Whole life insurance has been a pillar of income to life insurance salesmen for years. It is often recommended, particularly to high earners, as a guaranteed investment with some wonderful tax benefits. Alas, its flaws generally outweigh its advantages. Here's why:
Cons of Whole Life Insurance:
1) Whole Life Insurance Costs Too Much.
When a whole life insurance policy is sold (and they're always sold, never bought), the buyer and seller generally focus on the investment portion of the policy, not the insurance policy. The silly buyer just naturally assumes he's getting the insurance portion at the going rate (such as what he would pay for term insurance.) Fool. Like any business, they charge what they can get away with. If you're not paying attention, you'd better believe the price gets jacked up. A bigger problem is that young people can't afford enough whole life insurance to cover their actual need for insurance, so they end up buying a separate term policy anyway, or worse, they don't and walk around under-insured.
2) The Fees are Too High.
You don't pay the fees directly, but you do pay them with lower returns. For example, the commission on a whole life insurance policy is generally 100% of the first year's premiums then 6% of premiums every year after that. That's money that doesn't get invested on your behalf. By comparison, the commission on a term policy is about 50% of the first year's premiums, then 4% of premiums after that. It's pretty easy to see what the financial incentive is. Sell whole life instead of term, and upgrade the policy at every opportunity. 100% of a new policy is far better than 6% of an old one. “But you don't pay the commissions, the company does” argues the salesman. Where do you suppose the company gets the money from?
3) You Don't Need a Middleman for Your Investments.
Consider what the insurance company does. It takes your premium each month, pockets its profit, puts a certain percentage of the premium into a pool to pay the benefits of those who die, and then invests the rest in a relatively conservative portfolio, such as bonds. You can invest in bonds directly. Which return do you expect to be higher- the one where they shave off some profit before investing, or the one where you invest your entire lump sum? It's like buying a load mutual fund. In fact, some cash value life insurance policies actually DO HAVE A LOAD. Can you imagine? Not only do you have to pay for an expensive insurance portion, you then have to pay just for the privilege of investing your money with them.
4) Complexity Favors the Issuer.
After a while, people figured out that whole life insurance was a rip-off. So to disguise that fact, the companies just made the products so complex that only their actuaries could figure them out. Even those who have spent a great deal of time trying to figure these policies out don't understand them. Even the guys selling them don't completely understand them, but you better believe they understand the commission structure. Suffice to say, the more complex it gets, the worse a deal it is for you.
5) Even When it Works Out Okay, it Takes a Long, Long Time to do So.
Most whole life policies, if you hold them long enough, actually have an okay return. The returns often even beat inflation. Unfortunately, that usually doesn't happen for a while. Take a look at this chart of the actual returns of a policy:
This chart, from the Visible Policy (great site by the way) illustrates 4 lines demonstrating the actual performance of the site author's whole life policy. The solid green line is the cash value of the policy. The thin line is the total of the premiums paid into the policy. The reddish-orange dashed line is the effect of inflation on out of pocket dollars, or the real total of the premiums paid into the policy. The blue dotted line is the total cash value of an investor who bought a cheap term policy, and then invested the difference between the whole life insurance and term life insurance into a good bond fund. The left axis is in dollars, the bottom indicates the policy holder's age.
There are several things to notice. First, it took this particular policy owner 8 years just to break even, 12 if you actually consider inflation. 12 years is a long time to have a negative return. This was particularly true for me. The policy I once owned was still in the red after 7 years when I cashed it out after realizing the error of my ways. It should be noted that this policy owner has done all he could to minimize the effects of the fees. He bought a good size policy ($100K), he pays annually instead of monthly, and he bought it from a mutual life insurance company. And still, after 14 years in the policy, he is barely beating the total of the inflation-adjusted premiums and cannot even keep up with the guy who bought term and invested the difference in lowly bonds. I'm a pretty patient guy, but that's a long time.
Now, these policies eventually do give you an okay return after 30-40 years, especially when considering that the proceeds are tax-free. Unfortunately, almost no one sticks with them that long. But if you've had one for many years (say, more than 10), think twice before cashing it in.
6) Your Return Will be Much Closer to the Guaranteed Amount Than the Projected Amount.
When you are shown an illustration, they always show you the projected amount, but you don't ever get that. There may or may not be a chart of the guaranteed amount, which will be significantly lower. But you ought to pay far more attention to that, since the company has just about zero incentive to pay you any more than the guaranteed amount. In my limited experience, I barely made more than the guaranteed amount and didn't get anywhere close to the projected amount.
7) You are Not Adequately Paid for the Loss of Liquidity.
Stocks, bonds, and mutual funds can generally be cashed out any day the market is open. You can change investments or use the money for living expenses without much hassle. There are only two ways to get money out of a whole life insurance policy. The first is to surrender the policy. Since your returns don't even start becoming decent until after the first decade or so, it doesn't make sense to be surrendering policies frequently. That just enriches the salesman and the company at your expense. The second way to get to your money is to borrow it from the policy. This has a few issues. First, borrowed money is no longer available to your heirs as part of your death benefit. Second, just because it's your money you're borrowing doesn't mean the interest you're paying on that money goes to you like with a 401K. Some of it usually does, but not all of it. Lastly, in some complex cash-value policies, borrowing too much can actually require you to have to put more in each year to keep the policy in force. Heaven forbid the policy collapses on you and then you have to pay back all the money you've borrowed. Not a good thing when you're obviously short of cash (or else why would you be borrowing the cash value in the first place.) The buyer of a whole life insurance policy should be well paid for giving up this liquidity. Unfortunately, he is not. In fact, he won't even perform as well as an all-bond portfolio.
8) You Probably Don't Need the Income Tax or Estate Tax Benefits.
Insurance salesmen are quick to point out that since loans from your insurance policy are tax-free they're somehow better than 401K or IRA money. Never mind that you paid all those premiums with after-tax dollars. The proceeds should be free! The death benefit is also tax-free, which provides a way to avoid estate taxes for wealthy people. Of course, under current law, a couple doesn't even start paying estate taxes until $10 Million, a sum most doctors won't reach. And if you start getting close, there are other things that can be done, such as trusts and gifts to reduce the size of the estate. You could even, heaven forbid, spend the money on something fun or give it away to charity.
Pros of Whole Life Insurance
Now, I can think of a few reasons why whole life may be beneficial to you. Here are four:
1) You Don't Have the Discipline to Save Enough Money.
The idea behind buying term and investing the difference is that you actually invest the difference and then at a certain point are wealthy enough to self-insure against your death. If you can't do that, or don't want to, then you might be better off buying whole life insurance. Like a mortgage forces you to accumulate equity, a whole life insurance policy forces you to accumulate cash value. It might not be at a very good rate, but at least it accumulates. Many people don't save any money. Many of those who do bounce around from investment to investment, trying to time the market unsuccessfully. You're better off slightly under-performing a bond portfolio long term than dramatically under-performing a bond portfolio by being a crappy investor.
2) You Like Guarantees.
A whole life insurance product has a guaranteed return, no matter what happens in the markets. That guarantee is worth something. Probably not as much as you're paying for it, but it's worth something. If the next 30 years looks like the 2000s in the markets, those who bought a big fat life insurance policy instead of investing in stocks and bonds might have the last laugh.
3) You Have Already Been in a Policy for a Long Time.
As mentioned previously, after a decade or two, remaining in a whole life policy can actually be a good idea. The commissions and fees are water under the bridge now, so you might as well take what you can get. Especially in an era of low interest rates like now.
4) You Have a Need for Permanent Insurance, Especially as Part of an Estate or Business Plan.
Many undersavers have a need for permanent life insurance because they never become financially independent and have someone depending on them, such as a disabled child, even in their later years. If your child or spouse is dependent on your social security or pension payments, you'd better have a policy in place to protect that income stream. Most of the time, your spouse will get at least 50% of your benefits, so that doesn't become a big issue. If you save adequately, you can provide for a disabled child's future using your savings instead of life insurance proceeds.
More commonly, a wealthy person might have an illiquid asset, such as a farm, some rental properties, or a business. When that person dies, the asset may have to be liquidated rapidly at an unfavorable price to pay out the will proceeds or perhaps even pay the estate taxes. The death benefit of a whole life insurance policy can cover those costs. A partnership might also buy a whole life insurance policy on each of the partners so that in the event of death, the proceeds of the policy can be used to buy out the heirs of the deceased, avoiding turbulence in or even failure of the business. A term life insurance policy can often be used for these purposes, but not always.
There you go, 8 reasons to avoid it, and 4 to consider it. Try to resist the urge to leave yet another comment on this post. I know it's hard, but you can do it.
[A Note From The Author: This is the most visited post on this blog. If this is your first time here, welcome! This post has generated more hate mail and hate comments than all of my other ones combined. There are over 850 comments on it, which may take you over 4 hours to read. However, after two years of arguing with whole life insurance salesmen in the comments section of this post, I did a series of posts called Debunking The Myths Of Whole Life Insurance that quite frankly is better written than this post. I suggest you read that series instead of this post as it includes all the useful information in this post as well as in the lengthy comments below it. Since there are already 850 comments on this post, if you sell whole life insurance, don't bother leaving a comment on this post. Just send me an email telling me how big of an idiot I am. Please put “Whole Life Insurance is Awesome!” in the title so I'll know to delete it without opening it. ]
We got life insurance at http://insuranceforyourkid.com when our twins were born 2 years ago. We felt like it was a good investment and provides some security for our family.
You might also want to mention you own the site “insuranceforyourkid.com”
I am new to this site, and I’m glad I found it!
I’m 24 and a family friend is really pushing me for a $250k 20-pay WL policy. He’s selling it as a great retirement fund while still being able to protect my loved ones in the event that I suddenly pass away. The company is Guardian Life Insurance, and he always mention that they never miss a dividend payment. He is telling me over the long run, WL is a great retirement vehicle since it is guaranteed.
I see some of the benefits, but I think that a Roth IRA and term life will be just as good, if not better. I wanted to bounce this off of some of the readers. Would you recommend a 24 year old WL knowing that there will be 40 years until it is tapped in for guaranteed dividends?
Thanks in advance!
No. I’d recommend a Roth IRA and term life insurance. $250K probably isn’t enough insurance to meet your insurance needs. It would be very hard to recommend someone use whole life as an investment over a Roth IRA. In fact, you could probably successfully sue a fiduciary who did that.
When people are looking for guarantees…there is nothing better than WL insurance. Lifetime coverage, better storage of excess cash than Savings, Bonds, CD’s.
The only caveat is making sure you align up with a top rated mutual company.
I say this because on my 20 pay WL policy, at age 65… the internal rate of return on cash value is 5.66% and 7.87% on death benefit.
This portion of my portfolio is the only part that is guaranteed. All my other investments guarantee is that they will fluctuate : )
Hi Jeff–you’ll see lots of opinions on this website and here’s mine: I like permanent insurance as PART of your investment plan and, at this point in your life, PART of your risk management.
The policy you mentioned should have an annual premium of $3,455. The good thing about a 20-pay is that it’s paid up after 20 years. As a matter of fact, you can’t pay past 20 years. So, you’re 44 and have a paid up policy with $101,000 in cash value and $344,000 of death benefit. At 65, those values are projected to increase $317,000 and and $561,000, respectively. Not all bad.
The downsides are: 1) that amount of insurance is inadequate for your needs; 2) you can’t overfund (add additional money) limited pays without causing tax issues; 3) you can’t fund past 20 years.
Before starting any investment strategy, I suggest making sure you have savings equal to 6 months of living expenses stashed away and easily accessible. I suggest having excellent Disability Insurance (the Guardian does have the best own occupation DI for physicians). I suggest buying a term insurance policy of a million or more (you can buy $1 mil of Guardian 20-year term for $800 annually with an extended conversion rider, meaning you can convert to WL for the entire length of the term instead of 5 years without underwriting).
As your income and your ability to sock away money grows, I suggest funding tax-advantaged vehicles like a Roth IRA. If you receive matching dollars to fund a 401(k), I would do so at least up to the match.
I think a worthwhile goal is to save 20% of your income. I hope that, within 5 years, you can start funding permanent insurance and that funding represents a quarter of the 20% savings. I would use a WL99 contract and overfund it to maximize cash value.
There is a lot of wisdom in this post above by Bob. And I completely agree that Guardian has the best DI policy out there. I haven’t seen any better for high wage earners.
I’m surprised that you would say that Guardian unequivocally has the best own occupation DI for physicians. As I understand it, the “best” policy differs depending on state, specialty, and desire for various features.
I also think it is serious folly to fund whole life insurance before maxing out every available tax-protected investing account available to you. After that, well, if you want an investment that returns less than 5% despite you sticking with it for 5 decades, then go ahead and invest in whole life insurance.
What accounts are you referring to when you say “tax-protected investing” accounts?
401K, 403B, 457, Roth IRA, IRA, SIMPLE IRA, SEP-IRA, DBP, Profit-sharing plans, Keogh, Individual 401K, Roth 401K, Roth 403B, Roth 457 etc.
I didn’t know those were “tax-protected”. What does it mean to be protected from taxes?
It’s a catch-all term that includes tax-free accounts (such as a Roth IRA and a Roth 401K) and tax-deferred accounts (such as a traditional IRA or 401K.) Although I sense neither of your questions are actually serious.
My questions are totally serious. People might get the impression from you that these accounts save them money on taxes or something. Tax-deferral is just a fancy word for tax-postponement. The government gets their taxes no matter what. They get their taxes now on a Roth or they get them later with a 401k.
It’s not unusual for an insurance salesman to not really understand the different ways in which a 401K can save someone money. Their training, primarily in sales, focuses on the merits of investing through life insurance contracts or annuity contracts. Unfortunate really, but that’s the way it is. Don’t you think it is kind of sad that after several years of working as a “financial advisor” that you have to come to some yeahoo’s blog to find out how a 401K saves someone taxes? Anyway, for anyone who follows this argument later, I’ll spell it out:
1) Up-front tax deduction. My marginal tax rate is 33%. So by putting $1000 into a 401K, I save $330 on my tax bill this year. But wait, the critic may say. The government will get those taxes later. Yes, but that doesn’t count the time value of money. Having the tax savings now is worth a great deal. Not only do I have far more use for money earlier in my life before I’ve accumulated much of it, but the money saved on taxes can be invested and grow.
2) Tax-protected growth. A typical investment is taxed as it grows. Every year it kicks off dividends and capital gains. If you sell it with a gain, you will owe capital gains taxes. Not so in a tax-protected account.
3) Tax bracket arbitrage. You’ll recall I’m saving 33% of everything I put into a tax-deferred account now. Yet when I pull the money out, much of it will come out tax-free (due to the standard or itemized deductions), and a significant chunk of it will come out being taxed at 10% or 15%. Depending on how much I take out per year, some of it may be taxed at 25%. But on average, I’m likely to save taxes at a marginal rate of 33%, and then pay them at an effective rate of ~15%. Do the math. There are some real tax savings there.
Now, with a Roth account, you don’t get that upfront tax deduction, but you do get the tax-free growth, and tax-free withdrawals. In fact, those tax-free withdrawals could be stretched out over 150 years with a stretch Roth IRA given to a great grandchild.
Many insurance salesmen like to argue that whole life is like a Roth IRA. I’ve debunked this tactic before in this post: https://www.whitecoatinvestor.com/8-reasons-whole-life-insurance-is-not-like-a-roth-ira/
Aside from the extra costs and low returns (mostly caused by the extra costs and the conservative investment allocation) inherent in a whole life policy, you don’t get an upfront tax deduction. You do get tax-protected growth as the years go by. Then you have the strange situation when it comes time to spend that money in retirement. You can borrow it tax-free (but not interest-free) but you can’t actually withdraw it tax-free. In fact, if you’re not careful, the policy collapsed and all of a sudden the tax-free loans you took out become partially taxable. Passing on a Roth IRA in order to invest in whole life is pretty idiotic when think about it that way. Lots of extra costs and few if any additional benefits that can’t be obtained in another way.
Anyway, I get the impression you’re into the whole infinite banking/bank on yourself stuff. Your arguments will probably fit in better on this thread: https://www.whitecoatinvestor.com/a-twist-on-whole-life-insurance/
I’m not nearly as anti-whole life as most people think I am. If someone wants a safe investment that they are willing to hold for 3-5+ decades in order to get a return somewhere between 2 and 6% on their cash value, then fine, buy a whole life policy. If they have a need or desire to have a specific amount of money available upon their death no matter when that might occur, then fine, buy a whole life policy. If they find they’re paying high interest rates to a bank all the time and would rather bank on themselves, fine, buy a whole life policy designed for that. It’s not a magic pathway to wealth, but there are far dumber things to do with your money. But passing up a 401K or a Roth IRA to invest in whole life contracts? No, I don’t think that’s particularly smart.
Actually, I know full well how a tax-deferred investment saves money over an investment taxed each year. But you were acting like “tax-protected” qualified plans save people taxes in a way whole life does not. Whole life also grows tax-deferred, so that couldn’t have been your argument.
Your “up-front tax deduction” is no savings on tax at all. If I invest $10,000 into a 401k, at a 30% marginal bracket, I’ve postponed $3,000 in taxes. If I choose to invest that $10,000 into a Roth, I will have to pay $3,000 now and only have $7,000 to invest. Fast forward 10 years, and assume (for the sake of the Rule of 72) that both investments grew at 7.2% and doubled in value. The 401k is now at $20,000 and the measly Roth is at $14,000. But wait! There are no more taxes due on the Roth. The 401k, on the other hand, must pay the piper. Assuming the same 30% bracket, the 401k now owes $6,000 in taxes. What!?! How can that be? I thought only $3,000 was deferred? Nope. The government’s share grows along with the investment. So $6,000 is due the government, instead of $3,000, bringing the 401k to $14,000. The exact same amount as the Roth. Where are those tax savings at again?
Your “tax bracket arbitrage” claim makes many assumptions that are purely guesses on your part. How do you know what the tax brackets will be in the future? How do you what the tax thresholds will be? With $17 trillion in national debt, where will taxes go, up or down? Is that a risk someone should be willing to take and hope taxes will be lower?
