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. ]
Kathy above mentioned about DFA funds and someone responded that you have to watch out for AUM fees which I think is very wise. There are however, a few firms out there that charge flat fees for their advice and management. I have been using one of them for a few years and have been very happy with it and with its low fees. I have a portfolio of (mostly) DFA and (a few) Vanguard funds that have done well. Google DFA advisors and find these firms if you are interested. Merriman has a good site on DFA for education (fundadvice.com) and I have used Cardiff Park Advisors for my advisor (flat fee). There is also low fee only advisor named Evansson and his website has good, but very technical information. I just found this website have enjoyed all the information on it. I’m so glad that WCI is providing this kind of financial help to us docs.
Lawrence while im in agreement with you (except for people with a permanent need), that wouldnt make as much money. If im not mistaken the majority of policies still sold are permanent. The industry is such that there is no accountability for improper advice.
In my practice, I sell much more term life insurance than I do permanent for the reasons I mentioned. Nothing upsets me more than meeting with a potential client that has a small amount of Whole Life along with a small amount of term insurance when, clearly, the need for insurancewas much greater and the only one that benefitted from the coverage being structured the way it was – was the insurance agent.
I guess the way that I see it is that volume is a substitute for pressure and if I am providing a high level of service and putting the interest of my clients first, I will always be rewarded either by repeat sales, referrals to their friends and colleagues or both.
Another reason that potential clients need to do their homework in order to make an informed decision and not go on good faith alone.
I imagine you can make just as much money selling a $500K term policy as a $20K whole life policy.
You know the answer to that one – Not at all.
However, in the time that I would spend speaking to the client about Term, Whole Life and all of the other variations, answering a ton of questions I probably could have written 5 disability insurance policies along with the term insurance and been in the same, if not a better, situation financially – and the doctors would feel very good about their purchase as oppossed to questioning it for their lifetimes (and mine for that matter). This is just my opinion based on experience. I am sure that many others in my profession do not share this viewpoint.
and the doctors would feel very good about their purchases as opposed (typed too fast) to questioning it for their lifetimes (and mine for that matter).
I am current medical resident and have met the financial advisor at my hospital a few times re: various insurances. I have a pre-existing medical condition that likely will disqualify me from getting approved for disability insurance. (Have not applied yet, per my financial advisor’s advise, but he’s made a few calls and is not that optimistic). As he said if I got approved for life insurance, this might help my case when applying for disability insurance. Now I was approved for the life insurance through Guardian, and he’s really pushing me to get the whole life insurance along with the waiver of premium incase I do become disable. He said I should get the whole life insurance, then apply for the disability insurance. And even if I get turned down for the disability insurance, I can then decide to keep the whole life insurance or cancel afterward. Is this something I should consider doing? Or should I just get term insurance regardless, and also apply for disability insurance and see how it goes?
So you’re asking if buying whole life insurance in order to somehow be more likely to be approved for disability insurance is a good idea even if you only need term life insurance? Perhaps some insurance salesmen can comment, but I kind of doubt that it works that way. Guardian probably isn’t the best company to buy term insurance from either. They never seem to be on “the short list” when I personally compare prices, but given your medical history, it might be the best thing for you.Have you compared prices on term4sale.com for your health category?
Also, keep in mind that “waiver of premium” for whole life is not disability insurance. It just means if you’re disabled you don’t have to pay your life insurance premiums. My life insurance premiums for $1.75 Million in insurance is something like $100 a month. So basically it’s like having a $100 a month disability insurance policy. Not quite useless, but pretty close.
Thanks for responding, White Coat Investor! Exactly, I’m not sure if getting whole life insurance is going to help with my application with the disablity insurance, or if it’s just what my advisor says to get me to buy the whole life. I understand the “waiver of premium” clause. I didn’t think it was such a big deal because it at best will save me a few hundred for my term life, or a few thousand for my whole life. But the advisor guy harped on the fact that “the policy is self completing.” He literally said it’s as if I won the lottery to get this clause…really? I was quoted a rate for whole life, with all the clauses for $250,000 coverage for $2,700/year. The rate I was quoted for the term life for 1 million, year to year, starts out at I think $550. I’m not sure if I wanted a 20 year term what the rate is. But that seems high. As after I did all my blood work and met with the nurse, my advisor told me they rated me as the healthiest rating there is. The more I read about whole life insurance, the more I don’t like it. Question though, say I were to buy a max 20 year term life insurance. At the end, do I need to have another medical exam if I wanted to review for another 20 years ? (I know the premium at that point will be significantly higher).
If you think you’ll need more than 20 year term, just buy thirty. It won’t cost that much more. Perhaps $750 or $800. If you’re in the healthiest category, you should get a great price.
You don’t mention your age, but $1 Million of coverage for a healthy 30 year old can be as low as $425 a year for 20 year term and $705 a year for 30 year term.
Applying for Whole Life (or even Term Life) will in no way improve your ability to get a disability insurance policy with Guardian or any other disability insurance company.
