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. ]
Thanks for the comments. Although calling it a “stupid tax” is a bit offensive. After all if I pay a trained profession to work with me then I expect them to have my best interest at heart. I don’t research the chemicals the lawn guys lay down on my lawn but trust they are doing their job correctly. I don’t have time to second guess every professional I work with. But yes, I am obviously wondering if I was misguided a bit due to someone trying to earn more commission.
I am in the process of seeking another professional’s advice. But that is just one more person’s opinion. Thus I am doing some online research and it never hurts to get a few opinions in the process. After all this forum is all about whole life and I thought I could throw out a real life example and get another perspective.
A couple of things that may have been missed in the feedback …. while ~5,000 is not a large death benefit, it is permanent and will continue to pay dividends and can probably pay for my casket if I make it to 90 🙂
Sorry Amy, didn’t mean to offend. I’ll tell Dave Ramsey to quit calling it “stupid tax” too! Don’t feel too badly. I paid nearly the same amount of stupid tax into a whole life policy. It took me 7 years to realize it was a stupid thing to do. You figured it out in just 1. 🙂
If you’d rather have $5K in 60 years instead of $1K now, that’s okay. But realize it’s the same thing, more or less due to the time value of money, and represents quite a low level of return.
My wife and I both have $100,000 whole life policies from Northwestern Mutual. We have had them for 20 years. Our premium payments are $115/month for each of us. So we’ve both paid in about $28,000 over the past 20 years. Our current policy death benefit has increased to $146,000 and our cash value is $43,000 each. Not bad. We’ve paid in $56,000 over the last 20 years and I can cash out for $86,000 if I want. This policy has been a great savings vehicle for us. Northwestern has exceeded their projections every year and the cash value continues to grow exponentially. According to the projections, these policies will each be worth more than $100,000 in cash value in another 10 years. Not bad. A return of over $200,000 of an $80,000 investment. In this economy, I’ll take that any day.
DJ-
I’m glad you’re happy with your policy and its return. Truthfully, after 20 years, you ARE probably better off keeping it. But you ought to be aware of what your return really is.
You say you’ve paid in $56K over 20 years, so $2800 a year. That’s now worth $86K if you want to cash out. That’s a return of ~4.3% a year. You have also gotten a small amount of life insurance for that price which isn’t worthless.
You shouldn’t necessarily be happy with just getting a return of $200K on an $80K investment. If you invest $80K today, and in say….40 years, that investment is worth $200K, it means you got a return of 2.3%. And if inflation over that period were 3% a year, you’d actually have a negative return. You always have to calculate in the time value of money and other downsides, such as the loss of liquidity and the seriously negative returns you endured in the first 10 years of the “investment.”
I understand what you are saying. I was however, just rounding off to make my point. My actual cash value is projected to be more like $229,000, for an $80,000 investment over 30 years. Not to mention that my death benefit will be much larger, and I will have the ability to stop paying the premiums while the policy continues to increase in value ( although at a slower rate). I would think that running these numbers makes the policy a little more valuable. Also, my $80,000 “investment” was not a lump sum payment, but a small monthly payment over a long period of time which changes everything. Inflation is not as much of a factor then because todays dollars that I am putting in have a lot different value than the ones I put in 20 years ago. I do agree that it takes a long time for one of these policies to be worth it, which is what insurance companies rely on. Most people don’t stick it out for that long. I do however believe this policy has become quite valuable, for me at least. I am now reaping the benefits. Over the next 10 years, I will be putting in about $28,000 and getting a return of $143,000. More than a 500% return, not to mention the pure value of the life insurance policy. I’d like to see anybody match that.
DJ-
You’re making things seem better than they are. First, if you keep the policy until you die, you get the death benefit and not the cash value, not both. Second, if you decide to have the dividends pay the premiums, the cash value will grow slower and the death benefit will eventually be less than it otherwise would be. You can’t have your cake and eat it too.
The policy is definitely valuable (worth $86K now), but that doesn’t mean that an alternative investment wouldn’t have been better in retrospect. Let’s say you put $2800 a year into a stock index fund that returned 8% over the last 20 years. It would now be worth $128K instead of $86K.
Also, keep in mind that your $28K investment over the next 10 years does not give you a return of $143K. Your $28K investment over the next 10 years PLUS the $86K you could take out now, gets you a return of $143K over the next ten years. Not counting the (relatively low) value of the life insurance component, that is hardly a 500% return. In fact, using your figures ($86K now, $2800 a year for 10 years, worth $229K in 10 years) I calculate it out as about 8% a year. Now 8% isn’t too bad at all (thus why you should probably keep this policy now), but it’s nowhere near 500%.