I don’t think you understand the concept of “filling up the brackets.” Perhaps this will help:
http://thefinancebuff.com/case-against-roth-401k.html
It’s my belief that Guardian has the best DI because it’s true “own occupation” DI. If you’re a surgeon and develop a palsy that prevented you from performing surgery, some DI policies consider you partially disabled since you could still perform diagnoses, and prescribe medicine. Not so with Guardian: you’re considered fully disabled if not able to perform your specialty.
I agree that permanent life has a an investment component–it does deliver around 5% with a tax-advantaged aspect. Any any cash value accumulation is protected from lawsuits in most states (it is in Texas).
And time to clear up a persistent misconception: when you take tax-free distributions from your policy, you do so most effectively by going from basis to borrow. You don’t have to borrow from the life insurance company, but if you wish to maximize distributions, you will to preserve the non-taxable nature. Also, the misunderstood direct recognition aspect of the Guardian also means that your borrowing costs are contracted from the outset–about 7.8% for the first twenty years AND up to age 65, 5% thereafter–and when you borrow, your dividends actually improve. I don’t know what interest rates will be in 25 years, do you? How can you realistically plan with variable interest? It’s like an adjustable rate mortgage–it MIGHT work out.
Don’t get me wrong. I think Guardian DI is fine. I just think there are 4 or 5 other true own-occ policies out there that are also fine. For example, for my state, specialty, and coverage desires Principal’s policy was far better the last time I shopped.
I agree that permanent life has an investment component and provides asset protection in many states. I also agree there is a tax-advantaged aspect to it. I disagree that it “delivers around 5%.” If held to your life expectancy the return on investment for the death benefit is likely to be in the 4-5% range with the return on investment for the cash value slightly lower. It isn’t anywhere near 5% in the first decade and doesn’t begin to approach that for 20-30 years as discussed here: https://www.whitecoatinvestor.com/thoughts-on-permanent-life-insurance-returns/
There is a healthy debate about whether direct or non-direct recognition is better. Certainly if you plan to borrow frequently I think I’d probably go for the non-direct recognition. At any rate, I don’t like paying interest to use my own money. As my young children are very well aware, it’s better to get interest than pay interest.
Jeff, the one thing the owner of this site and other whole life haters never talk about is risk. They don’t talk about what happened to the people who signed up for “buy term and invest the difference” with the goal of retiring in 2008. There is a possibility that the cost of term insurance, the taxes, the fees and the losses will end up better than the internal rate of return in whole life insurance. And there’s also a possibility that it will end up worse. That is the truth and I haven’t seen the owner of this been completely honest about that. (If I missed it in the 500 comments, please let me know.)
After reading dozens of comments, it became crystal clear to me that the whole life lovers and haters both on this site really don’t understand whole life, how to design it, nor how to use it. Even the person trying to sell you a 20-pay policy is not up to my standard. I would DEFINITELY not buy a 20-pay at your age. I would buy a Paid Up at 65 with a properly structured Paid-up Additions Rider. (He probably won’t want to sell you that rider, because it reduces his commission.) I would also consider going with a different company than Guardian. Guardian is a great company, but I’m not happy that they’re direct-recognition with high loan rates.
If you’re going to plan for retirement, you need someone who understands how retirement income streams work. I would bet money that the White Coat Investor does not understand them, nor do most advisors. According to Monte Carlo historical numbers, you can only take about 3.5% out of your portfolio per year without a great risk of running out of money. (That’s with a 15% chance of running out of money, which is still high IMHO.) So if you end up with a million dollars in your qualified plan (Roth, 401k, IRA, etc.), you can take $35,000 per year in income. Congratulations. And if that’s in a 401k or SEP, that $35,000 is pre-tax. How does that sound?
Pensions worked because they combined actuarial science with investment return for a combination that is simply unmatched. If you want to succeed, you MUST do the same. You need actuarial science AND investment return for a safe retirement. And when you do that, your retirement income stream could easily double, even with 25% less money in your qualified plan.
If someone cannot explain to you how retirement income streams work, you may want a second opinion.
I would love to see some numbers on people that did term/invest the difference that had to retire in the 2008-2009 era; not to prove anything other than actually what happened. Buy term/invest the difference is a theory, like many others. It only proves wise/unwise based on the time the investments are needed. I see opportunities with WL and proper attention to PUAs, but I can’t ignore the possibilities of the stock market. The one thing I keep coming back to is that my retirement is a number that is dictated based on when I was born…the stock market reacts in complete disregard for who I am and how old I am. So, if I don’t have options, I will be a slave of the market and its timing. I think my WL policy can buy me 3-5 years if needed…look at what 3-5 years did from 2008!
Chris, you make some good points–a lot of life is simply good (or bad timing). How would you like to have been the kid whose Dad funded the heck out a 529 using mutual funds and then saw $200,000 drop to $120,000 in 2008 after he started his freshman year at that pricey private college? Helloooo student loans!
If you’re in your 30s or 40s, you can weather downturns in the market. I did. But when you get to be 55+, you get skittish–you don’t necessarily have the time to catch up again. I just transferred 60% of my retirement funds into a deferred annuity. My cap is 10% but my floor is 2%. I may miss a great market, but I won’t get killed by another “correction.”
And remember that accumulation has a flip side: distribution. Studies have show that sequence of returns has no bearing on accumulation, startling but true. Sequence of returns has EVERYTHING to do with successful distribution. Two bad market years in the first five and you’re hosed. However, if you only took distributions in up years, you’d be perfectly fine, even with a more aggressive spend down percentage. But what are you supposed to do in the down years, starve? Nope, just take tax-free distributions from that trusty whole life policy you properly funded along with your other investments.
The other arrow in your retirement quiver? Long term care insurance or one of its variants using WL or UL. Unless your retirement planning has made allowance for spending $80,000 a year in today’s dollars for care, and I rarely come across anyone who does.
Add one more person to that list of rare persons.
Long term care insurance isn’t ready for prime-time yet.
https://www.whitecoatinvestor.com/long-term-care-insurance/
Sequence of returns absolutely does have a bearing on accumulation. The key is to have high returns in your last few years of accumulation and your first few years of distribution.
As mentioned already, you can spend money from the bond or cash portion of your portfolio, or use an immediate annuity. You certainly don’t need to buy whole life insurance to get around the sequence of returns issue.
Insurance agent scare tactics only work on people who don’t understand that the guarantees provided by insurance companies aren’t free. If you want a guarantee, you’re going to have to give something up, and that’s usually a superior return. Insure only against financial catastrophe and self-insure everything else.
Bob,
If a Dad saw his college freshman son’s 529 Plan drop by 40% as you illustrated, then he must have been invested in a very aggressive portfolio just when he should have been invested in a very conservative portfolio if he couldn’t afford to lose $80,000 to pay his son’s college expenses.
Helloooo, he may not have needed student loans if he had an appropriate allocation. 🙂
I’m interested in learning how to guarantee the last five years of accumulation are first five years of distribution are high (and define, “high”). To me, it’s a lot like the game show host offers you the chance to win even more money or take your winning off the table. Often, they lose instead of taking the money.
Also, one of my friends has a wife with dementia. She really should be in the euphemistically named “memory unit” at the nice nursing home here, but $7,000 a month is too much for him. He could impoverish himself and his wife, and go on Medicaid. Or he could have purchased long term care insurance. It’s a needed product, since about 70% of us are going to need some form of LTC. I have a friend Jay whose Mom suffered a stroke and had two caregivers for the last ten years of her life. It cost them right at a million to keep her at home. They didn’t plan to use the money that way, but they did.
I have lots of stories like that, none made up. I own LTCi for my wife and myself. It’s not real expensive, about $2200 a year. It’s not perfect, but it protects us from having to impoverish the other spouse should we need it. There are now hybrid policies built on a UL chassis that I like as well. How about this: you’re 62, and you buy a $100,000 single pay policy. If you die, your beneficiary receives $200,000. If you need LTC, the benefits are $300,000 and are paid up to $5,000 a month (they would last 60 months, or longer if less than $5,000 a month was used). When you die, at least $20,000 is payable to your heirs, regardless of exhausting the LTC benefits. Oh, and if after a year or longer and you decide this was a bad idea, they’ll give you the $100,000 back.
Boy, that would be awesome to be able to guarantee that wouldn’t it? Of course there is none. I’m just pointing out the well-known sequence of returns problem.
If $7K a month is too much for him (and there is no cheaper alternative, which seems unlikely), then he should buy long term care insurance. Most doctors, however, ought to be able to self-insure that kind of risk. I don’t disagree the product is needed for a sizable segment of the population. My argument is that the product sucks. It’s been mispriced so that prices have later gone up or worse the company has gone out of business. There are lots of issues like that with it. It’s just not ready for prime time. I’m sure disability insurance had similar issues until the kinks got worked out.
I’m not surprised you like hybrid policies built on a universal life chassis. The more complicated the easier it is to slip in a few extra fees and commissions and profit for the company and their agent. Complexity doesn’t favor the buyer. The more straightforward the insurance policy (or investment for that matter), the better I like it. The devil is in the details of these complex policies.
What numbers would you like to see? A long term investor doesn’t suddenly have some huge issue due to one year of bad returns. Even someone on the eve of retirement still has 20 or 30 years ahead of him to invest. If he retires in 2008 and pulls out 3 or 4% of his portfolio to live on, he leaves the rest in the portfolio with a similar asset allocation to the year before. Then by the end of 2009, he’s made up his losses. He could have easily pulled that 3 or 4% from cash or bonds in his portfolio and wouldn’t have even had to touch his stocks for 3-5 years or more. You don’t have to buy whole life insurance to survive a temporary downturn like that.
If you’re worried about running out of money, buying immediate annuities, not whole life insurance is the solution.
Life insurance salesmen love to pull scare tactics like this. But the truth is that someone who invested in the market at 8% for several decades rather than whole life insurance at 4% can afford to lose half of that nest egg and STILL come out ahead, even if the downturn isn’t temporary. Run the numbers.
30 years, $50K a year at 8% = $6.1M
30 years, $50K a year at 4% = $2.9M
The lower returns inherent in an insurance based product make a real difference in retirement standard of living. The guarantees aren’t a free lunch.
It’s not either BTID or use the dollars for WL. I believe I’ve been consistent in this forum stating that I believe that a good mix is 75% investment and 25% into WL. But even those figures are dependent on where you are in your investment life-cycle.
Take the $50,000 you cite. Probably too much for a 30 year old, maybe not enough for a 55-year-old. Also, you note “pulling that 3 or 4% from cash or bonds in his portfolio.” So you do recommend diversification, just as I do, and you’ll agree that not all asset classes can be expected to perform the same, right? Riskier the investment, the higher the hoped for gain. WL is an asset class, but unlike other asset classes, it has mortality credits (annuities recognize mortality but they’re not appreciating assets).
I also counsel planning for the probable and protecting against the possible. 30-year-term is protection, yes, but probably an expense–highly unlikely that you will die. Permanent life insurance fully funded by retirement age is an asset that allow you to spend down other assets more freely since it has a death benefit should you possibly die early in retirement or take income distributions should you need them later in retirement.
Of course I recommend diversification and of course I expect asset classes to perform differently and of course it’s wise to plan for the probable and protect against the possible. Insurance is both protection and an expense. Permanent life insurance is part asset, part insurance, and part expense. I will admit, however, that the mortality credits are a very intriguing aspect of investing in insurance. So is the fact that most people bail out of their polices early. You’d think with 80%+ of people surrendering them early that somehow those who held on would get higher returns in the long run than what they actually get. The size of the benefit to the investor of mortality credits and early surrenders is rather disappointing IMHO.
If someone wants to put 75% of their assets into traditional investments and 25% into whole life, well, that’s fine. As long as they’re saving enough, they’ll likely be fine. But I don’t buy that 75%/25% is somehow better than 100% into traditional assets. Agents like to toss out this idea that “having permanent life insurance allows you to spend down other assets more freely” like there is some magic there. There is no magic. Guarantees aren’t free. If you invest in a low return investment like whole life insurance, you are likely to have less money, on average, than investing in higher return investments. Having twice as much money allows you to spend more freely too!
Whole life insurance gets tossed out there as a solution to many problems for which it isn’t the best solution. It isn’t the best investment. Stocks, bonds, and real estate are. It isn’t the best way to ensure you can “spend down assets more freely,” a SPIA is. It isn’t the best product for someone who needs to protect their family from financial catastrophe before they’ve acquired a sufficiently sized nest egg, term life insurance is. It isn’t the best product for someone who needs to leave behind a pre-defined amount of money upon their death, guaranteed no-lapse universal life insurance is. It isn’t the best product for someone looking to invest in a tax-protected manner with some asset protection benefits, retirement accounts are. It isn’t the best way to pay for cars and other large expenses, saving up is. What is it best for? It’s best for someone who wants or needs a gradually increasing permanent death benefit. Who needs that? Not very many people. So agents have to sell it for purposes other than what it is designed for. That’s the bottom line.
One of my hobbies is cooking and I’m a pretty good cook, graduated culinary school with honors, as a matter of fact. But, whenever I see anyone tout the “best” recipe, I always think, “nope, it’s YOUR best recipe!”
Life Insurance is like that as well. Sure, you need to cover risk of dying early, but how you go about that has lots of different solutions. Some believe you should buy the cheapest term and invest the difference. Others think the Death Benefit should be as low as possible, and the focus should be on cash value accumulation for supplementary retirement. Still others think Universal Life Secondary Guarantee is the answer. And, Limited Pays or WL100?
But saying you have THE answer is neglecting the question, “What do you want the insurance to do?” So, I welcome a dialogue with any of those choices as the question.
Me? My life insurance is WL99 on my wife and myself. I used a blend of WL and term and overfund with PUAs and have a current death benefit of $500,000 on each of us. My goal is to pay until age 66. At that point each policy policy will carry itself and the death benefit on each of us will be about $550,000 and the cash value around $230,000. I plan to spend down my other assets freely from age 67 to 82. If either of us dies, the other receives the death benefit. If we both survive, at age 83, our death benefits will have grown to around $700,000 each and the cash value to close to a combined million. If we wish, we can take tax-free distributions of $100,000 a year combined from our policies. That’s how I’ve planned MY “best” insurance. I wish I had started this plan in my 30s or 40s, but, alas, I didn’t see the light until age 53.
The only thing I hate about whole life is how it is sold inappropriately. Why else would 80% plus of folks drop the policy before their death? Once people understand what they bought, they realize they don’t want it.
Of course it’s possible that investing the difference could come out behind. However, it is highly unlikely. Think about it. What is the insurance company investing in? That’s right, the same stocks and bonds and other investments that you can invest in without them. So if my investments do crappy, so will the insurance company’s. If they manage to stay in business, your returns are likely to drop to the guaranteed return, which the last time I looked at a whole life policy, was less than the historical rate of inflation.
I love how whole life salesman (such as this poster) love to say that no one but them really understands whole life insurance. That’s ridiculous. Whole life just isn’t that complicated. If you think you have some understanding of whole life that no one else “gets”, feel free to submit a guest post about it. I find it unlikely that you’ve got an angle that hasn’t been discussed on this site at some point already.
Will….the bio on your website says you signed up with your financial advisory firm as a client in 2009 and then became an advisor there in 2010. I’m amazed that you were able to acquire such a superior understanding of whole life insurance in just 3 short years from the time when you apparently required the services of a commission-based advisor. Your entire firm has a single CFP in it. Even the founder hasn’t managed to get his ChFC yet. The testimonials on your website tout the fact that your firm doesn’t charge clients any fees. I think we all know what that means.
How much money would you like to bet that the White Coat Investor doesn’t understand how retirement income streams work? Just last week I spent a couple of hours chatting with Wade Pfau about retirement strategies. I’m pretty sure I’ve got a pretty good understanding of them. Then I spent some time listening to Bill Bernstein talk about shallow risk vs deep risk. I think I’ve got a pretty decent understanding of risk too. Finally, I spent 3 hours with Jack Bogle and guess what, nothing he said was new to me. The strange thing about all that was that not a single one of those guys thought investing in whole life insurance was a good idea. In fact, I can’t seem to find any investing authority that recommends it. The only people I can find that recommend it happen to sell it. Coincidence? I think not.
The only thing I hate about stocks, bonds and mutual funds is how they are sold inappropriately. They are not told the truth about risk, fees and taxes. They are given selective historical time frames that look good. People, as a general rule, hate the market after 2001 and 2008. They just don’t know other things exist.
You are dead wrong that insurance companies are investing in the same stocks, bonds and other investments that I have access to. I don’t put my money with a whole life company that invests in stocks. And they have access to 2 things I don’t have the pleasure of. Time and large investments. They plan like foresters and think a hundred years or more ahead of time. Because of this, they have high rate, investment-grade bonds paying double digit rates of return right now. I couldn’t get into to those, because I was in kindergarten. And they have billions of dollars. There are much better investment opportunities with that kind of money than with my piddly thousands. And if you want to talk about guarantees, let’s compare my guarantees with your guarantees. Please don’t tell me you were expecting to compare my guarantees with your fantasies. What’s the only guarantee in the market? A 100% loss. That’s it.
I did submit an angle that hasn’t been discussed. It’s called “withdrawal rate.” Please refute this simple scenario. You buy term and the invest the difference and end up with $1 million in your portfolio of stocks and bonds. According to Monte Carlo, you can safely withdraw 3.5%, for an income of $35,000/year in retirement. (You still have a 15% chance of running out of money.) Instead of doing what you do, I decide to shave a little off of my investments to buy a whole life policy. So I only end up with $750,000 in my stocks and bonds. But I now have a $750,000 whole life policy, with a permanent death benefit. So I take my $750,000 portfolio and trade it in for a SPIA, let’s say at 10%. I now have a guaranteed income for $75,000 per year until I die, compared to your $35,000. And I don’t have the 15% risk of running out like you do. When I die, my wife gets $750,000 tax free thanks to my permanent life insurance policy. She takes the money and trades it in for a SPIA, and she too gets $75,000/year until she dies.