If you are a graduating resident, I have the ability to provide you with Guaranteed Issue disability insurance through MetLife. If you would like to chat, feel free to call or send me an email.
Additionally, unless you are taking advantage of your hospital’s 403(b) plan and/or are contribution to a Roth IRA (“Backdoor” or otherwise), I don’t see any real advantage to you purchase a $250,000 Whole Life policy.
However, if you really want Whole Life, you can always purchase term from Guardian, MassMutual, Northwestern Mutual, New York Life and subsequently convert it to Whole Life in the future – but, keep in mind, you will be “overpaying” for the right to do this compared to purchasing coverage from a company that specializes in low cost term life insurance.
regarding Ray’s comments about Bernanke:
Economists & academics are pretty bad at investing. But unlike most doctors, they know it.
I had an extremely smart (& quite pretty) professor of global macro-economics at b-school. All of her money is in her zero-interest checking account. It’s not even in a short-term bond fund or money market.
Given that perspective, maybe economists are better off buying whole life insurance. Especially if they’re worth tens of millions.
And instead of buying whole-life insurance, you’re probably better off buying stock in Insurance companies.
As Buffett said, BRK gets paid 17B over a decade for the plesure of investing 70B of other people’s money and gets to keep the profits!
Living Off Dividends-
Great blog. First time I’ve seen it. Welcome to the site.
The linear extrapolation of compound interest on the investment into a “good bond fund” based on your definition is only correct if you take the investment without the affect of taxes. Taxes compound as does interest and this needs to addressed, a better measure would look at the cash flow. This would normalize what the true cash an individual has at their disposal. Also, if you decide to invest into a municipal bond fund or create a latter of munis, the IRR would still favor whole life in the later years. A would never suggest that whole life is the Holy Grail, for it is not.
The ability for individuals to self insure is limited at best and as an investment practitioner, the company has a whole life policy on life, to which there are the beneficiary. If you have a chance to invest the difference into bank stocks, take a look at their balance sheets. You will see that a JPM, BAC, and countless other banks have a significant portion of their tier-one capital invested in whole life. It is the Federal Reserve, OTS, and the OCC limited what a bank can invest in WL up to 25% of tier-one capital. You need to ask yourself if the banks and c-suite executives invest heavy into WL, it might be appropriate to consider it part of an individual personal strategy.
Taking anything in isolation, be it an individual stock, insurance policy, bonds, real estate, is improper and one needs to incorporate the prudent investor rule. It is important to look at the interconnectedness of ones entire life and how each components works in totality of individual personal policy statement.
pflynnharv-
You’re a little tough to follow due to typos, misspellings, and grammar issues, but I think you’re suggesting that an investor should invest in whole life (well, like most agents you qualify everything as “might”) because
1) Bond fund returns are taxed
2) Most investors can’t really self-insure (although you don’t specify against what) and
3) Bank executives use cash-value insurance policies
Those seem like pretty weak arguments IMHO given the the relatively strong reasons listed above to avoid whole life insurance policies. In fact, I think the second one is patently false, the first one often false (since bonds are generally put into tax-advantaged retirement accounts), and the third one irrelevant to a typical physician.
I did a comparison of VUL life insurance comparing it to putting your money into a 529 and paying the tax at the end with the 10% penalty over 30 years and then collecting a payment for 30 years. For the VUL to be better, you would need to earn approximately 7% on average and have to deal with an effective tax rate of about 50%. Since I have kids, I’ll use the 529 for them and then for the grandchildren, so there won’t be any tax anyway.
For all the complexities of life insurance, MECing the policy, and lapsing the insurance policy, I will hold off for now unless something better comes down the pipeline. Now, if there were no MEC limits, I think the insurance as an investment is a great opportunity for tax free growth and withdrawal. And in the 70s, that is what people did.
I think that Whole Life can be a great product and so can term. It boils down to what the individual needs and how he/she feels about the volatility in the market. Buy term and invest the difference is outdated, the markets over the past 15 years have been so unreliable and unpredictable. If the current tax law changes back (as it is set to do in 2013) then doctors and many others will have a very real estate tax issue. I would also like to comment on the many times it has been pointed out that 12 years with a negative return is bad. If you were buying a whole life for strictly an investment, that would be a correct statement. But the payoff is that you are getting both investment growth and death benefit. Also, the author states that you can invest in the same bonds the insurance company does. True, but you can’t invest the $250/month in them. You have to pay a lump sum OR buy a bond fund which charges fees as well so the Whole life, IMO, is a good way to diversify your portfolio, get some death benefit coverage and invest at smaller amounts in regular increments. Anyone who puts all of their money into WL isn’t maximizing their return, but it isn’t as bad as the author is trying to say. If I were a DR. I would put as much as I could into my 401k/403b plan, at least to the match, fund a Roth IRA (if I were under the income limit) and then I would put some into a WL policy and some into a taxable MF account to properly diversify. That would make the most sense and would give the best hedge against inflation as well as market volatility. BOB OUT!!
