Let me give you a few generic examples just so you get some kind of idea how this works.
40-year-old non-smoking male
Let's first look at a 40-year-old non-smoker in "normal health" such that insurers classify him as a "standard" risk. (That is actually the second worst classification. From best to worst, it typically goes preferred plus, preferred, standard, and sub-standard, which would be smokers and other very high risks. Different companies use different names, but you get the idea.)Let's assume he puts $5,000 per year into this specialized policy to maximize the growth of his cash (account) value. That amount would buy him $388,469 in life insurance (aka "death benefit" - not a great name if you ask me because when is death really a benefit?).
Because part of his premium is actually going to cover the life insurance (his risk of dying in a given year), at first his cash value is less than he put it. As the cash value grows with additional premiums and the "profits" returned by the insurance companies, the cash value does not exceed the premiums paid until year 10. So it takes 10 years to "break even" if you were ever planning to completely take the money out instead of just taking a loan against it (which I do not recommend!).
After 25 years, at age 65, the cash value has grown to $450,634 and represents a 4.29% internal rate of return (IRR, which represents the average annual return) on the premiums paid. After 35 years the IRR rises to 4.74%, and after 45 years the IRR rises to 4.85%.
It is important to realize that these numbers are not "guaranteed" as the "profit distributions" can vary over time. Of course it is unlikely that interest rates will go down significantly from here, so there estimates are probably pretty safe right now. BUT, there is also a minimum GUARANTEED return, which provides a much lower (but still positive) return over time.
(These numbers were from an example run with MassMutual as the insurer in May of 2014. These numbers will vary with both insurance companies and the date of the quote as interest rates change.)
Rates of return for various examples:
After 30 years, in the example above, the IRR is about 4.5%With another company, 35- year-old male, preferred plus rate, realized a 4.6% return after 30 years.
With that same second company, 35-year-old female, preferred plus rate, realized a 4.7% return after 30 years.
As you can see, younger, better health, and female gets you slightly better rates of return, especially in the short term, but over time, the gap narrows. The reason for this is that the insurance company has to set aside more money up front for older, worse health, and males to compensate for the higher risk of dying. If you don't actually die, over time, everyone gets about the same return on the insurance company's "profits."
Hopefully that makes sense. This is a huge topic that I am not doing complete justice to. If you have specific questions you want answered or clarified, please leave a comment and I will try and address all of those issues in a post (or several posts if necessary).
Next time, I will give you my preferred providers in the industry that you can contact to get a quote tailored to your specific circumstances.