It’s not about rate of return. It’s not about having the most amount of money at retirement. It’s about how retirement income streams work.
P.S. I wouldn’t expect John Bogle to tout whole life, because he wants everyone to put their money into his Vanguard indexed funds. If someone wanted to put their money in the market, I would have them do indexed funds or ETFs. I agree with John Bogle on this! My first task at my firm was to read his book called “The Little Book of Common Sense Investing.” But what is Mr. Bogle going to tell his clients to do at retirement? Take the $35,000/year and be happy?
I do appreciate you agents coming to this site over and over again to rehash these same arguments. I believe this is something like the 620th comment on this post. I can’t imagine any new readers are actually getting all the way down here. 100 posts ago someone said they had been reading for 3 hours to get to that point. At any rate, fresh content is good for the search engines and helps me rank higher, so I’m fine rehashing these arguments again. But I’m not fooling myself that I’m going to convince someone whose living depends on them selling whole life insurance that my views on it are correct and theirs are wrong.
I’m certainly not dead wrong that insurance companies are buying the same stocks and bonds that you and I are. Take a look at their portfolios. Sure, there are still some bonds in there with an 8% coupon, but the yield on them is 3%, just like the yield on a 30 year bond bought today. You can buy 8% coupon bonds too if you like on the secondary market. Most of them have a minority of the portfolio dedicated to private investments. But guess what, I have access to lots of private investments too. There are no magic investments just for insurance companies.
I find it unlikely that “people don’t know that other things exist.” You can keep thinking that more people would invest in whole life insurance if they just knew the truth- that it is a magic investment. But that doesn’t make it true. If you take all whole life “investors” as a sum, then their return must by necessity be less than that of those investors investing in the same investment without going through an insurance company. This mathematical truth is irrefutable. For every whole life person who does a little better (for example by getting mortality credits by sticking with it when others die or by reaping the benefits of not paying surrender charges), there will be someone who does worse (by paying those surrender charges.) Gross returns, minus expenses, equals net returns. You get what you don’t pay for. In order to provide an insurance component, a whole life insurance policy must, by necessity, have higher costs, and thus lower returns. Regular joe-blow investor can buy every publicly traded stock and bond in the world at an expense of less than 10 basis points. If he wants to deal with private investments, there are plenty of opportunities that are available to him because he doesn’t have to invest billions just as there are opportunities available to an insurance company that does have billions. There are no magic investments.
Mr. Bogle doesn’t care if you invest in “his” Vanguard indexed funds. He doesn’t own them. That’s what’s so special about him (and Vanguard.) Nor does he have clients. But if you want his advice about what to do about retirement, why not come to the Bogleheads conference next year and ask him yourself?
Now, let’s address your fantasy about retirement income streams. Okay, let’s say you’ve got an investor who invests $10K a year for 30 years. He earns 8% a year on the portfolio. He now has $1.2M. Another investor spent $10K a year on his whole life policy. Using a fairly typical return of 4% at 30 years, he now has a policy with a cash value of $580K. We’ll say the death benefit is $650K. Again, round numbers here.
The whole life guy decides he’s going to take his $580K, do a 1035 exchange and buy a SPIA with it. He can probably get a SPIA paying something like 6% or so (show me a SPIA paying 10% for someone under 80 and I’ll get you 100 buyers for it). So he gets $34,800 per year on that. We won’t even consider the interest payments he must pay the company in order to borrow his own money.
Now, the regular investment guy decides he is also going to use $580K to buy a SPIA. He gets that same $34,800 per year income from it. But he still has $620K of his portfolio left. So he decides to withdraw 3.5% a year from that too, or another $21,700. So his total income is $56,500, a whole lot more than the whole life investor. So what happens if they die. Well, if this SPIA was just on him, then the regular investment guy’s wife gets the $620K left in the portfolio. The whole life guy’s wife gets the death benefit MINUS the $580K already taken out, or $70K. Remember with whole life you get the cash value OR the death benefit, not both. In either scenario, the regular investment guy is better off. The only situation in which the regular investment guy wouldn’t be is if he dies before retirement. But that risk is easily covered with low cost term insurance.
Whole life insurance has been referred to as the payday lender of the middle class with good reason.
//I find it unlikely that “people don’t know that other things exist.” You can keep thinking that more people would invest in whole life insurance if they just knew the truth- that it is a magic investment.//
You misunderstood my point. I don’t like to look at life insurance as an investment. When I said other things exist, I was referring to alternatives to the market. Oil & Gas, REITs, real estate, commodities, etc. People are getting hosed in their 401ks comprised of confiscatory mutual funds with 3-5% in costs and fees annually. And I don’t think you’re loud enough about that. People reading your blog will take away that message that they need to max out their 401k first and foremost. I can guarantee you that these high fee mutual funds will leave them with less than whole life. I see it everyday. The only chance someone has at beating whole life is with an indexed fund. But again, I believe in the power of whole life as a personal bank (not infinite banking or bank yourself, that’s different), and use it for real estate and other investment opportunities along the way. When one sells their stock positions or keeps their money in a bank account until such an opportunity arises, they lose a ton of money in lost opportunity cost. But this is something you have shown you simply do not understand.
//For every whole life person who does a little better (for example by getting mortality credits by sticking with it when others die or by reaping the benefits of not paying surrender charges), there will be someone who does worse (by paying those surrender charges.)//
This is no different than the zero-sum game of the stock market. And of course, the market is a zero-sum game before fees.
//Now, let’s address your fantasy about retirement income streams.//
You didn’t address it, you didn’t understand it and you completely changed it. My numbers were conservative and bent toward you. My scenario has NOTHING to do with the cash value in the whole life policy. It’s strictly a death benefit play. And the death benefit needs to cover the other asset at a much later date, say 75 or 85 years of age. Have you looked what it would cost a 35-year-old on an all-base policy to have a $750k death benefit at age 75? Not much. Let’s try this again.
Person A invest everything into his 401k and ends up with $1m at age 65. Person B invests into the same 401k, but shaves off a little bit in order to fund a whole life policy that has a $750k death benefit at age 75. Because he did not contribute as much to his 401k, he only ends with $750k in his 401k. (You’re going to challenge my numbers, but they are right on. Subtract $3,500 from the $10k contribution for whole life. That leaves $6,500. $6,500 invested per year for 30 years at 8% ends up with $795,248.14.) Because Person B has a permanent death benefit, he can trade in his entire 401k for a SPIA without risk. (The reason I used a 10% SPIA is because that is a historical average. I also used a historical Monte Carlo rate of 3.5%. We have to compare apples to apples. Current SPIA rates are 7% and current Monte Carlo rates are closer to 2.8-2.9%. It’s six of one, half-dozen of the other.) So a 3.5% Monte Carlo approach on the entire $1m 401k only produces $35,000/year in income. The SPIA approach you mentioned only makes matter worse. If the husband dies, the wife doesn’t get $620k. He’s been spending down the portfolio, remember? She only gets $620k if he dies the first day. And what a mistake that would be. Half his portfolio just disappeared into thin air, and now she has to live off of $21k/year.
Person B ends up with $250k LESS in his portfolio, but he doesn’t care because he has a permanent death benefit. He can SPIA his entire $750k without any risk. A 10% SPIA would provide $75,000 in income, which is double the income provided by Monte Carlo for Person A. When he dies, it doesn’t matter if it’s day 1 or day 1,000. He’ll pass on a minimum of $750k (tax free) to his widow. She can then SPIA the entire amount and continue her income of $75k (or more because the death benefit grows in whole life.)
Again, no cash value is ever mentioned in my scenario or ever used. This is strictly a death benefit play. Would you rather have a guaranteed $75k in retirement income for both spouses no matter how long they live or $35k in retirement income with a 15% chance of running out of money?
P.S. You keep taking a stab at whole life because you have to pay interest to use your own money. This is not true. First and foremost, you are not paying interest to use your own money. That’s not how whole life works. You are paying interest to use the life insurance company’s money. When you compare the cost on an investment, the lowest cost is whole life. If you go into debt to make an investment, your cost is the cost of the debt. Let’s say the debt costs 6-8%. If you sell a position to invest in something else, the cost is what you were earning or could have earned in that position. Again, the cost could easily be 6-8%. If you borrow the money from a whole life policy, what is the cost? Well, assuming a RoR of 4% inside the whole life policy and an interest rate of 4.4% (which is a real interest rate on one of my 4 policies), my cost is only 0.4%. It’s the least expensive way to make an investment.
You can keep taking pot shots at financial advisors who help their clients obtain a permanent death benefit, but at least myself (and others I know) practice what we preach. (I currently put $25k/year into whole life.) So we’re not exactly as bad as you paint us. Since we practice what we preach, that only leaves 2 options. One, we are doing the right thing for ourselves and our clients. Or two, we are idiots and are ruining our own financial lives along with the financial lives of our clients. There are no other options. I’ve seen more than my fair share of advisors recommending the mutual fund of the day, and don’t have a dime in what they’re recommending their clients. But I’ve never met one advisor recommending whole life who doesn’t personally own it and believe in it. That says a lot.
I’ll try to be louder about not paying too much in mutual fund costs. My last 401K charged 2.5 basis points including fund ERs. My current one charges $200 a year, plus 5 basis points. The ETFs I hold in it are less than 10 basis points. I agree there are crappy 401Ks out there and crappy mutual funds that are every bit as bad as some of the insurance-based investments out there.
What kind of a guarantee are you offering with respect to Whole Life vs a 401K? Because you owe it to me already. I had a negative return in my whole life policy, yet somehow have a markedly positive return in my 401K money. So whatever your guarantee is, please send it to me via paypal as a “tip.” You’ll find a link on the homepage to do so.
I hope people do take away from my blog the need to max out their 401K first and foremost. That is nearly always the correct path for a physician in his peak earning years. It provides asset protection, estate planning benefits, multiple tax breaks, and solid investment returns.
While I’m a huge advocate for low-cost index mutual funds, I don’t think one HAS to use an index fund to beat whole life’s returns. Any reasonable fund is likely to do so.
Infinite banking and Bank on yourself advocates also use their whole life policy as a personal bank to buy consumer goods or investments like real estate. I fail to see how your approach is any different, but feel free to enlighten me. I certainly do understand the opportunity cost associated with using a different source of funds to make an investment, I just see it as lower than the cost of using an insurance policy instead.
The reason I challenged your numbers is that you use the wrong ones and the devil is in the details. You used a 10% SPIA. I challenged it. Now you admit that 7% is all you can get. Now you say you want to use historical rates yet claim a 3.5% withdrawal rate only provides an 85% chance of lasting 30 years. The historical SWR studies show that a 75/25 portfolio has a 100% chance of surviving 4% withdrawals adjusted to inflation for 30 years.
http://www.fpanet.org/journal/CurrentIssue/TableofContents/PortfolioSuccessRates/
Why would I believe any of your numbers when you can’t seem to figure out which ones you ought to be using? Your salesman tactics may work a potential client without much financial sophistication, but to anyone with any reasonable amount of education about this stuff, they just look silly.
Let’s talk about this example of yours. You’re suggesting that an investor can have either a $1M 401K or a $750K 401K and a whole life policy with a $750K death benefit. But this reflects some serious misunderstanding. The first misunderstanding is that if you decide not to put $3500 into the 401K that you somehow still have $3500. You don’t. You have to pay taxes on that $3500. You’ve got $2345. Last time I checked, $2345 bought less whole life insurance than $3500. Second, you’re using a scenario where someone dies before his life expectancy. It doesn’t take a genius to see that if you’re going to die young, your best investment (at least for your heir) is going to be owning as much life insurance as possible. If I knew I was going to die at 40, heck, I’d plow $100K a year into 5 year level term insurance if I could talk someone into selling me that much and make my heir a billionaire. But if you’re going to run numbers honestly, you’ve got to use the person’s life expectancy. If you die before then, insurance based options tend to look better, and if you die later, then they look worse. That’s just the nature of mixing investing and insurance. Third, you forget that using a SWR approach to a portfolio increases payouts every year. A SPIA does not do this. Consider a SPIA taken out at age 60 (pays something like 5.6% nominal). Some guy using an SWR approach to his portfolio might only get to withdraw 4% (use a lower number if you prefer, but 2.8% is ridiculous). How long until the SWR guy is getting more than the SPIA guy with inflation at 3%? About 12%. After that the SPIA comes out behind. You can buy an inflation-indexed SPIA, but it pays much less as you would expect. Fourth, under most scenarios using an SWR approach, the portfolio ends up larger at death than at retirement. Most of the time, you don’t end up spending down. That’s why it is called a SAFE withdrawal rate, because only under the worst historical circumstances do you end up running out of money. Under average or better circumstances, you end up leaving your heirs vast sums of money. Is there risk when you don’t spend money on buying guarantees from an insurance company? Of course. But if it is a risk you can afford, you’re better off self-insuring it, on average. Otherwise the insurance company would go out of business. That’s not an opinion, that’s just how math works.
So let’s talk about your scenario again without all the saleman tactics. One guys retires at 60 with a $1M 401K. The other guy retires at 60 with a $750K 401K and a whole life policy with $114K in cash value and a death benefit of $305K. They both annuitize $750K and buy a SPIA that pays until both spouses die (that pays 5.61%, or $42,065). They both die at their life expectancy of 83. The extra $250K the regular investor dude didn’t annuitize has continued to grow at 8% and is now $1.47M. The whole life policy now has a cash value of $305K and a death benefit that is slightly higher. Since both wives had been living on $42K, they keep on doing so. Then they die a couple of years later. Which heirs are happier? There are no magic investments and guarantees aren’t free. You can argue that the returns on the whole life policy will be a little higher, and maybe they will be, but they’re going to have to be an awful lot higher for your scheme to work out well for the average retiree.
I understand just fine how the whole bank on yourself works using a non-direct recognition policy. What your analysis leaves out (it only costs me 0.4% to borrow) is that you had to endure crappy returns for a number of years in order to get that cash in there. If you had used a more traditional investment, your opportunity cost might be higher, but you also would have more money to use in the investment. The question that insurance agents want you to ask yourself is “Would you rather have $1M in a traditional investment or $1M in whole life insurance?” when the real question is would you rather have $1M in a traditional investment or $600K in a whole life insurance policy?
I agree that advisors ought to invest in exactly what they recommend to their clients. I also believe that one can have a very comfortable retirement investing in nothing but whole life insurance, providing he saves enough money along the way. However, I believe he is likely to be able to have more money in retirement, retire earlier, or save less money by using a different strategy. So I guess if my only two choices are that you’re doing the right thing or you’re an idiot, I guess I’ll go with option # 2. But I think the truth is probably neither of those. I think you’re simply overestimating the merits of investing through life insurance and underestimating the merits of traditional investments, particularly using tax-advantaged retirement accounts. If I were a whole life salesman, I’d make all my comparisons to a taxable investing account rather than a 401K or Roth IRA. It’s a far less formidable castle to storm. If someone wants a really conservative investment with good asset protection after maxing out their 401Ks, well, it’s a little harder to argue against the life insurance approach. But instead of a 401K? Nah, that’s easy to shoot down.
Thanks to everyone and esp WCI for great and easy to follow information on this site. I’ve been following this post for a while and have been mulling over a decision myself about the type of policy I am looking for. I recently talked with an agent to discuss the different merits and downsides of different policies mainly btw WL and Term. He pretty much agrees that one should get perm insurance for the death benefit, and proceeded to list the pro/cons of WL – mostly pros, and mostly the sales tactics that I’ve read over and over on the previous posts.
He agreed that if you buy term and invest the difference then that should outperform the cash value portion of the WL policy, but then he also said that it would not outperform the death benefit. I didn’t quite understand what point he was trying to make with this as it would seem he was comparing money that I would be using while alive vs money that would be passed on. But then I thought a little more and came up with this scenario to see if it were true or not. I am looking at this not from an investment point of view, but from a death benefit point of view where I would want to leave my spouse as much money as possible.
He gave me a sample generic quotes for someone of my age/health, and said a 30 yr $1 mil term policy would be about $1000/yr. Similar WL policy would be $10,000/yr. With all other things being equal, ie maxed out 401k, Roth, HSA, same amount in portfolios and assets, etc etc, one person gets the term and invests the rest and the other gets the WL.
This leaves $9000/yr for person A to invest, at say 5% real return for 30 yrs = ~600,000. I don’t know how much the cash value in the WL would be but it doesn’t matter for this particular scenario. The death benefit would be $1 mil on the WL…so if both people died 1 day after the term expired, the person who had WL would have $400,000 extra to leave to his spouse, right?
However, if both lived to their life expectancies…say 20 more yrs…the 600,000 (without anything extra added) would compound to ~1.6 mil. So it seems like from the perspective of leaving as much money as possible…if someone passes earlier, it might be better to get the perm insurance, but if you have good genes, then it might not? Of course, you cannot predict the future…and also, if someone were solely wanting the death benefit, I know that from reading all of these posts, guaranteed no lapse UL would be a better option.
Is this a too oversimplistic way of looking at this? I’ve probably missed something major…
Thanks in advance for helping to clarify this.
While if you die early, of course investing the difference isn’t going to outperform a life insurance policy. However, at your life expectancy, the return on the death benefit is only slightly better than your return on the cash value, and both should be easily surpassed with a traditional investment. On average, you’ll come out behind buying a whole life policy versus traditional investments. It has to be that way, right? Think about it. If it wasn’t that way the life insurance company would be out of business. The difference in returns reflects the additional insurance costs including the agent’s commissions and the company’s profit. (Not to mention an insurance company’s portfolio is generally quite conservative, primarily invested in bonds.)
If your goal is to leave a definite amount no matter when you die, then guaranteed no lapse is best. If your goal is to leave the most possible (on average), then investing it traditionally is the best. So when is whole life the best, you may ask with good reason. Only when you want a low return investment that must be held for decades to get that low return.
