Is life insurance a good investment for leaving money to your child?

I could invest $50,000 in a universal life insurance policy with no monthly payments and a death benefit of $188,000 or I could invest $20,000 with monthly payments of $88 for a death benefit of $100,000. The policy is in force until age 119.

What am I missing here?

Investing, Life Insurance
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June 2016

You are missing the time value of money. Let’s assume you purchase the UL policy when you are 40 years old for $50,000. You have an outflow in year one of $50,000. If you were to pass away the next year, at age 41, the internal rate of return (IRR) of the policy would be 276% – a great rate of return!

However, it is highly unlikely that you will die at age 41 and the insurance company knows this. What’s more likely to happen is that you will live until you are ~93 years old. If you do, the IRR for the policy drops from 276% to 3%. All the insurance company needs to do to make money is out-earn a 3% annualized return on your dollars.

Additionally, $188,000 in today’s dollars adjusted for an annualized inflation rate of 2.1% would have the purchasing power of ~$59,000 fifty-three years from now. In essence you would be paying $50,000 today to give your kids $59,000 in inflation-adjusted dollars about fifty years from now – an IRR of 0.31%. That is the time value of money.

Instead of buying the insurance policy, let’s assume you invested the $50,000 in a moderately aggressive portfolio comprised of 60% equities and 40% bonds, earning an annualized 5% return. In the same 53 years, the initial $50,000 you contributed would have grown to ~$660,000 or $215,000 adjusted for 2.1% annual inflation. So, would you rather leave your kids $59,000 or $215,000?

The same analysis applies to the $20,000 initial outlay policy with the $1,056 annual premiums, except that it’s worse. If you were to live to age 93, the IRR of the policy, unadjusted for inflation, would be 0.83%, and the $100,000 would have the purchasing power of ~$32,000 today.

Life insurance policies should rarely, if ever, be viewed as investments. They are a way to transfer the risk of your untimely death away from your loved ones by providing a means for their support and well-being. A well-diversified portfolio will serve you much better in the search to leave behind a legacy for your children.

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