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In my previous post I’ve written about the true cost of terms plans, which evoked a discussion and gleamed some important points. This particular post is to address ‘the other side’ of the spectrum – the whole life plans – and hopefully balance the bias.

Using the previous case study of the 26 year old male, I shall expound on it and determine what is the true cost of the whole life plan to him. Now, in terms of the cost, there are actually two types:

1) The ‘actual’ cost of the policy (i.e. how much he has to PAY for it).
2) The ‘opportunity’ cost of the policy (i.e. the value of the next best alternative forgone as the result of making a decision. In this case it is usually assumed to be better investment returns).

Now, if the insured were to purchase a limited-payment whole life policy rather than a term plan, his ‘actual’ cost would be \$2,394.15, which is the annual premium.

On the other hand, if the insured were to purchase a term policy, his ‘actual’ cost would be \$312.70, which is the annual premium.

So essentially there is a yearly difference of: \$2,394.15 – \$312.70 = \$2081.45

In other words, the insured would have an excess of \$2081.45 per year if he had opted for the term instead of the whole life.

Once we ascertain the excess, this is where the second aspect of cost comes in – the opportunity cost. Here it simply means what better use could he have for the \$2081.45 – like for instance investing. If the insured uses this amount of money to invest for 30 years (put in \$2081.45 for a limited-payment of 20 years and let the the amount accumulate till 30th year) at a range of hypothetical rates of returns, he will get back the corresponding amounts:

Annual rate of returns – Amount at the end of 30 years: Read more…