A few observations.
1) With most whole life policies, the dividend option is “Paid Up Additions,” meaning purchasing additional death benefit. Therefore, the death benefit is not 1 million after 30 years, it’s likely closer to 1.6 million (assuming a 35-year-old purchasing a 1 million face amount). The cash value is projected to be $771K after 30 years, and premium is level at $12,230. That’s an IRR of 4.44%. DB IRR is 8.44% after 30 years.
2) We will assume no premium is paid past 30 years, the policy is “offset.”
3) In 20 more years, the the death benefit is $2.387 million, the CV is $1.92 million. Respective IRRs are 4.55% CV and 5.14% DB.
Remember, your premiums are guaranteed to be level. The only non-guaranteed item is dividends. If we go through a period of higher inflation (which I personally believe we will), your cash values and dividends and, therefore, your death benefit will increase.
Regardless, if WL is PART of your investment/risk management strategy (20 to 25% of total investment dollars), then you are able to leverage your WL when deciding how to take distribution from your remaining retirement assets.
I understand what projected IRRs are for the CV and DB. I do not, however, believe that current purchasers of whole life are going to get those. I doubt they’ll end up with the guaranteed IRRs, but it wouldn’t surprise me to see that in the end the returns were closer to the guaranteed than what is currently projected.
“Leverage your WL” sounds sophisticated until you get down to the nuts and bolts of what that means. What it typically means is that you have less money to use for whatever purpose you want it for, but you do have that permanent death benefit hanging out there that you’d like to make the best of.
You missed this: with participating WL, you elect a dividend option with the default being “Paid Up Additions.” As dividends are paid, additional death benefit is bought and cash value accrues.
In the example you gave, spending $10,000 a year on WL, the death benefit is projected to increase to $1.6 million after 30 years. Your policy could offset well before then, but let’s say you pay for 30 years. After 20 more years, the death benefit increases to $2.3 million. Also, projected cash values were $677,500 at age 60 and $1.7 at age 80.
From age 60 to 80, you could have spent down your other retirement accounts freely, know that either the death benefit would be paid or, if you survive well into your 80s or 90s, you can take tax-free distributions (example, $160,000 tax-free from age 81 to 90 and still have a death benefit of $1 million).
Projected being the key word in that post.
Well, I don’t think that investors in the S&P are going to realize 10 to 12%, regardless of what Dave Ramsey says. My research shows that it returned 7% during the last ten years. I have a compliance approved marketing piece that shows the actual 25-year historical IRR of a WL policy from 1986 through 2011 of 4.86%. The S&P returned 9.3% during that same period, according to my research.
So let’s use those numbers and, for simplicity, assume we can invest in a Roth IRA so we’re paying taxes on the front end so won’t worry about tax ramifications. A 35 year old has $40,000 to invest. He buys a 25 year term insurance policy for a million death benefit and that costs him $700 a year. He invests the difference of $39,300 and at the end of that 25 year period, he has $3,816,298 and no life insurance. Man B spends $10,000 on WL and invests the remainder. His investments are worth $3,217,511 and his has WL with a death benefit of $1,159,982 and $488,755 in cash value.
Since we’re now 60, we’ve got to make the money last. I could buy a SPIA as you’ve suggested, but survivorship pays less than single life (and I have no life insurance and I have to think of my spouse). I could buy a period certain, but that potentially pays much less if I survive beyond the period. Since my nest egg is likely now in pretty conservative investments, I could also take a conservative spend-down distribution of 3 to 4%.
Man B has more options (leverage) since he has the life insurance in place. He could buy the lifetime annuity since the insurance death benefit fills the bucket back up. He could ladder annuities. He could buy a period certain annuity and let the cash values swell in his life insurance and then take tax-free distributions from his policy. He has the ability to take more aggressive distributions from his retirement accounts (5 or 6%) since the insurance will come into play.
By the way, I was not suggesting his put all his money into annuities, just some of it. The Society of Actuaries White Paper notes that a secure income stream actually encourages you to invest in riskier and potentially more lucrative investments, i.e. staying in the market rather than shifting to a bond-heavy portfolio, potentially giving you more return in retirement.
Or he could die during the first ten years of retirement, sad to say, but the insurance again leverages for his beneficiaries. When I talk to clients who’ve been whip-lashed by the market since 2000, they’re skeptical of 9 or 10% returns. If I had an absolutely guaranteed 7.5% to offer them, I’d be rich (and I would invest in it too!). What’s the expression, “Past performance is no guarantee of future results”? The more volatile the investment, the truer that is and the more timing comes into play.
Come on Bob. If you want to pretend to make some kind of a fair comparison, let’s do a fair comparison.
First, the 10 year return on the US stock market for the last 10 years. I’m glad you’ve done some “research” into this. I went ahead and did it too. It took about 18 seconds to go to Vanguard’s site and see what the ten year return was for their Total Stock Market Index Fund. It’s 8.33% per year as of 9/30/2013. That’s an average annual, not an annualized return, which will be a little lower. Not bad for a “lost decade.”
Second, I see no reason to use the return over a random 25 year period in the past. If we’re going to do a comparison, let’s try to estimate returns going forward from today. I asked an agent to send me a “good whole life policy” (my exact words were to send me the best one he could find) a while back. You can argue it may not be the best policy ever, but I think you’ll find it hard to argue it was cherry-picked as a crappy one.
It’s a MetLife Promise Whole Life 120 $1 Million policy for a 30 year old male in New York quoted in November 2012. Basically, you pay a premium of $8580 per year (if paid monthly) every year until you die or turn 120. At 20 years, it guarantees a cash value of $190,000 and a death benefit of $1 Million. It projects a cash value of $242,226 and a death benefit of $1,152,905. The midpoint values are $214,817 and $1,072,657.
So returns on that cash value would be 0.89%, 2.09%, and 3.18% depending on what you believe the future holds.
So rather than use your rather optimistic 4.86%, let’s pick the midpoint value of 2.09% over the next 20 years. I know it’s a little painful to compound money at less than the rate of inflation, but it seems like a pretty good guess for where today’s whole life purchaser is likely to end up.
Third, let’s take a look at what that term insurance would really cost. We’ll use a value from term4sale.com for a 20 year policy for a healthy 30 year old male. It’s $410 a year.
Fourth, we need to choose a value for what an investment portfolio is likely to return going forward. I agree that using the historical S&P 500 index return is probably optimistic, although Vanguard’s fund has returned 10.82% per year since inception. Let’s knock it all the way down to 8%.
Now, we’ll assume the investor has $40K a year for life insurance and investing. The first guy puts $39,590 into the 8% investment, which after 20 years is worth $1.96 M. He is now able to retire and no longer has any insurance need. The second guy puts $31,420 into the 8% investment and $8580 into whole life insurance. After 20 years the investment is worth $1.55M and the cash value on the whole life is worth $0.21M for a total of $1.77M, or $219K less. In return for having $219K less money, he has a life insurance policy that will pay $1.07M in the unlikely event he dies and he gets to pay $8580 per year for whole life insurance throughout his retirement.
So let’s just say for fun that both of these guys decide to annuitize their investments. At age 50, that payout is 5.39%. So the first guy gets to live on $105K per year. The second guy gets to live on $75K per year plus he gets this life insurance policy he doesn’t actually need. The first guy is asked if he would like to buy a life insurance policy for $40K per year and he looks at you like you’re nuts. The second guy is asked if he would like to turn in that life insurance policy for an extra $40K a year and he asks, “Where do I sign up?” That policy is only worth $215K. Getting $40K a year of income out of that $215K is like buying an annuity that pays 19% at age 50! That’s a heck of a deal. What’s the best way to get that deal? Never buy the whole life policy in the first place.
Now, I’m not saying having some extra life insurance policy sitting around doesn’t provide you some flexibility in retirement planning. But the cost is too high. The guarantees are too expensive.
The really sad thing wouldn’t be if he died young. It would be if he lived too long. The longer he lives, the worse that whole life insurance investment becomes.
In order for someone to make a logical decision to buy whole life insurance, he has to place an extremely high value on a permanent death benefit. The fact is that very few people need or want that when they really understand the cost of getting it. It isn’t that a whole life policy has no value, it’s simply that the opportunity cost is too high.
Well, I think we’re having a good dialogue. I went to the Vanguard site and found the Total Stock Market Index fund you referenced. It note 8.33% average annual returns for the last ten years and 4.61% since its inception date of 11/13/2000. I’m leery of average returns–up 100% one year, down 50% the next is an average return of 25% but you’re still at zero–so I much prefer annualized as a metric. Looking at the performance metric of the growth of $10,000 during the last ten years on the Vanguard site, it looks like the annualized is 7.94%. I think we’re being kind to use that to predict the next 20 or 25 years (note the 4.61% since inception) but, okay.
The period from January 1, 2000 to December 31, 2009 was indeed a “lost decade” for the market, with the S&P returning an average of 1.21% and and an annualized return of -.99%. You can verify my numbers at http://www.moneychimp.com/features/market_cagr.htm.
Your term quote was for the very best health class, super preferred, by the way. I’m not saying that a 30-year-old in good health is not likely to get that, but I like to be a little more conservative. Second best class–preferred non-tobacco–is $550 for 20 years with 1 million face and $750 for 25 years.
MetLife isn’t a bad company, but it’s a stock company not mutual. Stock companies are run for the benefit of stockholders, mutuals are run for the benefit of policyholders. The product he sent you was the equivalent of Guardian WL121, which means premiums will be paid through age 121 (or until the insured dies OR until the internal values allow the policy to offset–pay for itself through internal values). Offset is important. I certainly don’t plan to pay premiums past my retirement age. The benefit of a WL121-type policy is lower premium, $8,250 versus $10,050 for the WL99. WL121 also has a lower IRR, projected to be 3.33% at 20 years versus 3.93% at 20 years for the WL99.
If you’d asked me to show you a good policy for a 30 year old, I wouldn’t have defaulted to the cheapest product. My design would use WL99 with superior IRR and I would have strongly suggested adding a Paid Up Additions Rider for two reasons: 1) Cash value accumulates more quickly and boosts the IRR; 2) It allows the policy to offset more quickly if desired (natural offset is illustrated as occurring after 11 years, so offsetting in 20 is just about assured).
I always illustrate guaranteed and mid-point assumptions as well. The software will only allow me to illustrate with the currently declared dividend of 6.65% or lower. The midpoint assumption is halfway between the guarantee of 4% and current dividend. Since current is 6.65%, midpoint is 5.33%. The lowest dividend since 1980 was in 2006 at 6.5%. Mutual insurance companies are conservative beasts! (The highest was 13.25% in both 1985 and 1986. This illustrates that there is an inflation adjusted aspect of WL, and I personally believe the next 20 years will bring higher inflation and if I’m right, higher dividends).
So, I’ll be very conservative and use a 6% dividend for all 20 years. I’ll put $12,000 a year in the WL ($10,000 base, $2,000 PUA) and invest the difference of $28,000 at 7.94% which will accumulate tax-free, somehow. The other guy buys the 20 year term at 2nd-best class at $550 and invests the difference of $39,450 at 7.94%. At the end of 20 years, Man A has $1,373,915 in investment accounts, $375,272 in cash value in his WL, and a $1,471,259 death benefit. Premiums are offset–no more outlay.
Man B has accumulated $1,935,748 and his life insurance has expired. Now, a twist: Man A and Man B are both married, with wives 2 years younger than themselves. Therefore, when Man B tell his wife he’s going to retire and annuitize his investments so he can receive $104,400 a year, she says, “Not so fast, big boy, what about me?” Grumpily he agrees to buy the 100% survivorship annuity and his income drops to $92,568. Wehn he and his wife die, payments cease, no benefit to heirs.
Man A sees he can buy a 20 year period certain annuity with his retirement account and receive $91,992 a year. If he and his wife both die within this period, his heirs still receive the balance of the payments and the proceeds from his life insurance.
Man A reaches age 70 and no more income from his annuity. He starts taking tax-free distributions from his WL policy of $65,000 a year and does just fine. He dies at age 85 and leaves $1 million tax-free to his 83-year old wife and she annuitizes whatever portion she desires and does just fine. She dies at 90 and leaves kids and grandkids a nice inheritance
We don’t know when we’re going to die, but we are. If there’s a desire to leave a legacy, Man B’s plan doesn’t work. If Man B dies before life expectancy, his plan doesn’t work very well. If Man B and his spouse die before life expectancy, it really craters. A good plan works well regardless of the circumstances.
Your turn!
Bob,
I don’t think we’re going anywhere with this. What exactly are you hoping to accomplish with this exchange? I can’t write you 1000 words a day about whole life insurance for the next 10 years. I’ve got some other projects I need to be working on, and 400 other pages on this blog that also receive comments. If you feel like you have some new perspective that has somehow been missed in the last 600 comments, feel free to submit a guest post to the blog on it. Guidelines are here:
https://www.whitecoatinvestor.com/contact/guest-post-policy/
I’m not saying any of the plans put forward are the best ones for any given individual. Certainly some silly 20 year guaranteed annuity is kind of dumb. The point of annuitizing is to insure against running out of money. Of course if you’re married you need to make a plan to provide for him/her in the event you die first. I disagree that buying whole life insurance is the most efficient way to do that, but I’m not surprised that you, as someone who makes his living selling the product, disagrees with me and I doubt I’d ever convince you of that fact.
If you want to leave a guaranteed amount of “legacy” at death, permanent life insurance is a pretty good way to do it. I think Guaranteed No Lapse is best, but if you want that amount to gradually increase a little, whole life isn’t bad. If you want to leave the highest amount possible, you’re better off simply investing. If you live to close to your life expectancy or longer, you’re more likely to leave more.
I did use a life insurance quote for a healthy 30 year old….for both the term and the whole life policy discussed. For those who have bad health, or who have dangerous hobbies, life insurance is more expensive. One reason, among many, that I don’t use life insurance as an investment is that I don’t get those rates if I’m honest about my hobbies. At least stocks, bonds, and real estate don’t care about your hobbies or your health. I see that as a huge strike against investing in insurance. If the insurance portion is super-expensive, it makes it that much worse as an investment.
One thing you don’t get as a WL guy is that there is a continual stream of people showing up on the blog, emailing me, or posting on internet forums about how they were suckered into buying a lousy whole life policy that has provided crappy returns and now after 10, or 20, or 30 years they have to decide what to do with it. There are thousands and thousands of these people who regret this purchase. When 80%+ of purchasers of a whole life policy are dumping it at some point before death, that’s a pretty good indication that it wasn’t really what they wanted or needed. Especially in a situation like we’ve been discussing, where someone is only investing $40K a year or so. If someone is only investing $40K a year, it’s pretty darn easy to get all of that into a retirement account of some type. Investing in WL at that level of savings not only means they’re getting a low return investment, it also means they’re missing out on serious tax breaks available elsewhere.
Well, I guess I’m trying to get you to understand that WL can be a valuable part of your investment mix. I consider it an asset class.
I also want you to see how we’re all fed the information we want to hear. You want to believe that the stock market will return 8% or better for a predictable period, and I don’t think you allow for an increasingly conservative strategy as you age and near retirement. You want to believe that people are infinitely insurable–every 30 year old is pref plus nt. You thought that you had to pay insurance premiums for life–you didn’t understand premium offset. You don’t value that all cash within a policy is free from lawsuits, a valuable feature for physicians and a litigious society. And, while you believe in the 8% from the market, you think a 4% IRR is overstated from a conservative insurance company!
I think you’re a very smart guy and make some valid points and I don’t think we’re so diametrically opposed as some might think. I think your approach can work fine, and I know my approach can work fine as well, and work regardless of life’s circumstances. Can you say that about your approach? What if you become disabled? What if you die early in retirement? These are real issues.
1) I do understand premium offset. Don’t worry. If someone wants to invest in a whole life policy they should buy a policy that only requires payments for as long as they want to make payments.
2) I agree that I think a 4% IRR is way too high of an estimate for many whole life policies going forward, especially for a period of time less than 3-5 decades. While no one knows what the future holds in the market, and many smart people estimate that an investment in an S&P 500 index fund will return less than 8% a year going forward from here, I think it is more likely that we could see an 8% return on US stocks than a 4% return on a whole life policy bought today and held for 20 years.
3) I disagree that all cash within a policy is free from lawsuits. Asset protection is very state specific. Here is one of my favorite resources on this topic:
http://www.assetprotectionbook.com/forum/viewtopic.php?f=142&t=1566
For example, in Alaska only $12,500 cash value is exempt from creditors. Not very useful. Yet a Roth IRA is 100% exempted and $67,500 of your home equity is exempted. Buying whole life in Alaska for the asset protection benefit would be pretty dumb.
4) You can call anything you like an asset class. I don’t care if you invest in the “Mouse Dropping Asset Class.” That doesn’t mean it is a good idea. Rick Ferri (Author of All About Asset Allocation) gives some good tips on how to decide when to include an asset class in your portfolio I’ll be writing about soon. Needless to say, Whole Life Insurance wouldn’t be included.
5) Let’s talk about your what ifs. They’re real concerns. But I don’t think they’re best addressed by Whole Life Insurance. What if I become disabled? If I become disabled in my working years, my disability insurance pays. If I become disabled in my retirement years, I still live off your portfolio just as if I wasn’t disabled. What if I die early in retirement? Then my wife lives off my portfolio just like we both would have done. Either way, no need for a permanent death benefit. The insurance benefit provided by whole life insurance (a gradually increasing permanent death benefit) simply isn’t needed by the vast majority of people. That’s the bottom line, and it’s common sense. Buying insurance you don’t need isn’t a good idea.
6) I agree that a very conservative portfolio may not outperform whole life insurance. If someone wants to hold a portfolio of all or mostly bonds, they may be better off with the 2-5% IRR that a whole life purchaser is likely to achieve over his lifetime.
