When Susan came into the world in 1974, of course her parents wanted the best for her. At that time, one of the loving things many parents did for their children was to purchase life insurance policies on them.
Parents had two reasons for these policies. The first was to pay for the funeral if a child were to die prematurely. The second was to build a little nest egg that the child might use later in life for college or a down payment on a home.
When Susan was six months old, her parents bought a $2,500 whole life policy on her. That amount would actually have purchased two funerals in 1974. The premium was $38 a year. If we adjust these numbers for inflation, they are comparable to a current policy with a death benefit of $12,000 and an annual premium of about $180.
The agent explained they could purchase term insurance on Susan for $12 a year, but this would not accumulate anything to help Susan with a down payment on a home or college tuition. For an additional investment of $26 a year, Susan’s policy would grow and accumulate dividends, giving her the cash she would need for that down payment.
Susan never did tap her policy for college or her first home. Instead she let it grow and accumulate, doing nothing but toss her annual statements into a file folder. Even so, Susan’s parents dutifully paid the premiums every year.
This year, Susan became curious about her policy and dug out her most recent annual statement. She learned that if she died today her death benefit would be $2,945.90. This was the original $2,500 face value of the policy, plus dividends of $445.90 that had accumulated over 39 years. If she wanted to cancel the policy, the company would send her a check for the “surrender value” of $1,120.45.
Susan grabbed a calculator and figured that the total premiums paid were $1,482. At first glance it would appear the policy may not have been a great investment, since the cash value in the policy was less than the sum of the payments. But to make a fair comparison, she needed to subtract the cost of providing the insurance ($12 a year, or a total of $468) from the total premiums. Only $26 a year, or a total of $1014, had gone toward accumulating the cash value. It was actually the $1,014 that grew to $1,120.45, which represented an annual return of about 0.25%.
Susan was curious what the $26 a year might have grown to if her parents had purchased only the term insurance and invested the difference in a stock mutual fund. She did some research and found there was a reasonable chance stocks might have returned 8% annually, meaning she would have $6,212 today. That would make a down payment on a small house and might pay for one semester of tuition at a state school. The death benefit of almost $3,000 from the term life policy would pay about half the cost of a proper funeral.
Susan realized cancelling the policy and adding the money to her investment portfolio would be the best financial decision. She was surprised at how difficult it was to carry out that decision. The policy had “always been there.” Cancelling it felt like rejecting a loving gift from her parents, especially since her father had died a few years earlier. The policy was part of her security. Giving it up was an emotional as well as a financial decision. Susan said, “It was like saying goodbye to an old friend.”
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