Also keep in mind that you’re probably using the projected future value, not the minimum guaranteed value. In my experience, the policies generally grow at a rate a whole lot closer to the minimum guaranteed rate than the “projected rate.”
Like I said, you’re probably at the point in the policies where it makes sense to keep them. But don’t kid yourself that they are some kind of magic investment.
I still think FROM THIS POINT FORWARD, this policy is a good “investment.” Ignoring its present cash value. Every day I put $1 in, it turns into more than $5, over the next 10 years. AND…..I continue to have a life insurance policy with a death benefit of $150,000+ that increases every year. And if I keep it longer than 10 years, those numbers are much higher.
Also, over the last 20 years, this policy has not only EXCEEDED it’s MINIMUM guaranteed cash value, it has beaten it’s PROJECTED cash value. EVERY year for the last 20 years. It is nowhere near it’s minimum guaranteed value.
Even using your figures of including it’s present cash value, your 8% annual return for the next 10 years is something a lot of investors and mutual fund mangers would kill to have.
Maybe I will just keep this policy until I die. By then, this policies cash value will be worth about a million dollars…….and so will the death benefit, which increases yearly as well. Then I can have my cake AND eat it too! This is some kind of magic investment.
NWM dividends have been decreasing for decades. When treasuries/bonds returned 8% or more then these typically returned 6% on the death benefit. Someone purchasing today should realize the return is at least currently going to be much lower unless interest rates rise substantially and stay up.
And no you cant get both the cash surrender value and the death benefit. Every dollar you loan out of the policy (which is at 8% interest) means a dollar less of death benefit. If you loan out too much and the policy crashes then you dont even get that difference but instead just get a big tax bill as well.
Just an FYI, northwestern mutual charges an 8% interest rate to get to the cash values, but they credit your account a borrowed rate dividend of 7.45%. So the loan you’re taking out is really only .55%. Not too shabby.
Rex,
You have to look at both sides of the coin though with an unbiased approach. You take note that NWM life policies paid out less in dividend interest rate when rates on treasuries/bonds were higher, you also have to look at the fact that NWM life policies also were consistently ticking forward when market scenarios were much lower across the board. I know many permanent whole life owners that were grateful to have the insurance in place when their market based portfolios suffered. Sometimes peace of mind is important, as well as the gaurunteed values. Not to mention if you look at the loan provisions as 8% , taking into consideration the lowest dividend rate northwestern has paid is 6.15% in the last 30 years, essentially that 1.85% net interest rate would have posed as a better alternative than a loan from the bank, as previously stated.
I by no means am an advocate of using permanent life insurance to provide for all of your retirement goals, but with regards to a financial planning, I think that it is a good piece of the puzzle to ensure cash flow. I think it should be a conjunction of some permanent life insurance forced savings, term insurance for adequate coverage, and a sound allocation model based portfolio with investment objectives. There are very few people that can self-insure for the duration of their lives, and as stated before the majority of Americans have a hard time sticking to systematic savings.
Before I keep rambling, the goal of this post is not to be advocate, but yet make a statement that for the majority of americans I feel, budget permitting, that their is a place for some forced savings into a permanent insurance policy. As long as it is just that, savings, and not the sole crutch for retirement.
Just my two cents….
no that doesnt work especially for NWM since its a direct recognition company. The loan will reduce the dividend furtherr. Additionally the concept for forced savings is complete insurance agent garbage. Only like 20% of whole life policies are kept in force until death. Thus almost none of the clients actually received that benefit yet they paid for it. In fact the majority dont even get to even with cash surrender value equaling premiums paid. The actual truth is that 99% of people in america would be better off if they never heard of permanent insurance. You dont need to self insure for the duration of your life and if you did well then permanent insurance has shown not to work for the majority of people who purchase it.
I think “forced savings” is a very weak argument for permanent life insurance. Paying those premiums is no more forced than contributing to a 401K or a brokerage account each month. In fact, I think the reduced flexibility is a significant downside to saving in an insurance vehicle. If I lose my job I can quit 401K contributions for a few months until I get another one. Not so with a whole life policy.
I really don’t know what to think of you WCI. You dispense some wise advise about back door Roths, etc. But then, you say something patently false like a 401k is more flexible than a dividend paying WL policy.