7) You state that you want me to understand (admit?) that whole life can be a valuable part of an investment strategy. Yet after 600 posts, no one can even provide a quote from a respected investment expert who doesn’t sell life insurance who recommends it be part of an investment strategy. 80%+ (I can’t remember the exact percentage, but it’s somewhere in a comment above from Rex) of people who buy it surrender it. That’s a damning statistic, and one for which its advocates have no useful explanation other than “there’s a lot of bad agents selling it inappropriately out there.” I doubt I’ll convince you of my point of view, and I certainly doubt you’ll convince me that yours is correct, so if that is really your goal, I’m not sure you’re using your time and effort wisely.
I agree we’re spending too much time on this so I’ll try to be brief:
1) In your post dated October 29, 2013 at 3:17, you stated “In return for having $219K less money, he has a life insurance policy that will pay $1.07M in the unlikely event he dies and he gets to pay $8580 per year for whole life insurance throughout his retirement.” That’s what led me to believe you don’t understand offset.
2) There are many WL providers out there. Some are better than others. A well-designed policy from a mutual is very likely to have a better than 4% IRR over a 25 year period. You can do even better with a 10-pay policy. You can improve the IRR and cash values by overfunding with Paid Up Additions.
3) Correct, for the 700,000 people who live in Alaska, only part of their life insurance and home equity is protected. For the 26 million who live in Texas, all their cash value in WL and all of the homestead is protected. You should ascertain how your state treats these values.
4) Richard Weber, MBA, CLU, a fee-only life insurance advisor has written a white paper entitled “Life Insurance As an Asset Class.” He does not sell life insurance. I’ll be happy to send you the paper unless you’ve already made up you mind without reading an opinion that varies from your’s.
5) DI has a current limit of $17,000 a month. Will that replace your earnings? Will that allow you to contribute to your retirement at the level you planned to? BTW, if you had Wavier of Premium on your WL, then that plan would be self-completing.
6) You’ve asked posters to respect your audience, those in the medical field, many of whom are high earners. WL premiums are expensive compared to term and, as result, WL may be best suited to higher earners who can buy and hold for a 25 year plus period.
2)
1) The policy used in that example is paid until death. I understand not all policies are structured that way. The shorter the pay period, the higher the premium. When buying a whole life policy, you should structure it so you only pay into it for as long as you want to pay into it within MEC considerations.
2) I agree you’re likely to get a higher return with a 10 pay policy. I agree that buying PUAs can improve returns slightly. Paying annually instead of monthly can improve them as well. But we’re talking a few basis points, not a few percentage points.
3) I agree.
4) I’ve seen the paper, or at least one very similar to it. Even if we call it an asset class doesn’t mean it is a good asset class to invest in. A fee-only insurance salesman is still an insurance salesman so I’m not sure that qualifies as a disinterested party. Perusing a recent talk given by Mr. Weber confirms my suspicions since it includes a section on how treating life insurance as an asset class helps agents boost their sales of these products: http://www.imdrt.org/2013am/handouts/Weber.pdf
5) Yes, $17K tax-free to age 65 would be more money than I could ever need (I carry less than that). I disagree that is the limit on disability insurance as noted in this post: https://www.whitecoatinvestor.com/financial-advice-for-high-income-doctors-part-2/ I also disagree that buying waiver of premium riders is necessarily a good idea. Guarantees aren’t free. The money to pay them must come from somewhere. Buying disability insurance and directly insuring your liability is a better idea IMHO than trying to cover your liability using a product that isn’t designed to do that.
6) I agree that WL is better suited for a higher earner. I consider it financial malpractice to be selling it to someone who hasn’t even maxed out their available retirement plans yet, including most doctors. I disagree that buying and holding it for a 25 year period is adequate to make it an acceptable investment. If you’re going to buy WL insurance, you’d better be planning to hold on to it for your entire life.
1) All participating WL policies will show a natural offset, usually in about 14 years per my experience. If you decide to overfund with PUAs (as I recommend), then the period can indeed be shortened.
2) A 10-pay can boost IRR by 30 basis points, not insignificant
3) We agree!
4) Richard Weber doesn’t sell insurance. He is a fee-only planner who understands the value of permanent insurance. Yes, the Guardian likes him and his research, not surprisingly.
5) $17K is the individual limit offered by the Guardian. You could add group and even go with Lloyds for more DI. If you’re a highly compensated doc making $500K to 2 million a year, you’d be wise to go with Lloyds. And $17K a month may sound like a lot until you compare is with potential earnings.
6) I consider it financial malpractice to not insure your human life value before maxing out available retirement plans. I like term that is convertible to high-quality permanent insurance for this purpose. I believe you misinterpreted what I meant about the 25-year period. Maximizing the cash value IRR occurs after 20-plus years. The death benefit IRR is higher for the first 20 years. I do believe you should hold on to it for life, and enjoy its flexible benefits during your life, as well as its death benefit.
1) I agree. You probably also ought to mention that your future cash value will be lower than illustrated if you’re using dividends to offset premiums instead of to build cash value.
2) I’d buy 30 basis points. No, it isn’t insignificant, but it hardly turns a bad return into a good one. Plus it requires a lot of cash early on. There are several little ways like that to improve WL returns (pay annually, PUAs, 10-pay periods, 7-pay periods etc). But you know what, I keep running into people whose agents didn’t do those things. Is it because they want their clients to have low returns? Or are they ignorant? Either way, it makes them look pretty bad.
4) I agree Weber’s conflict of interest is far lower than a commission-based salesman. He did, however, spend 25 years as a successful life insurance agent (presumably earning commissions) as a CLU. It’s a little misleading to say he doesn’t sell insurance now without mentioning that he did for decades. Nevertheless, I like a lot of the stuff he’s doing. I disagree with him that WL insurance is an attractive asset class for a typical investor.
5) I don’t think comparing your disability insurance to your earnings is the right way to go. I think you’re better off comparing it to your needs. If you can live on $10K a month indefinitely, have a portfolio that is highly likely to support that income after age 65 without any further contributions, and have a good disability policy that will support that income until age 65, then why exactly would you want to spend enough to insure your entire income? Insure against financial catastrophe. I don’t need to live better if I’m disabled than I’m living now.
6) You don’t need to insure your entire human life value. Insure your needs, not some vague number an insurance salesman encourages you to use. Of course the death benefit IRR is high if you die early. What’s the IRR on a term policy with a face value of $1 Million and an annual premium of $200 if you die the day after you bought it? It’s incredibly high. That’s why if you’re going to look at the IRR to death you really need to take into account life expectancy. But the cash value IRR can be used at any age.
I have worked at one of the top rated mutual life insurance companies for 8+ years and my father is 30+ with that same company… One constant thing I see is the people that do the most WL business are the advisors who OWN the most themselves. I also have heard the comment (too many times to count) “I wish I would have bought more of this when I was younger”
WL insurance is a luxury to be able to afford. That is why a lot of advisors talk with white collar professionals, because they can make it work.
When you buy life insurance initially it is for one reason, however those needs WILL change over time. The purpose of owning WL later in life is based on wants. It allows an individual more flexibility, more guarantees, and more security.
THe comparison of WL insurance and a equity mutual fund is comparing apples and oranges. It is all about managing risk. If it were just about “rate of return” wouldn’t we recognize lottery winners as savvy investors?
And on one of your last comments of “The really sad thing wouldn’t be if he died young. It would be if he lived too long. The longer he lives, the worse that whole life insurance investment becomes.”
OBVIOUSLY your understanding of life insurance in rather low… Because just the opposite is true.
All right. Another agent. This post is like a WL insurance salesman magnet. I agree that whole life insurance would be better called a luxury than a good investment.
I don’t agree that it is about managing risk. For most retirees, it’s managing a risk that no longer exists for them. It’s just a “luxury.” If they can save enough that they are comfortable despite having a good chunk of their portfolio in such a low-returning investment, fine. But when the typical professional in his 50s only has a low 6 figure portfolio, I don’t see that as being the case.
Of course dying young is bad and living a long time is good, but strictly financially speaking, the sooner you die the better the return on any type of a life insurance product.
Just commenting because I saw my site was referenced in the comments above (linked to the Mass Mutual Dividend Study).
I am going to assume for a moment that this will reach past the author’s obviously biased opinion against whole life 🙂
***
“Sam……
If you dont need or want a permanent death benefit then buying any whole life product is a mistake. You can not buy the product as a strict investment unless you want a very poor decision. The primary reason for a permanent life insurance policy must be a permanent death benefit for it to make sense. The basic reason is as follows: When you buy Mass Mutual or any whole life, you are buying bonds but are paying also for insurance to cover your entire life but on a level basis, paying also for a very pricey middle man, and decreasing your liquidity.”
***
This is precisely why you do not take advice from bloggers on the Internet (sorry if that sounds a little curt, but this kind of life insurance bashing is getting really old and stale). I can’t untangle every comment in this thread, but I’ve read enough to know that the author’s information is very piecemeal. He knows just enough to be dangerous to the general public (i.e. those who know less than he does).
For example: “you are buying bonds but are paying also for insurance to cover your entire life but on a level basis, paying also for a very pricey middle man, and decreasing your liquidity.”
This is an extremely misleading statement. First, you’re not buying bonds, per se. The insurer’s GIA is comprised of about 60 percent bonds in many cases. So yes, there are bonds, but you’re also buying into 40 percent of something else.
Second, you are not paying for insurance on a level basis. This is something you can look up in the policy illustration. The net cost payment index always decreases in a whole life policy. That’s because, as cash value builds up, the net amount at risk goes down. You’re actually buying less insurance. So, level…yeah…no.
A pricey middle man. This really depends on how you buy the policy. But you could also say this about every investment or financial product. Some are really expensive. Some are really cheap. Yes, there are really expensive policies out there. And, there are 20+ ways to make the policy more expensive. But there are also 20+ ways to make the policy less expensive, emphasizing cash value growth and death benefit. Is there a difference between a policy where the costs consume 0.5 percent of the total lifetime cash value and a policy where those costs rise to 2 or 3 percent? What do you think?
Liquidity: This is always an issue because the policy is front-loaded. But that doesn’t mean you can’t get 60 to 80 percent of your premium back as cash value in the first year. By the 5th or 6th year, you’re positive on the IRR until the day you die. That’s really easy to do if you know what you’re doing. So, if your investment time horizon is less than 7 years, it’s probably a bad idea to buy whole life. But then, it’s probably a bad idea to buy any long-term financial product. You belong in CDs, money market, cash, and short-term bonds.
Lest I be confused with a cheerleader, I’m not advocating whole life for everyone. Like pretty much everything else, there are many times when it makes sense, and many times when it doesn’t.
If you want financial advice, hire a real financial professional (yes, I realize it’s very difficult to find someone you trust. It’s like that on this side of the fence trying to find a good doctor who is holistic without promoting hokum). As doctors, what would you say to a patient that told you he went to every energy healer, swami, acupuncturist and Chinese medicine doc before coming to you about his broken leg? You’d probably tell him to stop being an idiot, then treat him.
In 2010, insurance company assets were invested 70% in bonds (almost all in run-of-the-mill corporate and treasury bonds), 1% in preferred stock, 10% in common stock, 6% in mortgages, 1% in real estate, 4% in cash, 3% in loans to their policy owners, and about 5% in “other.” 60% is close enough, but as long as we’re tossing out facts, we might as well look up the right ones. It’s not that hard.
In my opinion, the vast majority of those selling life insurance know just enough to be dangerous. The author is not only biased against whole life, but also against famine, stale bread, and the beheading of kittens. As long as we’re discussing bias, it should probably be mentioned that the author makes nothing if a reader buys whole life insurance or if a reader does not buy whole life insurance. Most of those arguing against him stand to gain financially from the sale of whole life insurance. I don’t think it is difficult for a reader to see where the bias lies.
I disagree that there are “many times when it makes sense.” Only those who sell it believe that. I do, however, agree that there are rare times when it makes sense and that there are many times when it does not make sense.
The blog isn’t about medicine, which has plenty of problems, but at least all of its licensed practitioners spent years studying their craft and have an ethical and legal obligation to put the needs of their patients/clients/customers first. Someday perhaps the financial industry will arrive at the same place. Until then, anyone hiring a “real financial professional” had best follow the guideline of “caveat emptor.” The sad truth about picking a good financial advisor is that by the time you know enough to do so, you know enough that you can do it yourself. Maybe that’s true about medicine too, I dunno.
White Coat Investor: you do realize this is 2013, right? And that not all insurers allocate their portfolios the same? A lot of insurers are divesting out of government bonds, dropping the ratio.
[Off-topic ad hominem attack removed.]
As someone who is at this fork in life I am very interested in this debate…
My financial understanding is equivalent to my ability to read an EKG (MD’s should get this joke…)
I could care less about all the explanation and graphs and projections.
I’d LOVE to hear from an actual doctor…nearing retirement or in retirement and hear about his experience with Whole life insurance.
I plan to ask around and get actual people’s experience.
all this theorizing and guessing and salesmanship doesn’t matter. its like all our research articles and journals. data can be twisted to represent anything you want. I want to hear about actual experience that people have had.
If it was so great it…everyone would have it.
Also you have to be suspicious of these MASSIVE insurance companies and the slick insurance salesmen and their Audis…that money is coming from somewhere. I’ve been in practice for a year and make a pretty decent average salary for an ortho doc and I’m not crusin in an Audi yet…LOL
I’m sure with all the MDs on this site we can track one or 2 MDs that have benefitted (or been suckered) from a whole life ins policy…
I’ve got plenty who “were suckered.” Here’s one that was relatively happy with his:
https://www.whitecoatinvestor.com/a-whole-life-insurance-success-story-the-friday-qa-series/
Bonedoc: try contacting these guys: http://theinsuranceproblog.com
I’m positive you’ll have a good experience with them. I have no financial connection there. I just happen to know for a fact they do a really great job of clarifying the complexities of life insurance. Unfortunately, the owner of this blog is pretty set in his ways. Which is fine, except he repeatedly posts factually incorrect or misleading information. That’s a problem when people rely on this blog for guidance. They’re getting facts, which are true in one context, but they’re also getting only half of the story.
To the owner of the blog: if you ever want to have a meaningful discussion about life insurance, and you’re willing to put it on your blog, let me know. I’m more than happy to oblige. I guarantee you, you have all of this backwards.
Here are the guidelines for guest posts:
https://www.whitecoatinvestor.com/contact/guest-post-policy/
Consider that your invitation.
I do like theinsuranceproblog. I find him, like most agents, far too positive about life insurance but agree he generally gets the facts straight, unlike most agents.
Many thanks to WCI for posting the initial article and sticking with all of the follow-up posts that his opinion drew. This topic is obviously near and dear to the hearts of many. I think it has taken me over 4 hours to get through all of the posts. What better way to spend a Sunday afternoon while watching my Lions beat the hated Bears!
First let me say that I am the not-so-proud owner of a large and now fully funded (if the projections are to be believed) permanent life policy. As per bonedoc’s request I’ll throw in my 2 cents.
First, I totally agree with WCI that these things are way over sold. If the only tool you have is a hammer then everything looks like a nail. The commissions on these products for their promoters are huge and hence, permanent insurance ‘solutions’ are highly promoted. I don’t think that there is any situation where the quote from Upton Sinclair could be any more true, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” That said, I really have never had the impression that the people selling the various forms of permanent life have any more than a cursory understanding of it. In this regard, I would say that this article and thread have been very elucidating.
As far as background on me, I am an MD nearing early retirement. I consider myself a Boglehead and subscribe to the principles (well except for the fact that I hold this product – please don’t kick me out!). I have maxed out every taxed deferred vehicle available to me and have substantial taxable holdings inside my corporation. My major holdings are Vanguard ETFs – VTI, VXUS, etc. I have always been fairly anti-insurance and held DI and life insurance through my university employer until I went private. I likely would not have wound up with permanent life insurance except that my accountant, who is a trusted life long friend of the family’s, suggested that in my situation, permanent life insurance was a reasonable option. It seems that as the years had gone by, I had become one of those chosen few for whom permanent life insurance made sense. Sure.
So anyway, after some research I took the plunge and bought a 10 pay policy that committed about 20% of my savings capacity for the 10 year period. The sales part of the deal was very telling from my point of view. In the beginning, the agents were scarily overattentive and I was the recipient of many freebies – sporting event tickets, dinners, etc and what seemed like endless attention. Of course, they were also interested in capturing my ‘other’ business. It took a couple of years for them to give up on that idea. Also over the first few years there was a clear effort to keep me from dropping the policy which would have resulted in a huge loss for me but apparently a bit of hit for them too. I recall one particular meeting as a renewal date approached, it was myself, my two agents, my accountant, an insurance company actuary and another insurance company representative. In my head, I was chuckling on recalling a Warren Buffet quote, “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” I had absolutely no doubt who the patsy was at this table. And so it went. Not surprisingly, as I got near the end of the ten pay period, they seemed to have quite a bit less interest in me. At that meeting, it was clear that I almost certainly knew more about the product than my agents did (I guess this was appropriate as I had much more money at stake) and even the insurance company reps had some difficulty answering questions to my satisfaction. As MDs, most of us probably take some pride in our ability to communicate complex procedures and statistics to patients that do not have a medical background and I think that we have an expectation that ‘experts’ in other fields should be able to do the same. In this field, it seemed not so much. The actuary was a bit ruffled when looking at future projections 30 years out that I calculated a rough rate of return in my head and pointed out that it was really not likely to be any better than inflation. He agreed.
So I have the policy. I always paid it annually and funded the ‘investment’ component to the maximum allowable. It has never been my plan to take a ‘loan’ against the cash value. It has only ever been another bucket, another way to diversify. I don’t really like the policy or having bought it because it annoys me that it is the most opaque and intentionally complicated product I have ever owned and it goes against my grain in terms of understanding what I have ‘invested’ in. There is obviously no free lunch and the insurance companies make big money on these things. Of course, I have had the insurance coverage and will continue to have it but this coverage certainly could have been had for much less.
So in the end, am I satisfied with my policy. Not really but mainly because it is so complicated and I still have the sneaking suspicion that it will need further funding down the road for some as yet unforeseen reason. It is insurance after all and it seems the only way to win is to lose. I’m hoping to win the game of life so I will likely be a ‘loser’ on the policy but in that case, I’m not likely to mind too much either way.
