiar with the phrase “comparing apples to oranges.” Well, consider for a moment what this actually means. Say you’re grocery shopping, and looking for fruit that is high quality and good value. If you’re comparing the data from one type of apple to the data from one type of orange, you can’t really make an informed choice here.
Instead, you can make a better decision by first comparing all of your apple options based on price per unit, and your own personal preferences, like Honeycrisp or Granny Smith apples. The same goes for oranges, and whether you want Cuties or Blood Oranges. This way, you have an accurate way to assess the worth of the fruit you’re buying, in the proper context.
Life Insurance: Compared to What?
This same logic can be applied to the financial assets you buy. Whole life insurance is more than just an insurance policy because of the cash value component. We believe that this cash value component is a way to create a savings fund that can be used for emergencies and opportunities. However, it’s far too tempting to compare whole life insurance to other assets.
In fact, we recommend that you DO compare it to other assets. This, after all, is part of the due diligence process. However, people tend to compare apples to oranges, which creates an inaccurate analysis.
The Wrong Comparison
The cash value component of a whole life insurance policy is a savings vehicle that allows you to automate your savings. The policy grows through your premium contributions (which are automated), as well as a guaranteed growth rate and non-guaranteed dividends. However, one of the most efficient methods of accessing cash value tends to be the most contentious. That is to say, accessing cash via policy loans.
A policy loan is a loan that your insurance company can give you, by collateralizing an equivalent portion of your cash value. By doing this, you are keeping your cash value intact so that it can continue to grow uninterrupted. However, because it’s a loan, you do pay interest on the cash.
This is where things can get a bit murky. Naturally, people want to compare the rate at which the cash value grows to the interest rate of the loan. And on the surface level, this seems like an obvious comparison. After all, why would you pay to access your own money?
However, the truth requires a bit more digging.
Comparing Cash to Cash
The cash value of your life insurance policy is the savings component of your life insurance policy. Therefore, a more accurate comparison to make is “cash to cash” or “growth to growth.” This means, essentially, comparing what your cash value looks like to what it might look like in another account. One of the most comparable accounts is a bank account, particularly your savings account.
As of right now, cash value growth is about 4.2% NET, depending on the life insurance company you work with. This rate can fluctuate, (yet there’s a guaranteed minimum rate of about 2% net). When you open a savings account with a bank, rates are often much lower than this–think about 1% give or take, and they are taxable. If you’re looking purely for a place to store and grow your cash with certainty, whole life insurance comes out on top.
This isn’t the only factor to consider, either. Your cash value account also grows tax-advantaged. Meaning that while your account grows, you don’t pay taxes on the growth. You can even access your cash through a policy loan without creating a taxable event. Bank earnings, however, are subject to income taxes and are therefore reduced even further. If you’re seeking growth and certainty, you should be seriously considering whole life insurance.
What About Other Growth Accounts?
You may be thinking, what about other growth-oriented accounts like a 401k or the stock market? To that, we’d say once again, make sure you are comparing apples to apples. Life insurance cash value shouldn’t really be compared to investments at all so you’ll want to look at the data. Whole life insurance has guarantees attached to your cash value. These guarantees include:
- A minimum guaranteed rate (around 2% net as of this writing)
- An increasing minimum floor, in other words, you cannot lose value (unless you withdraw or default on a loan)
When you invest in the stock market or a correlated asset like a 401k, you can incur losses that stunt the growth of your money. And while the average earnings may look good, the actual rates are less than stellar because of the time spent making up for losses. Ultimately, and especially for your emergency/opportunity fund: slow, steady, and guaranteed wins the race over unpredictable and volatile.
Comparing Access to Access
Then, there’s the matter of the policy loan. Instead of comparing the loan solely to the growth, it’s important to compare taking a policy loan to other methods of accessing capital. For example, a fixed rate policy loan as of writing might look like about 6% give or take. A more accurate way to compare data here is to compare this to another loan. Depending on your lender, you might pay anywhere from about 5% to 35% for a personal loan.
In some cases, a bank loan might actually be a better interest rate, if you qualify for the money. In which case, that’s a great option! Just because you can take a policy loan doesn’t mean you have to. It does, however, strengthen your ability to access cash. For example, banks like using cash value as collateral, too. It’s certain, so it bodes well on loan applications. Doing so also means that if you struggle to repay your loan, you can use your cash value as a backup. In fact, because of the flexibility of a policy loan, you could use that to repay a bank loan and then set your own repayment terms on your policy loan.
In cases where a policy loan is cheaper, you can access capital without question. You don’t need a “good enough” reason for the life insurance company to agree. The option to get a loan from your insurance company or strengthen a loan application elsewhere is a great advantage to your cash value.
Another popular means of accessing cash is via credit cards. They’re simple and easy, yet come with a steep APR. Many credit cards start at about 18% and can go well beyond that. If you had the choice to pay with your credit card at 18% or a policy loan at 6%, it might seem like a no-brainer. (And your life insurance loan has no bearing on your credit score.)
What About Loans Vs. Cash?
You may be wondering, isn’t it easier to just access cash at NO interest? In theory, yes. However, as Nelson Nash would say, you either pay interest or pass it up. While in some cases paying cash is the simplest route, it’s important to consider Opportunity Cost in your choices. While you may avoid an interest payment by paying for something in cash, you may also lose the opportunity to earn interest.
When you access your cash via policy loan, you give your cash value the opportunity to compound uninterrupted. That means that your cash is earning at its highest potential. If you were to withdraw cash rather than borrow against it, you lose the opportunity for that money to earn anything. In the grand scheme of things, this can diminish the overall power of your account. While the growth rate and loan rate are not equivalent, they are also the wrong things to compare. The value of earning interest on an increasingly large amount is priceless.
Putting It All Together
Comparing life insurance to other assets isn’t always cut and dry. However, it’s clear that in all cases, whole life insurance offers something critical. It provides certainty, and that certainty strengthens almost any other asset you may have.
The certainty of life insurance makes the uncertainty of the stock market more tolerable and ensures that there are some things you don’t lose. The loan component provides flexibility, even if you get a loan elsewhere. The reliable, automated savings means you can expect growth without loss. Protection is necessary to assure the probability of your growth curve happening. If we put all our clients in a room, they would tell you that they would rather have a 100% chance of getting to 95% of their Maximum Potential than a 50/50 chance of getting to 100% of their potential. This, in essence, is what life insurance can do.
If you’re interested in learning more, or you have questions about how life insurance can help you, we’d love to hear from you. You’re welcome to connect with us here or email your questions to us directly at email@example.com.