Imprudential, Yet Again

Richard Z: “Years ago my parents were tricked into buying life insurance policies from Prudential for (i.e. “on”) all their children and (gasp!) their 3 year old grandchild. I forget what it was called then but now it is known as Variable Appreciable Life. The snake oil salesman promised my parents that if they put in $94 a quarter in my case (I was a 22 year old single male nonsmoker at the time), at the end of 10 years my $50,000 policy would be paid up. (FWIW I am still single with no dependents.) When I turned 32 my parents handed the responsibility for the policy over to me. I noticed then that I was still being billed quarterly but could refuse payment. Prudential simply took it out of the investment portion of the policy.

“My last statement showed a net loss of over 3% for last year. This is partly due, as the statement clearly pointed out, to the subtraction of various management fees. What I would like to do immediately is turn it in for its cash value (a little over $4K) and put that money in this year’s and next year’s IRA.

“Question 1): Am I doing a smart thing? And Question 2) If the answer to Q1 is “yes,” how do I convince my parents of that? I know this seedy little salesman will tell them I’m doing it. And they will think I’m throwing all their money away. They have no concept of how meaningless a sunk cost is in making a decision like this.”

Well, first let’s take a look at what your parents were sold. You’re right in thinking it wasn’t a wise buy. Unless their goal was the peace of mind of knowing that if one of you died young, they’d at least get a little money out of it — unlikely — what was the point?

That you might become uninsurable by the time you had dependents? And that you would then die, and that this $50,000 — oh, happy day — would provide a nice life for those dependents for a year or two until they went on some game show and won the money they really needed to have a nice life?

Otherwise, what the heck good was this insurance policy? What were they thinking?!

Thank heavens they had a financial professional guiding them to this prudential decision.

Now let’s also look at the numbers. For $94-a-quarter — $376 a year — to have grown to a cash value of $4,000 after 10 years is for it to have compounded at something less than 1%. (Gee! We invested just $3,760 over 10 years, Madge, and it grew to $4,000! Where can I get some more of that?!)

Then again, you had this (unneeded) $50,000 of life insurance protection along the way, which Prudential would have had to shell out if your bungee cord had popped, so from an actuarial point of view, it was not as if they were taking you to the cleaners. For a 22-year-old who actually needed insurance, because he had, say, a young child or dependent parent, it could have been worse. (But a $500,000 term life insurance policy, in this circumstance, would have been about 10 times better — and about the same price.)

Say you had skipped the life insurance policy and invested the money at 7% after tax instead. It still would have worked out to only $5,500. Not a fortune.

And at that point — now, aged 32 — say you did need life insurance. If you were sure you wouldn’t die young, you could just keep that $5,500 growing, and — if you earned 6% a year after tax — it would be $50,000 by the time you were 70, when your arteries might actually have begun to clog, and $161,000 by the time you were 90 and the heart by-pass had turned into an underpass. (I’m not sure what that means, exactly, but in the life insurance game, one always reaches for a euphemism, and all the obvious ones have already been taken. OK: dead. You were 90 and dead.) Make that $278,000 if it could have compounded at 7% after tax or $477,000 if you want to be really unrealistic and assume 8%.

But who can be sure to live to 70 or 90? The whole point of life insurance is that you might not.

So if and when you do have dependents, you might well want to buy life insurance. Inexpensive term life insurance.

In the meantime, your IRA plan makes sense. It might well grow to over $100,000 by retirement, and you won’t have to have an underpass to collect it. This is all thanks to the generosity of your parents. So the proper strategy with them is to say, “Thank you: because of your foresight in saving for me, I’m going to have a six-figure increase in my retirement assets.” Granted, they didn’t choose a great investment vehicle (okay, they chose a LOUSY investment vehicle), but they did do something which could be a meaningful contribution to your future security. Plus, as the estimable Less Antman notes, it was a lousy investment primarily because you didn’t die — so essentially this whole mess is your fault.