Again, great thanks to all of your time WCI and to all of the other contributors. In closing, I would say that I am very happy to have not bought this product early in my career and before every possible tax-advantaged account was maxed out and every last debt was paid off. I’ll continue to follow the discussion with interest.
Thank you for taking the time to not only let me know how long it takes to read to this point, but also for sharing your story in detail.
If it’s a true 10-pay policy then it will require no further funding and, indeed, no further funding can be made. That’s why it’s called a 10-pay.
10-pay WL products have as their goal the maximization of cash value. Great vehicles for supplemental retirement income. Highest IRR of all WL products. Point being, UpTooLate, what do have? When you say you’ve “funded it to the maximum available” that’s a red flag to me. The design of a 10-pay WL policy is that it IS maximum funded–that is, you can’t add PUA without it becoming a MEC. So, do you mean you’ve paid premiums as presented?
And what was your cumulative outlay and what is your current cash value and death benefit? And what was your age when you took out the policy and what was your writing class? Without this information, it’s impossible to judge whether your have a good or bad deal. Please share and share what insurance company you went with.
Hi, I need people’s thoughts on the following…I know it may sound crazy but given the environment we live in today it is a valid question. Is it better to own a home and invest in term life or is it better to rent and own whole-life?
The reason I ask is that property taxes, association fees and home owners insurance alone in Chicago would be more than 1000+ month outside of monthly mortgage payments. And when I am done paying off my home I still have to pay property taxes and insurance and association fees…
At the same time I do not feel home values will sky rocket anytime soon. We have a baby boomer population that is nearing retirement age and the life expectancy age has gone up. Most of these baby boomers will have to downsize their lifestyle and possibly that could mean selling their property…which I would think will cause more supply than demand.
If I were to pass away before my policy expires, my family hopefully can use the proceeds to pay off a home and continue it to pay taxes, association fees and insurance….
On the other hand if I were to own whole life, i would be paying the middle man but with the cash value factor, i can leave my family the proceeds w/o the headaches of property taxes,insurance and association fees…And if i lose my job it seems that missing a payment on my insurance and rent seems less risky than missing a payment on home, taxes, association fees and home owners insurance.
I understand there are tax benefits w/ owning a home but paying taxes, association fees and insurance on a home I feel is lot more in the long run than what i would pay for whole life and monthly rent payments…and there is no guarantee that home values will go up or down…With Whole Life its not going to give me much but its better than the risk of property value going down.
So am I making a valid argument? what do you guys think? own a home and get term or rent a home and buy Whole-Life?
Thank You!
If you’re going to live in the same house for a long time, you’re almost surely better off buying it than renting it. Think about it. If it were cheaper to rent it than own it in the long term, why would the landlord choose to own it? Real estate isn’t just about appreciation, it also pays dividends. If it is an investment property, you get rent. If it is your own residence, your dividend is the rent you would otherwise be paying to live there. Yes, taxes, HOA fees, insurance and other investment expenses come directly out of the property owner’s return.
After you pay off your home, you also have to buy food. Is that a reason not to buy a home? If you’re still making mortgage payments, there’s a good chance you need life insurance. The cheapest way to get that is to buy term insurance for a term that covers the period when you are paying off your home.
I don’t care what you “feel” about paying taxes, HOA fees, and insurance. Run the numbers and it becomes quite obvious that over the long-term investing in real estate, including your own home, is a better financial move than investing in whole life insurance. It’s not even close. The “return” for my mortgage payments, property taxes, insurance, and maintenance is free rent, the amortization, the appreciation, and the tax benefits (tax break on mortgage interest and property taxes.) So let’s say you own $100K of a $500K home with property taxes of $4000 per year. You’ve got a 3% 15 year mortgage. Your P&I payments are $2755 a month, of which $1762 is principal. You’re in the 33% bracket. You spend 1% on maintenance on average each year. ($5000) The home appreciates say 3% this year. It would cost $3000 per month to rent a similar house. So in year one, your expenses are:
Mortgage payments $2755 * 12 = $33060
Your insurance = $1000
Property taxes = $4000
Maintenance = $5000
Total = $52060
Your gains are:
Amortization $1762*12= $21,144
Avoided Rent = $3000*12 = $36000
Tax benefits = $5252
Appreciation = $15,000
Total = 77,396
Gains minus expenses = 25,336
Divided by your $100,000 investment and you’ve got a 25% return on your money that year. Even if you subtract out $15,000 for closing costs in year 1, you’re still looking at a 10% return on investment. Even if your expenses are a little higher or the appreciation is a little lower you’re still coming out way ahead. Adjust the numbers to your liking, but do run them rather than basing your decisions on feeling.
What’s the return on whole life insurance in year one? I’ll give you a hint, it’s usually something like negative 40%. Now, to be fair, you’d have to add in the costs of term insurance, which is trivial, and make adjustments as you go along. But the avoided rent, amortization, and appreciation go up each year. The returns on whole life do improve as the years go by, but when you consider the primary benefit of owning a home (avoided rent) it isn’t even close.
Only a truly unscrupulous or ignorant whole life salesman is going to argue that whole life insurance is likely to provide a higher return than real estate over the long run.
Below is a great calculator that might help you determine if it is better to buy vs. rent:
http://www.nytimes.com/interactive/business/buy-rent-calculator.html?_r=0
Thx for the info. Actually the salesperson was pretty much saying the same thing you were saying but I had different thoughts based on ‘feeling’. His suggested that if I was going to continue renting due to uncertainty of job security and making payments then I should buy term and for now open a Roth IRA with him or Vanguard to start saving money for home and use the money(10k) towards my home purchase when I am ready from the Roth. This way if I never end up buying a home, the money in Roth keeps growing but if I do,then I can use upto 10k from Roth as well.
He did say if I decide not to ever buy a home then opening up a very low whole-life policy about ($50/month) to lock in the rate w/ additional purchase benefits might make sense for me if I have any discretionary money left over after contributing to a 401k and maxing out roth IRA. The reason for that is if I live till 85 or 90 or more then my term will expired and since I would not have home equity, the whole-life policy has a guaranteed death benefit that comes in handy if the investments in my portfolio are not where they need to be.
Thanks again for the info.
Where do the investments in your portfolio need to be on the day you die at age 90? Seems to me that $0 would be fine.
When he says “might make sense” I agree. It might, but probably not. What he is right about is that there is definitely not point in buying a whole life policy if you’re not already maxing out all available retirement accounts.
This is an awesome calculator. Thank You!
Good to hear from Uptolate…
Yeah my feeling about this is that of course the insurance agents support this wholeheartedly and believe in their gut that this is a great product. After all many of them have a WL policy as well.
But I don’t think for a minute these guys are out there selling something they don’t believe in. They aren’t looking to steal our money…
Everything they know…every fact and figure, comes from their training programs that teach them this is the worlds best thing to do with your money. I’m the large commissions help as well. But when your training pumps you full of this knowledge its only natural that you go out and regurgitate it and try to make a living as well. All the formulas and projections are created and written in their training manual.
And like all investments, I am slowly learning that diversity is all important…dot com burst, real estate tanked, stock market tanked, gold rose, so having your money spread out among different things is probably the best goal. And maybe WL is one of those places you can put your money
Again would love to keep hearing from people who have made this work. near retirement, in retirement…
Agents, have your success stories post here! With so many happy clients I am sure you can rustle up one or two to post their experiences here…
thanks again. and this is a great resource for MDs as we get ZERO training about what to do with our money during residency and makes us ideal patsies to be taken advantage of. No offense to the agents but I think we have to have a healthy level of suspicion…
I absolutely agree that insurance salesmen selling whole life insurance believe they’re doing a good thing. My whole life policy was sold to me by one of the best friends I ever had.
WhiteCoatInvestor:
You said “Divided by your $100,000 investment and you’ve got a 25% return on your money that year.”
My reply: not even close. Your numbers don’t jive with the U.S. census data or the NAR’s figures, which place the appreciation of homes since 1963 at about 5.4 percent annually – of course local real estate figures can vary a bit from national figures.
But let’s say that we’re arguing that homes have gotten bigger – this surely improves the rate of return. We’ve got bigger, more expensive homes now than we did in the ’50s and ’60s. Avg square footage in 1950 was about 983. Now, avg size is 2349 s.f.
5.4 percent annually from 1968 to 2009 is the rate of appreciation quoted by the National Association of Realtors (NAR – so, here we have an organization truly committed to favoring real estate appreciation figures).
But, adjusted for the now-larger homes being built, the cost went up by only 3.7 pc annually (cost per s.f) – that’s your appreciation on real estate. The rate of inflation during that same time was almost 4 and a half percent.
So, 10 percent is wishful thinking, I think. The appreciation is actually negative when adjusted for inflation. But even if you want to throw inflation to the dogs, it’s still only between 3 and 4 percent, on average. Maybe you got lucky and lived in a place where it appreciated 8 percent annually for 20 years. But that isn’t the norm – by definition of “average” rates nationally.
Now, that’s just appreciation. Figure in maintenance, interest, taxes, etc.
Only an ignorant or unscrupulous insurance agent would say whole life appreciates at a better rate than real estate over the long-term? I just don’t think that’s a true statement, and the U.S. Census Bureau and the NARs don’t agree with your opinion either.
You said: ” The returns on whole life do improve as the years go by, but when you consider the primary benefit of owning a home (avoided rent) it isn’t even close.”
You are correct about one thing, it isn’t even close. If you want a high temporary death benefit, a 30 year term will do you just fine. If you want a high lifetime death benefit, a UL with secondary guarantees or a blended whole life will do just fine.
But I know you’re speaking to high cash value whole life. Blended whole life policies with added PUAs do very well in that respect – arguably better than the 3-4 percent that you’ll get from real estate over the long-term because you pay very little in commissions and fees to the agent and the insurer and most of the money gets the benefit of the insurer’s GIA, most of which are earning in excess of 5 percent annually with at least one that I personally know of that’s earning 7. And, if your policy pays dividends, you’re compensated during inflationary times.
There’s just no need to make any of this up when all of this info is publicly available…
Real estate returns are not solely (in fact not even primarily) dependent on appreciation, as discussed here:
https://www.whitecoatinvestor.com/how-to-make-money-investing-in-real-estate/
Figure in amortization, depreciation, and cash flow, not to mention the effects of leverage. I stand by my statement that expected returns on real estate are around 10% a year.
I agree that 30 year term will do just fine if you want a high temporary death benefit and that if you want a lifetime death benefit a permanent insurance product is what you should buy.
Whole life dividend rates are not returns and high inflation will absolutely pummel whole life insurance returns since the lion’s share of the insurance company portfolio is invested in nominal bonds.
WhiteCoatInvestor: Most of the advice in the article you link to doesn’t apply to people who own real estate as a primary residence (i.e. they won’t get cash flow). Additionally, I disagree with how you’re calculating all of this. It’s non-objective.
Finally, if you’re buying it as an investment, you typically don’t do this as a hobby. Well, some people do, but they tend not to make a ton of money without having some type of organization and backing (i.e. a property management company). It’s a lot of work to manage properties. At some point, you stop being a doctor, and you start being a real estate investor. Which do you want to be?
The bit about equity counting as return is a bit of creative accounting. Mortgages on a real estate property being paid off aren’t a “gain.” The loan itself gives the property a negative ROI in the same way that first year ROI on whole life is negative. Not sure why you give real estate a pass on that one but conceptually it’s the same thing…
“Avoided rent” is not a gain. By that argument, I could say, well, “avoided losses in the stock market” are a “gain” when buying whole life. I’m sure you see where that could go…
I’d like to know more about how you calculate the tax benefits. Are you calculating a straight 33 percent or are you actually applying the taxes progressively as we have here in the U.S.?
Whole life dividends are returns. As far as taxes are concerned, they are a “return of premium” until the dividend exceeds the premium. That’s why all policy dividends are taxed when you remove more than your cost basis. It’s true that divisible surplus includes excess premium payments, a return of loan interest paid on policy loans, and favorable mortality experience, but it also includes investment returns from the GIA. But this is a moot point once your cost basis is recovered. By definition, it’s a legit return at that point. I can make that happen in about 4-5 years in many cases.
If you’re counting real estate returns properly, that won’t happen with your home. You’ll be recovering your cost basis for the next 15-30 years, depending on the loan you choose.
High inflation will not pummel participating whole life, unless you’re talking about straight whole life. The dividend rates follow inflation. That’s why 1980s dividends were 10-15 percent and not 2 or 7. That’s also why the dividend study posted at my site shows Mass Mutual’s IRR on its 10-pay north of 6 percent, even after the high interest rates of the 80s. If inflation pummeled whole life as you claim, you’d see evidence of it from the old mutuals on all of their policies – but you don’t.
You stand on your claims, but I have evidence to the contrary. So…where do we go from here?
Avoided rent and amortization surely do count, only a fool would ignore them. Money doesn’t care where it came from, it’s fungible. But if you want to invest in whole life insurance, knock yourself out. I don’t really care. I think it’s absolutely hilarious that I have two prolonged arguments going on on this blog right now and I’m defending real estate investing in one and criticizing it in another. Maybe I should get the two of you together and get myself out of the middle.
The dividend rate is not the rate of return, much as you would like it to be. Maybe this guy’s post will help you understand that: http://theinsuranceproblog.com/10-pay-whole-life-round-up-who-is-the-best/.
Dividends were 10-15% in the 1980s. You could also describe them as 10-300% in the 1980s. But it would probably be more accurate to describe them as 7-11% in the 1980s. http://www.northwesternmutual.com/about-northwestern-mutual/financial-information-and-reports/Documents/294692.pdf See page 8.
Inflation in 1974 was 11%. What were dividends then? About 5%. In 1980 inflation was 14% and whole life insurance dividends were 7%. I have no idea why you think whole life dividends are some kind of inflation hedge. They aren’t. The guarantees provided by whole life are no indexed to inflation. If your guaranteed insurance is $1 Million, and $1 Million today becomes worth $300K in today’s dollars due to inflation, that insurance company isn’t guaranteeing you any more than it has promised. There’s no inflation hedge there. Since long term projected returns going forward are little more than the historical inflation rate, it won’t take much of a spike in inflation to decimate them. Insurance companies don’t have magic investments. They hold mostly nominal bonds, and nominal bonds get hammered by inflation.
Mass Mutual’s IRR on 10 pay is 1.47% over the first 10 years, 4.49% over 20 years, and 5.10% according to this agent: http://theinsuranceproblog.com/10-pay-whole-life-round-up-who-is-the-best/ and that’s only the projected scale. The guaranteed scale is far less. I think describing 1.47% as “north of 6%” a little misleading.
But like I said, I do not care what you invest your money in. If you’re convinced the best possible investment for you is whole life insurance, I’m not going to try to stop you.
Here, I’ll do your readers a favor. Run the calculations using this calculator. It’s extremely accurate: http://michaelbluejay.com/house/rentvsbuy.html#taxschemes
Play with the numbers and remember than appreciation isn’t linear. Depending on what you think will happen in your neck of the woods, you might benefit from owning a home anywhere between 2 and 11 years (or more). If it takes you 2 years to recover your cost basis, that’s probably a good deal right?
If it takes you 10 years, you have some thinking to do.
Well I hold a Realtor’s license as well as an insurance license so my quick two cents is buy a house, but buy it to live in, not as an investment. Don’t buy if you’re planning on staying less than three years (or, better five). It costs about 8% to sell a house so that’s the minimum break even.
Always buy a house that’s easy to sell. Repeat that phrase 10 times until you get it. You can change everything but the location so, yep, that’s important. So’s the school district if you have kids, not just because of education but because that’s who your kids will be hanging out with and you with their parents.
By the time you’ve gotten the custom drapes, remodeled the kitchen, put in a pool, replaced the AC and on and on…after 10 or 20 years you’ll sell it a profit, but not nearly what you think.
Also, the best investing advice I every heard for docs was, “One house, one wife.” Key to your financial success.
I agree you shouldn’t buy a house “as an investment”, but should realize that it pays you dividends in the form of “saved rent” when you consider the rent vs buy decision, which is totally off topic for this thread.
WhiteCoatInvestor: I’m just responding to a point you brought up, off topic or not. I disagree that “saved rent” is a dividend. That’s sort of like saying “saved principal contributions to the stock market” is a dividend for whole life. You don’t count the money you didn’t spend elsewhere as a gain in your current investment strategy.
Realistically, I think the best you could argue is that it is a potential loss avoided – potential because it doesn’t always make sense to buy a home (see the calculator I posted. It’s very well designed).
Everyone would be earning double what they’re earning now if they counted losses avoided as actual gains. And, the IRS would have a field day with you. Only actual gains are gains. Think of it this way: forget the specific asset involved.
Let’s say you had a choice of two assets. You choose one over the other. Naturally, the one you didn’t choose is the one you didn’t buy into and thus didn’t “fund.” There’s no gain or loss there. As far as you’re concerned, what happens to that unchosen investment is irrelevant to your portfolio and net worth.
Should an investor with $100K buy a home to live in or should he pay rent and buy a whole life insurance policy? The first guy doesn’t pay rent. The second guy does. Why in the world wouldn’t you count that in your comparison? I don’t care if the IRS counts it or not. It certainly should factor into your decision whether you choose to call it a “dividend” or not.
Of course it doesn’t always make sense to buy a home. I don’t see where anyone was arguing otherwise.
WhiteCoatInvestor: At one point, you’re saying to consider the fact that one person pays rent (OK, that’s fine. I provided a calculator so readers can do the calculations). Before, you were trying to claim that not paying rent is somehow a gain – it isn’t. That’s not how you make the comparison of rent vs buying.
Of course that is how you make the comparison of renting vs buying. Any good calculator acknowledges that.