BOB-
Buy term and invest the difference is only outdated in the minds of those who make money selling permanent life insurance. Of course the financial markets are unpredictable. That’s why you get paid to invest in them. If they were predictable, you’d get exactly what you get by sticking with very safe investments like FDIC insured savings accounts (less than 1%), treasury bonds (less than 2%), and whole life insurance (negative for at least the first decade.)
You’re right that whole life insurance contains a death benefit in addition to an investment-like component. The problem is that not only is the investment component too expensive, so is the death benefit.
Investing $250 a month into a bond fund is no big deal, especially since many bond index funds charge less than 10 basis points a year to manage your investment. Hardly a significant issue.
And as has been discussed on this blog many times, you don’t need to be under the Roth IRA income limit (a majority of docs aren’t) to do a backdoor Roth IRA.
Please don’t advise your clients to buy cash-value life insurance instead of maxing out their 401Ks and using a backdoor Roth IRA. It’s bad advice. Permanent life insurance is for those with a need for a permanent death benefit. Most doctors won’t need that. Even if estate tax laws change down the road, and if the doctor cannot then qualify for a permanent policy, there are other ways to deal with having too much money.
BTID is the only way to go- there is one life insurance company that ONLY sells straight level term PRIMERICA life- A+ rated by AM BEST- BBB rated – compare on findthebest.com
And PFS investments received the DALBAR mutual fund service award 10 in a row-also money magazine Gold Nova award- NYSE(PRI)
I would also love to add when you do not actually have an insurance policy otherwise you do not take part in any group insurance, you will well reap the benefits of seeking the assistance of a health broker. Self-employed or those with medical conditions usually seek the help of an health insurance agent. Thanks for your blog post.
I have found this blog very informational and one of the best sources of information on whole life since I began researching last month. I am researching whole life after what I feel may have been a poor financial decision. I have a whole life policy that was opened just over a year ago. Now after some research it seems I should max out our 401 k and other investments instead. I believe it may be the best decision to get out, however I am now nervous of making another bad decision. My agent says the best decision is to keep it open. Any advice from this group?
Details are as follows:
– 290,000 death benefit ( which really is not enough coverage for our situation anyway)
– 973 cash value
-339 monthly premium
– the 2012 dividend was 321
– p.s. I already opened a new term 750,000 policy on my husband for ~400/year (33yr male with excellent health)
As I see it my options are:
1 . Close it and lose money ( or to look at it more positively .. I paid for one year of very expensive insurance)
2. Call is paid-up for and have 4,820 for a death benefit and the account would be a MEC ( but would this be an issue as I do not plan to borrow against it ? )
3. Reduce the coverage to 25,000 ( as this is the minimum I was told I could reduce to) and reduce my monthly premium to 29.
Any opinions from this group would be very appreciated!
So you’ve paid $339*12= $4068. It’s worth $973. $4068-973= $3095.
Dave Ramsey would call that a $3095 “stupid tax.” A year from now, your stupid tax will be nearly double.
I’d cash out now and move on (assuming you have an adequate amount of term life in place.) Sometimes, after a decade or so, you’re better off keeping a whole life policy. But not after a year. Especially when you aren’t maxing out the 401K.
What were you expecting the agent to say?
Don’t mix insurance and investing.
Amy-
I think your statement “$290,000 death benefit (which really is not enough coverage for our situation anyway)” should give you your answer.
Putting the possible need for permanent death benefit aside, I am shocked by the number of insurance agents and financial planners that put their own needs first and not those of their clients.
First and foremost, life insurance is not purchased for your benefit, it is purchased to protect your family. Purchasing an inadequate amount of Whole Life Insurance for a substantially higher premium compared to the proper amount of term insurance simplydoes not accomplish this task.
Additionally, until you own your home, max out your retirement plans, fund Roth IRAs (back door or otherwise), fund for you children(s) college education(s), Whole Life Insurance should not even be on your radar.
Changing the policy to Reduced Paid-Up status or lowering the death benefit to $25,000 is meaningless as not only are both amounts too small, the will also be eroded by inflation.
Based on the limited information you provided, you take the little cash value you have and purchase an adequate amount of 20 or 30-Year Level Term, fund your retirement plan and find yourself a new agent.
Consider the lesson you learned worth the price of admission.
Amy n,
I would not recommend trying to fish for free advice on public forums, especially when thousands of your dollars are at stake.
If you act on someone’s advice from here and later find out it didn’t apply to you and you lose lots of money, you’re out of luck. What happens to you is of little consequence to the person whose advice you took…. that is unless you sue them I guess. lol
While I agree you should be skeptical of anything you read on the internet, advice found in “free internet forums” sometimes has one advantage over advice received from professionals- the person giving it isn’t generally trying to sell you something.
If you’d like a professional’s opinion on your whole life policy, you may try this guy (he’s not trying to sell you anything but his opinion):
http://www.evaluatelifeinsurance.org/
For a flat fee of $90 he’ll (almost surely) tell you to cash out your whole life policy.