The positives of buying (and negatives of renting):
1) You don’t pay rent
2) You amortize the loan
3) You get some tax breaks
4) The property appreciates
5) No increase in rent with inflation
The positives of renting (and negatives of buying)
1) No property taxes, lower insurance, and much less maintenance costs
2) No lost opportunity cost of the downpayment
3) No transaction costs
If you’re not comfortable calling “not paying rent” a gain, that’s fine with me. Tomato, tomatoe.
WhiteCoatInvestor: I agree that you weigh the pros and cons of buying an asset. What I disagree with is that, in your above example, you can legitimately count $36000 as a gain, unless you are redefining what “gain” means. So, for example, if you were accounting for this in your net worth, you wouldn’t add $36,000 to it…
…maybe you mean not paying rent is a “benefit?”
I don’t think it’s a “Tomato, tomatoe” issue. “Gain” means something very specific to most investors.
Yes, you mentioned you disagreed with that several times. I understand you disagree with that.
I absolutely would have $36,000 more in my net worth BECAUSE I DIDN’T SPEND IT ON RENT.
1gain
noun \ˈgān\
: something wanted or valued that is gotten : something that is gained; especially : money gotten through some activity or process
: something that is helpful : advantage or benefit
: an increase in amount, size, or number
I am in charge of all the life insurance reviews (coast to coast) for a very large wirehouse so I feel fairly qualified to opine on this subject.
I have seen more WL polcies in one week than most people see in a lifetime. I break them down and present the facts…good or bad.
I had to stop reading the posts due to the enormous amount of misleading information on how these policies actually work and about life insurance in general. Some info was accurate but most was not (including the original poster’s 8 reasons).
That said, if we go back the the original poster’s message, then I would have to agree…WL sucks! This isn’t so much due to the product (althouh the product can make a huge difference as well) as it is with the agent and the way the policy was designed to acheive an objective/goal of the client.
I stopped counting but if I had to give a % of the policies I reviewed that actually made sense based on the goal/objective of the client, I would say around 7-10%. Keep in mind, I have reviewed thousands of policies. I have the opportunity to actually speak to the client and more times than not they say, (with WL) “I was sold this as a way to fund retirement”, but the design was sabotaged from onset. Hence WL sucks for that client.
Life Insurance Retirement Plans (commonly known as LIRP’s) are what was supposed to be built but the policy was never blended or had any PUA rider (additional rider) or funded properly or even had the loan protection rider attached (some come with and others do not).
While we are focusing on higer income earners in general (Physicians in particular for this thread) and in my opinion the only candidate for a LIRP (high income earners above traditional funding limits). BTW, IUL and par WL are the two most successful products for LIRPS although many of the IUL’s have not yet been proven. VUL real scares the hell out of me and I have only seen a few look decent.
For what it’s worth, I am not a huge fan of WL (or LIRP’s in general) but under the right circumstances, design, product, risk tolerance, time horizon and luck…they can’t be great. Again, 7-10% is what I have seen work.
Also as an FYI: Ohio National, NWM and Mass just delcared their 2014 dividend and the news is good but please do not be fooled by a dividend rate. For example, Mass Mutual declared a 7.1 dividend rate for 2014 but this does NOT mean 7.1% to the individual policy owner.
Work backwards! What is your goal and how long do you have? What is out there that can get me to that goal? Does WL (a LIRP)fit into the catagory of products that can get me there? I heard this once and it made sense: Delaring that a particular product is always a bad is like saying a specific golf club is always bad. Each club has a specific job to do througout your round and may be better designed to acheive success than another at a particular time. If your job is to go 100 yards and land softly – a wedge is likely better than the driver for success. Does that mean the driver is worthless? I have also seen people (pros) use a 6 iron to bump and run from under 100 yards where the wedge didn’t make sense. WL is a tool that can create success you just have to know what you are doing to create it.
So the guy who reviews whole life policies all day long agrees that 19/20 policies are sold inappropriately. I can’t say I find that surprising.
As I parse through this post, I note:
1) “That said, if we go back the the original poster’s message, then I would have to agree…WL sucks! This isn’t so much due to the product (althouh the product can make a huge difference as well) as it is with the agent and the way the policy was designed to acheive an objective/goal of the client.”
So the product is okay, it’s the way it was designed that’s bad.
2) “Life Insurance Retirement Plans (commonly known as LIRP’s) are what was supposed to be built but the policy was never blended or had any PUA rider (additional rider) or funded properly or even had the loan protection rider attached (some come with and others do not).”
A “Blended” policy most commonly refers to a policy that blends whole life with term but I’m unsure how this benefits the accumulation of cash value within a policy unless the goal was to increase the DB so more PUA could be stuffed into a policy with a limited pay product (a 10-pay, for example).
However, over the longer period a WL policy is expected to be held–especially if the goal was for supplemental income in retirement–the addition of PUA is not that significant. For example a 35 year old who funds $12,000 a year for 30 years in base premium vs the same guy who funded $12,000 split $6000 base and $6000 PUA will show a difference of about 5% in cash value at the end of the period. I’m not knocking 5%, but it’s not as though the success of the funding depended on it. I always like to add PUA to a policy, but that’s how I like to design.
3) ” BTW, IUL and par WL are the two most successful products for LIRPS although many of the IUL’s have not yet been proven. VUL real scares the hell out of me and I have only seen a few look decent.”
Indexed Universal life has too many moving parts–cost of insurance can change, performance caps, crediting methodology, unrealistic illustrations leading to underfunding–and Variable Universal Life is worse. Think about it: If it’s such a good idea to use equity performance for your funding, why don’t the insurance companies do the same thing? Whole Life is the best vehicle, and WL from a mutual insurance company like Mass Mutual, The Guardian, Northwestern and NYL are the best.
4) “Also as an FYI: Ohio National, NWM and Mass just delcared their 2014 dividend and the news is good but please do not be fooled by a dividend rate. For example, Mass Mutual declared a 7.1 dividend rate for 2014 but this does NOT mean 7.1% to the individual policy owner.”
Of course a dividend rate is not an interest rate. But, all things considered, a higher dividend rate is better. I expect dividends to increase in coming years as interest rates creep up.
5) “Long paragraph using golf analogy”
Well, yes, of course you should clearly define your goals and look at options. Be skeptical of anything that sounds too good to be true. And look both way before crossing the street.
Two quick comments about dividend rates and interest rates:
1) I’m not convinced that interest rates are going up any time soon.
2) I’m also not convinced that the effects of these low interest rates these last few years have already shown up in whole life dividend scales. Their dividend is a bit of a black box, coming (presumably) from the returns of their portfolio (mostly longer-term nominal bonds), mortality credits (i.e. overpaid insurance), and surrender fees from other policy holders. It would not surprise me to see dividend rates continue the gradual downward slide that they’ve been on since 1985.
Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, chaired President Ronald Reagan’s Council of Economic Advisers from 1982 to 1984, disagrees with you regarding interest rates. The Fed, through “quantitative easing” has kept them artificially low for years.
Dividend interest rates mirror that of bond rates, but they weathered the lost decade in the market rather well (2000 thru 2009).
http://www.project-syndicate.org/commentary/the-sources-of-upward-pressure-on-us-interest-rates-by-martin-feldstein
First, I don’t like the term “lost decade.” Most of my investment horizon has been in the “lost decade” and it certainly wasn’t lost on me. Although US large caps had a rough time, lots of asset classes did just fine.
Second, the term “lost decade” generally applies to stocks, not bonds. Of course bonds did well at a period of time that stocks performed relatively poorly.
Third, neither Martin Feldstein, nor anyone else, knows where interest rates are headed in the future. I agree the Fed has kept them low for years. What I disagree with is that you can somehow use that information to predict the future. Of course some vague prediction like “interest rates will go up in the future” is highly likely to eventually be true, but it isn’t actionable information. People have been talking about rates going up for 4 years now and what has happened? They’ve gotten lower and lower.
Last, whole life dividend interest rates do mirror bond rates, but typically with a lag of 2-4 years. Since rates have been very low for the last few years, I wouldn’t expect whole life dividends to start rising anytime soon. This year’s relatively stable dividend rates (after years of dropping) are likely more a result of outperformance of the small chunk of insurance company portfolios invested in stocks, which have had a fantastic last 4 years. We’ll never know, of course, since the source of whole life dividends is essentially a black box.
When people refer to “the market,” the most generally accepted index is the S&P 500, representing 70% of the value of U.S. stock markets. A return of -1% over that decade would define lost decade to me.
This comes from someone who has been invested in the market since 1988, by the way.
Well, I guess you have the right to define “lost decade” and “market” any way you please. I don’t agree with either of your definitions. Not to mention the whole concept of a lost decade is completely cherry picked. If you use 2001-2010 instead of 2000-2009 you get 1.3% instead of -1%. Going to 2002 to 2011 you get 3%. Go from 2003 to 2012 and you get 7% per year. Use 1998 to 2007 and you get 6%. And that’s just looking at a single asset class.
I can say this for whole life salesmen. They are persistent. They will keep arguing with you until you either buy a policy or get up and walk out. I had an email this week from a resident who went to a “free” meeting with a financial adviser sponsored by the hospital. After 2.5 hours of arguing with the “adviser” about whole life the light went on and he stood up and walked out. He realized the salesman was not going to stop arguing. When a commission might be tens of thousands of dollars, it’s worth hours of arguing to get it. The conversations on this thread remind me of that. You might argue for a little while about this aspect of whole life, then a while on that aspect, then you’re off talking about real estate, then you’re arguing about the lost decade etc etc etc. The only way to “win” is to get up and walk out. Lots of heat, very little light in the last 100 comments.
I don’t deny that you can make positive gains in the “market.” But you have to be willing to be in for the long haul to do so if you take into account the cyclical nature of said market. We could go on all day “cherry-picking” time slices.
By the same token, buying WL is for the long haul as well (although it works spectacularly well if you die in the early years!). Devoting a portion of your investing income into WL and having the WL fully offset by retirement age makes everything work better and I can show you how.
“I can show you how” sounds like something off a Saturday evening paid radio spot. Why not just show me how instead of telling me you can do it?
Gosh, that was illuminating.
WhiteCoatInvestor: Nice definition of gain. Clearly I was talking about the context of investing. I even said “very specific to most investors”.
You said: I absolutely would have $36,000 more in my net worth BECAUSE I DIDN’T SPEND IT ON RENT.
My reply: You’re right. You didn’t spend it on rent. No, you don’t have the $36,000 from not paying rent. It goes to your mortgage.
No, most of it goes toward amortization of the loan. I’ve still got it in the form of home equity. That increases my net worth. Some of it goes toward reducing my taxes via the interest rate deduction. Some of it goes toward paying my property taxes (also deductible) and insurance (deductible on an investment property). It’s very different from going toward rent.
Seriously though, this entire discussion is off-topic for this post and I’m about to delete the entire thing. This thread is on whole life.https://www.whitecoatinvestor.com/wp-admin/edit-comments.php#comments-form
WhiteCoatInvestor: Nice definition of gain. Clearly I was talking about the context of investing. I even said “very specific to most investors”.
You said: I absolutely would have $36,000 more in my net worth BECAUSE I DIDN’T SPEND IT ON RENT.
My reply: You’re right. You didn’t spend it on rent because YOU SPENT IT ON MORTGAGE PAYMENTS. So, you don’t have the $36,000. Asset. Liability. Pretty basic accounting there…unless you’re living in your car?
You said: So the guy who reviews whole life policies all day long agrees that 19/20 policies are sold inappropriately. I can’t say I find that surprising.
My reply: He said 7-10%, which admittedly isn’t a great number either. He also said a bunch of other things you conveniently ignored. So, for example, a lot of it is agent education and the way they design the policy. He also said: “Some info was accurate but most was not (including the original poster’s 8 reasons)”
You said: I think describing 1.47% as “north of 6%” a little misleading.
My reply: No, it’s not misleading. I specifically referenced actual policy performance from the Mass study. You reference…an illustration these guys did which isn’t meant to predict policy returns. It actually says that right on the illustration if you read it.
The article you linked to about the 10-pay also says this: “The evaluation here was merely to look at what carrier products performed the best for cash value and death benefit given a pretty narrow scenario. It’s a starting point, not an ending point.”
Maybe you didn’t read down that far…
I think you’re just doing backflips to support your preconceived notions. I get that you don’t like WL. There are some bad things about it that you never touch on. No need to make stuff up or misrepresent data.
Please enlighten us to the “bad things about whole life” that I haven’t even mentioned. I’m sure readers will be interested.
Here is a policy I just reviewd for a physician. Female 43 rated Preferred Best (of course Preferred Best…why not since less than 10% reeive Preferred Best, but it makes the illy look better).
$2,000,000 face
Base WL 99 -$27,620 (no blending, just all WL)
PUA rider – $100 ( really, only $100 extra PUA rider…OK!)
PUA waiver of premum on $100 rider – $4.25
Waiver on base premium – $1,280
Total premium – $29,004.25
The illy runs out to age 100 NEVER showing an income (why else be in a WL contract unless taking the tax free income at a certain point for a certain # of years? Otherwise, they paid a whole hellaofalot per year for $2mm DB.)
Draw a line in the sand when premiums will stop and income starts. For example, starting max withdrawals at age 65 lasting for say…20 years. They illys are absolutely pointless until tehy show INCOME…remember this is a LIRP.
At age (beginning of age) 65, this Physician had paid in $360,705 with a total cash value of $981,985 and a total DB of $2,708,796. I do not care what the illy reads after this date until I see a withdrawal column. She paid for 22 years and wants to supplement her income. So whats say you on the IRR?
I think I came up with about 2.7%.
Also, people want to mix apples and oranges when comparing WL to equities – please dont! These WL LIRP’s are (IMO) DEFINED BENFIT PLANs not DC’s. Think of these WL LIRP’s as a PENSION and the IRR is going to be more closely related to fixed income portfolios (income tax free -hopefully). If properly desinged, we could get this closer to 6% IRR after 22 years not 2.7% (changing carriers and desing of course). If you want market risk and want to do better, dont do this strategy. If you want a PENSION consider this product/strategy only after it has been designed properly to acheive the desired pot of money. You are not buying this for DB, so please take into consideration that I strongly suggest a term to cover the need until it is no longer needed. This of course, will lower the net amount you should use -lost opportunity cost to compare against BTID.
I gave this a proposal an F…actually an incomplete – no grade. Again, they can make sense if you are interested in a DB and want to avoid market risk.
To make some points on an an earlier posters comments:
“Whole Life is the best vehicle, and WL from a mutual insurance company like Mass Mutual, The Guardian, Northwestern and NYL are the best. ”
Some times they are but I often see these carriers toward the bottom for income solve. The above physician case was Guardian by the way (2.7%)!
They CAN work but way too often they are designed so poorly.
WCI- I really like your thread. Although I do not agree 100% with you on some of your life insurance and annuity idealogy (maybe closer to 50%), I think you foster a great enviornment for honest debate and education. Keep up the good work.
If you want a pension, why buy whole life? Why not just buy the darn pension? This is a need that a SPIA fills far better than a whole life policy.
Are you suggesting you buy a PENSION via a SPIA – not sure you meant that. Are you talking about buying or opening a Cash Balance Plan or another type DB plan? OK – but income is fully taxable. I do like the ROTH 401k (if available) but still has limits on contributions.
How did you get the final pot of money to buy a SPIA? What terms are you suggesting in the SPIA? Life only, Life with X-certain? Period certain only? I think you will find SPIA’s to be very poor right now but things change. Also, Exclusion ratio vs. tax free.
SPIA’s can be great for sure but you need to get to tht magic # to turn on the SPIA/PENSION. How did we get there? You invested in what…equities? this is not the same thing, totally different, can’t compare WL to outside investing. If you want exposure to markets – don’t do this. If you want to fund a future PENSION conservativley, then this MAY make sense. The only way to tell is to run the numbers.
Here is a scenario to compare against:
Accumulation Period: A $10,000 annual premium paid until the insured reaches age 64 (25 Premiums) then a maximum
income stream calculated from retirement to age 85 (20 years).
$250k paid in. Cash value at age 65- $489,421 / Tax free Income for 20 years – $37,380 ($747,600)
(*Best quote used)Now if you wanted to buy a 20 year period certain SPIA at age 65 (todays SPIA rates) you would need a lump sum of $554,856 (non-qualifed to be fair) to generate $37,380 and $9,644.04 would be taxable. If you only use a 20% tax rate, then you would net $35,451 from the SPIA. To get it closer to the life PENSION, you would need a lump sum of $593,681 – it would net $37,936 from the SPIA. Your 25 years of $10k would need to earn 6%. Plus the life insurance will still provide $175k+ in death benefit after distribution is over.
And remember I am only using 20% tax so if higher, then the SPIA looks worse.
* I wouldnt recommend Life only but would consider Life with cash/installment refund but the income would be lower but may last longer than 20 years
If 6% is easy, then dont do this but if you are conservative then it may be an option.
You need to reach a magic # to trigger a PENSION during your accumulation phase – so what vehicle are you going to use during accumulation phase?
I agree that whole life is a conservative option. The problem is that it is TOO conservative an option. What is the goal during accumulation? To grow your assets. If you already have millions you can take a conservative approach. But you know what, I know very few people that already have millions at 30, 40, or even 50. They need their money to work as hard as they do. Returns of 2, 3, 4%, perhaps even 5% if you have a lot of faith in the future performance of whole life just isn’t going to cut it against the historical inflation rate of 2-4%.
This is exactly the main problem with whole life. It is too conservative to meet the accumulation needs of most investors. So yes, I would suggest investing much more aggressively, using stocks, perhaps tempered a bit with bonds, and real estate. Then, as you get older and want to buy a pension, purchasing a SPIA, or perhaps a series of SPIAs to provide a floor of guaranteed income in retirement.
And no, you don’t buy a SPIA with bells and whistles. You pay a single premium, and they pay you a certain amount each month until the day you (or you and your spouse) die. That’s the SPIA I’m talking about. No guaranteed periods.
You invest in standard investments during your accumulation period, you cover the catastrophe of dying before acquiring a large portfolio with term insurance, and then in retirement you spend money from Social Security, your SPIA(s), maybe some investment real estate, and a portfolio of stocks and bonds. Voila, no permanent life insurance needed.
I see a cash balance or defined benefit plan as a separate issue. I’ve got a defined benefit/cash balance plan. I stuff a bunch of money into it. When I leave my employer I can convert it to an IRA. I can then either invest it in standard investments or buy a SPIA with it or any combination of the above. There’s no rush to buy a pension since the deal only gets better as you develop health problems and get older. If interest/SPIA rates seem to suck when you’re sixty, you’re free to wait until you’re 65 or 70 if you like.
So I guess I agree with you. You CAN’T compare risky investments likely to significantly outpace inflation (like stocks and real estate) to conservative investments (like whole life insurance.) The difference in return is just too big to ignore.
So let’s take your scenario, which as I understand it is $10,000 a year for 25 years then a maximum income stream for 20 more. Let’s assume a portfolio of stocks, bonds, and real estate makes 8% a year. So after 25 years you have $789K. A pretty typical looking whole life policy over that period of time would have an IRR of 2-4%. Let’s give it the benefit of the doubt and call it 4%. So you’ve got $433K. Now you can do whatever you please for the next 20 years, but the whole life investment is never going to make up for the fact that it has to start the distribution period with 45% less money because it simply didn’t grow fast enough during the accumulation period.
And your idea of paying 20% taxes on $37K in income is bizarre unless there is a whole lot more income coming from somewhere else, or a high state tax. I calculate out the federal tax bill for a married couple taking the standard deduction as less than 5%.
At any rate, as I tell everyone else, if you are content with the low expected returns of a whole life policy, and willing to hold it until death, then go for it. I mean, is it better than a savings account? Sure. Is it probably going to be better than buying treasury bills and short term bonds at today’s interest rates? Probably. But I don’t see any of those as the right portfolio for the typical person trying to save for retirement.
WCI-
I think we agree that if you are bullish, then go equities and not WL.
Regarding SPIA’s:
“And no, you don’t buy a SPIA with bells and whistles. You pay a single premium, and they pay you a certain amount each month until the day you (or you and your spouse) die. That’s the SPIA I’m talking about. No guaranteed periods.”
As far as the SPIA, are you suggesting that you buy the LIFE ONLY SPIA? So what happens if you die shortly after you purchase the Life only SPIA – the company keeps everything. Sorry kids, I wanted to gamble…I paid $500k for this SPIA and only received $45,000. The company won that bet big time…or is that a risk you are willing to take – that you outlive the mortality tables.
As far as the SPIA tax rate of 20%, I was suggesting that it was your overall income tax bracket, not just on the exclusion amount. If you are only pulling in $37k, this thread would have never been started and you have bigger problems. I was taking everything into account and figured your tax bracket. The SPIA had an exclusion ration that is taxed at ORDINARLY INCOME – I used 20%. Is 20% too high – then you are broke in retirement or give a lot to charity.
I don’t think you have to be very bullish to assume equities are going to do better than 3-5% nominal on average over the next 50 years. If equities do that poorly over that time period, then you’re likely to end up with the guaranteed rate from the WL company anyway, assuming they can stay in business. That’s around 2%. Seriously, you’ve got to be pretty pessimistic to think equities aren’t going to do better than 2% over the next 5 decades. Might as well buy bullets and canned food in that scenario.
Heck yes I’m suggesting buying a “life only” SPIA. If you die shortly after you purchase it, then yes, the company keeps everything. It’s insurance against running out of money. Just like if term insurance doesn’t pay out because you lived too long, there’s a cost to that. Insurance isn’t free. That’s why you don’t buy insurance you don’t need. You obviously don’t put money into a SPIA that you’re planning to give to your children. I don’t care what they think of my financial decisions, IT’S NOT THEIR MONEY. In fact, it might not even be their money when I die. I may leave it to charity or something.
If 20% isn’t too high you aren’t broke in retirement. That’s silly. Give me a break. You can have lots of income without ever getting to a 20% effective tax rate. I don’t have a 20% effective tax rate on a physician’s income now. 401K/IRA withdrawals are also taxed as “ordinary income”. That sounds like some kind of weird scare tactic to throw that out there. How much income can I have without paying 20% in taxes? Let’s see. First, let’s assume I’ve got 1/2 of my money in Roth accounts and 1/2 in tax-deferred accounts (incidentally about where I am at right now.) Now let’s assume the standard deduction and two exemptions. So, your first $12,200 + $3900*2 withdrawn from that IRA is taxed at 0%. The next $17,850 is taxed at 10%. The next $54,650 is taxed at 15%. Right now the effective tax rate on that $92,500 withdrawal is less than 11%. If you’re also taking out $92,500 from the Roth account you’re now at $185K, far more than I need to have a very comfortable retirement. But wait, there’s more. How high can we go before we get to a 20% rate? We can take out another $73,900 out of that 401K at 25%. The effective tax rate now is $17%. Including the Roth withdrawal, we’re now at $332,800 withdrawn from retirement accounts without paying 20% taxes on the 401K withdrawal. We can take out another $76,650 at 28%. If we took it all out, that would finally raise the effective tax rate on the 401K withdrawal to 20%. Matching it with a Roth IRA withdrawal, that leaves a total retirement income of $486,100 with a tax on the 401K withdrawal of 20%. Since most retirees never save enough to support a withdrawal that large throughout retirement, it stands to reason that most retirees will have an effective tax rate lower than 20% in retirement. Obviously pensions and SS affect that some, but even so, you can have lots and lots of retirement income without hitting 20%. The idea that you’re “broke” in retirement if your effective tax rate is less than 20% is kind of silly, don’t you agree?
I have a couple of questions/observations about your scenarios:
1) If you’re mid-30s, do you envision remaining fully invested in equities for 50-plus years? Or do you plan to gradually shift to a more conservative allocation as you grow older and near your goals?
2) What if you’re starting in your 40s or 50s? Does that change matters?
3) If you’re married, would you choose a SPIA upon retiring that, if you died early, provided no income to your surviving spouse?
4) You’ve advocated for equities. You’ve advocated for bonds. I don’t believe that you’ve advocated for a 100% allocation in either. Yet, when WL is suggested as an allocation, you’ve derided it as being too conservative as if the WL is the entirety of the investment allocation? I’ve been pretty consistent in advocating 20 to 25% of your investment dollars to WL and, in fact, the IRR is very bond-like if you wish to view it that way and it has its inherent tax efficiency as well.
1) What do you mean “fully invested?” I’m not “fully invested” now if you’re referring to a 100% equity portfolio. Here’s where the whole life salesman recommends replacing your bonds with whole life insurance. The problem with that approach is that it defeats two of the purposes of holding bonds. First, it’s harder to rebalance a portfolio where one of the asset classes is whole life. You’ve now got to take a loan and pay interest just to rebalance your portfolio. Second, some people may not look at their life insurance as part of the portfolio like they would bonds, so the volatility may get to them. The real question you’re asking here is should whole life be an asset class you include in your portfolio. I think it shouldn’t. It’s characteristics as an asset class aren’t particularly attractive in my view. But hey, you want to invest in whole life for 50 years, knock yourself out. There are dumber things to do with your money.
2) Matter to who? And in what way? I have no idea what you’re referring to. Are you suggesting whole life becomes a better investment as you get older? This is an investment where your expected return for the first 10 years is pretty much zero. That doesn’t seem like it would become MORE attractive as you get older.
3) Would you? Do you have something against your spouse?
4) That’s not a question just because you put a question mark at the end of it. 🙂 I know you consider WL an asset class worthy of inclusion in a portfolio. I disagree.
Disclaimer–I’m a Guardian agent (and Mass Mutual and myriad other carriers as needed), but I know Guardian really well.
1) Your premium is correct at $29,004 but then you show total outlay of $360,705? Simple math shows this is 12.5 years of funding which would take her to age 55.5, not age 65.
2) So let’s take her to age 65. Total outlay is now $665,814 (paying 23 years). Her CV is $1,062,065 and her DB is $2,777,907. Policy is completely offset, no further premium needed.
3) She now has options: A) Do nothing, and let this be legacy funding for her children. She dies at age 85 with $3.6 million tax-free to beneficiaries; B) she takes immediate income from age 66 to 85. Tax-free income is $63,968. At age 76 her outlay is actually negative. She dies at age 85 and leaves $1 million in tax-free death benefit; C) at age 65, she now has the freedom to spend down other assets at an aggressive rate knowing she has this as back-up. Rather than taking a 3 or 4% “prudent” spend-down, she spends at 5 or 6% over a 15 year period. At age 80, she’s in great health and now uses her WL as supplementary income and the solve is $148,644 tax-free from age 80 to age 94 and she leaves 1 million tax-free to heirs.
The 2.7% IRR you note is at policy year 18. This is a long-term solution and at policy year 30, the IRR is 4.1%.
But–all illustrations do is show HOW it can happen not WHAT will happen. Are dividend rates low now? Yes. Are SPIA rates low now? Yes. Will dividends and SPIA payouts increase in the future? Very likely–Janet Yellen today said she would keep rates artificially low through “quantitative easing” until the unemployment rate, now at 7.3%, dropped to 6.5%. What do you think that will do to the stock market and the bond market?
Another observation: you think that only having $100 PUA rider was a bad design. Well, the opposite would be to fund to the MEC limit, agreed? Let’s say she had a million base and the rest was PUA and WP. At age 65, her CV would be $1,123,802 instead of $1,063,320, a difference of 5.7%. Now, I don’t knock 5.7%, but it’s not critical to the successful implementation of this policy (and she would have had less death benefit from age 43 thru age 65 as well). With a $100 PUA, she has the opportunity to dump in unscheduled PUA–bonuses, inheritance, salary increases–without any further underwriting, up to the MEC limit. Not a bad strategy.
Beginning year 65:
Paid in – $638,094 ($360,705 was the cash value of adds)
Cash Value – $981,985 (DB = $2,708,796)
Illustration did not show any income. I am less concerned about IRR than I am about income solving.
waiting till age 70 to turn income on:
Paid in – $776,694 (premium reduced to $27,720 from age 65-70)
Cash Value – $1,424,088 (DB = $3,084,121)
Again, no income solve illustrated. I want to see income under a few scenarios, change plan desing to give options including blending:
You and I both know that the higher cash value doesnt alwasy equate to highest payout within WL from carrier to carrier. Carrier A might have a higher cash value at age 65 or 70 than Carrier B but provide less income under certain solves. How does this Guardian compare to Penn or Ohio for income at age 70? How does it look when blended way down and max PUA rider
for income at age 70?
My point is to be able to compare all available option for the client based on their goal/objective. The provided illy was incomplete and thus a misleading sales piece since client wanted alternatives for retirement planning.
Then you should ask the agent for those solves. Incomplete is different from misleading.
One point you don’t make but should when considering income is whether the loan rate is variable or fixed. The Guardian loan rate is 5% after 20 years AND after age 65. Direct recognition actually lowers that effective loan rate into the 4’s. It’s important because to preserve tax-free income, the solve is to basis and then borrowing from the insurance company.
By the way, in my post above, I did show income solves–it’s not hard to do, just ask the agent.
“Incomplete is different from misleading”
Not to me.
Hmmm, so you suggest sitting down with an adviser for an hour, he gives you a solution and that’s it. Good or bad.
It doesn’t work that way, Brian. You sit down, you find out what’s important, you don’t rush to a solution, you organically work through the process until everyone is on the same page. It may be two, three, four meetings or more. Ask. Refine. Test. Refine. Solve. Revisit regularly. It may take a month, it make take 5 years.
This is all very interesting. Lot’s of info on what is an investment and insurance and such, whole life, universal, variable life and term. There is actually no difference, it is all term packaged in different ways. Age and the amount of coverage play an important role in the design of the plan the fits each buyer of insurance. The key is the options and flexibility the purchaser has in the future. Low cost term is convertible to usually high priced badly designed products… Anyone can jump into what looks good and costs the least today. It all comes down to what are your options in the future. Whole life is just decreasing term with a reserve of your own cash to offset the difference. And the one design to be very careful of is the guaranteed universal life products. The are only high priced term with a name that does not match.
Guaranteed no-lapse universal isn’t “high priced term”, it would be better described as low-priced “whole life.”
Ah, we agree. Universal Life with a Secondary Guarantee means the insurance will never lapse as long as you pay your premium. It’s possible to design it as a ten-pay which works well for estate planning too.
But, the kicker is that if you don’t pay your premium, it WILL lapse. You should compare a WL-term blend to see if that works better for your needs.
Heaven forbid, insurance that lapses if you don’t pay the premium. Pray tell, how long does a whole life policy last if you don’t ever pay the second premium. There’s no magic insurance product out there that you can just quit paying the premiums on and expect nothing bad to ever happen. Whole life just pays its own premiums out of your cash value when you quit paying. You can do the same thing and likely have more money to pay the GUL premiums out of your investment account. All that said, so few people need a permanent death benefit that these are products hardly anyone needs anyway.
Its always funny when people try to knock whole life insurance – the simple fact that you WILL die means you need insurance until the day you die in order for it to actually pay off.
What does term do?
Provides a safety net young people who don’t have a lot of assets built up but have long term obligations – young children, new homes, cars etc. Should they die their family would be hurt financially. So term is a low cost safety net for those obligations in the SHORT run
WHOLE life is just that – your ENTIRE life. Have you looked in to term life insurance for say a 60-70yr old man? Ask them how much that costs lol
WHOLE life is priced knowing you will die – that’s not an IF its simply a WHEN.
So how much will a whole life policy pay out when you finally die? Much much more than you ever paid for it. Many policies have an average of 5.5% with dividends reinvested – tax free to use before death and tax free to your heirs after death – no limit
Term insurance is a short term band-aid to a LIFE long problem. Agents can sell both – all of them would sell you term if you asked for it – those looking to protect you your entire life will offer you WHOLE life so you are protect until death, which we all know will come.
What will term do? Rise in cost? Yup – Pay you back? nope – at best a return of principle which is basically an interest free loan to the company lol
Term is just straight insurance and may or may not pay out – Whole life pays out EVERY TIME – so it has to be more expensive because everyone knows you WILL die lol There is no maybe there.
The Whole life is a guarantee – tax free growth, tax free use because its INSURANCE – not an investment
Should it be your driving retirement vehicle? No
But its a safe place for the money you HAVE to have when you retire. Safe, steady, consistent growth. The insurance company is taking on all the risk – you are paying them for that – the price you pay is whats agreed to meet whatever dollar amount YOU set.
If you agree to 500k and die next year – you think your premiums can offset that? Knowing you will die and agree to protection to death how much money will need to be collected from now until you die to offset the GUARANTEE of 500k?
The policy is for protection – You can easily do a mix of both to find a balance and upgrade your whole life policy over time as you make more money and can afford PERMANENT insurance vs Term – term is temporary insurance that will go away – whole life is just that – there till you die.
Trying to say a temporary fix is better than a permanent fix is always hilarious – when the temporary fix goes away and that person dies what happens? No protection
How much protection someone needs is personal – getting that level of protection is always cheaper with the temporary fix because the odds are against someone dying young.
You also age and develop health risks. Try getting term once you have medical issues.
If you take out a whole life policy at 30 vs a 10yr term and then develop health issues near 40 – do you really think term will still be “cheap” lol Your whole life policy will not change at all.
These are the moving targets of life and since no one knows what health issues may come (which effect your insurance rates) its nice to know a policy will remain the same even if you develop cancer. Do you think a term company will re-new when you have been diagnosed stage 4? Sorry – better luck next time
Will the money you saved by going term matter when you cant get a new term policy anymore and you have no life insurance close to dying?
Things to think about
Welcome to the blog Sergio. Have you been selling whole life insurance for long? You might want to read through some of the comments above before repeating the same old tired arguments for whole life that have been thoroughly debunked above.
You are correct that term insurance is for a specific term. A wise investor insures against his death until his portfolio can cover that need. For most docs saving 20% of their income from the time they leave residency, that term should end in their 50s, and 20-30 year level term insurance bought around age 30 is exceedingly affordable, unlike whole life insurance.
You are also correct that a typical investor in possession of a whole life policy will get more from that policy than he ever paid into it, particularly if he dies just after paying the first premium, but even if he dies at his life expectancy. Unless you count inflation. And the time value of money. And you assign some kind of a reasonable return for tying up that money for decades to that time value of money. In that case, the investor is likely to do poorly when compared to a “buy term invest the difference scenario.”
I agree with you it should not be a retirement vehicle. And since there is no need for the vast majority of investors to have a permanent death benefit, there is really no need to buy whole life insurance…at all.
I agree you are paying the insurance company to take on some risks, but unfortunately they’re not going to take on perhaps the most important one, that your money doesn’t grow fast enough to meet your financial goals. In fact, they essentially guarantee that you will not be able to overcome that risk.
I’m surprised you don’t know how to calculate how much money you’d have to put away to guarantee $500K at your death, whenever that may be. Why don’t you go ahead and run an illustration for a no-lapse guaranteed universal policy on your computer? Then you’ll know.
You say you can do a mix of term and whole life. That is true. But since the whole life serves no purpose, the ideal mix for the vast majority is going to be 100% term, 0% permanent. Upgrading the whole life policy is even sillier than buying it in the first place.
Trying to say a temporary fix is better than a permanent fix to a temporary problem isn’t hilarious, it’s just the truth. What’s hilarious is that insurance salesmen keep showing up on this webpage making themselves look bad by repeating the same old drivel taught to them by their employers in their training (which is 95% sales, and 5% financial.)
I agree that buying a 10 year term for a 30 year need is silly. I also think buying a 100 year term for a 30 year need is silly. So are the scare tactics you employed at the end of your lengthy comment. A wise investor with a well-thought out investing plan and adequate term insurance is covered whenever he dies. If he dies before the portfolio hits escape velocity, then the insurance pays. If after, then the portfolio meets those needs. There’s no reason to let an insurance salesman terrify you into buying something you don’t need, like whole life insurance.