Huh? It is true that you can stop 401k contributions if needed, but please tell me how you access these funds? Oh yeah, that would a be with a 49% tax rate. (39% top marginal rate and 10% penalty…oh wait, I forgot state tax) Retirement accounts are some of the most illiquid assets you will ever own. (They’re designed that way…) On the other hand, you can stop paying your WL premiums if needed. The company will borrow the money from your CV to pay your premium. You can even take a withdrawal of cash value from the policy. This will, of course, reduce the death benefit and the accumulated value of the policy. Further, the withdrawal is tax free up to the amount of premiums you’ve paid into the policy. How much better flexibility can you get than that WCI? Oh yeah, you don’t need an excuse either like death in the family, illness, loss of job, foreclosure, etc. You can take it whenever and for whatever reason you want!
You people need to stop comparing WL to investments, i.e. stock market averages. If you absolutely insist on comparing returns, compare them to bank CDs or bond funds. They are that safe and that stable. I don’t think I have ever heard of a life insurance company losing customers’ funds and/or failing to pay death benefits. Many mutual companies have been in existence since the 1800’s; many have paid dividends through world wars, great depressions, banking collapses, inflation, cold wars, revolutions, etc. Every single year. WL cash values should be compared and allocated the same as bond allocations and/or cash in the bank.
If you are doing it any other way, you are doing it wrong. Period.
Maybe you don’t want an allocation to cash or bonds in your financial plan. That’s fine. Don’t buy WL insurance either; go with the term and invest the difference. You are obviously very comfortable with risk (at least you think you are).
Compare apples to apples and oranges to oranges, otherwise you will make poor financial decisions. That is GUARANTEED (just like CV accumulations). See what I did there? Ha!
One last point, buying a great concept from a crappy company will always be a bad decision. Buying a hammer to cut a board will always be a bad decision too. You must utilize the correct tool for the task. Surely you docs can understand that….
WL is one of the most amazing financial products on the market when bought from the right company and used for the right job. Have you asked yourself why Congress passed laws to limit it’s use in the 80’s? Hmmmm, makes you think! Hey WCI, can you tell me why the government limits my access to cash value policies like WL? I believe they passed those regulations specifically because docs were abusing, errrr, utilizing these types of tools. Rebuttal?
You’re an accountant and you have no idea how to access 401K funds? This post might help:
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
The rest of the arguments you spread out over 8 comments in this long, long comments thread have been dealt with in the series of posts linked to at the beginning of this post: https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance/ I’m not going to rewrite them for every insurance salesman (even those with CPA after their name) who comes by this post and gets fired up enough to spend 2+ hours reading and writing comments.
If you think life insurance is awesome, go buy some. No one is stopping you. If you want to sell it to doctors as a great retirement plan in order to generate huge commissions, well, I have a problem with that, because I disagree with you and I get emails from dozens of doctors every month who have been sold crappy insurance plans that aren’t what they thought they were.
I have the whole life policy from AXA -Equitable for about 17 years.It has not done very well but I guess it is too late to get out of the trap. Can someone tell me, How does AXA- Equitable as a company compare to other similar companies which compete to trap us innocent guys and gals? Did i get screwed up more than average, just average or less than average? How is their reputation?
Nobody can answer that bc the true return can only be determined after your death. It is true that most people 17 years in should keep it if they want some death benefit. You have 3 options. Surrender and pay taxes on gains. 1035 exchange into a low cost annuity such as vanguard in order to defer taxes. Keep the policy and ask for in force illustration as well as one over funded up to mec limit. Your goal here is to maximize cash value and take about 90% out late in retirement leaving the difference between that and the death benefit to your heirs. James hunt has a fee service to evaluate your policy.
I don’t know much about AXA in comparison to others. You’re probably right that after 17 years you’re probably better off keeping it. I’d pay Hunt to evaluate it if I were you.
My wife and I have a newborn and we are starting to save for college. We were going to invest about $20k a year in our state’s 529 plan for about 3 or 4 years, and then let the principal and interest compound (hopefully) till the baby goes to college. I went to a college financial planner just to double check that this plan would work, but his main suggestion was that I not do a 529 plan and instead buy a whole life policy. His reasoning is that whole life policies are “invisible” for financial aid and scholarship purposes, while 529 plans and regular investment accounts in the parents’ names are counted against the child in awarding scholarships, grants, and financial aid generally. (I then found out that the advisor was also an insurance agent who would be selling the whole life policy.) The advisor/agent said that a whole life policy will give us the benefits of: (1) not causing the child to lose financial aid eligibility; (2) the same amount of money invested in the whole life policy will be available for funding college if we want it to be; (3) the money in the whole life policy will grow tax free; and (4) if the child gets full ride scholarships or something similar and there’s money leftover in the whole life policy, the parents have the flexibility to use the money for themselves, which they couldn’t do if the excess money was tied up in a 529 plan.
While I am very averse to whole life policies for the 8 reasons listed above, and I really don’t like that the advisor is trying to sell me insurance, I still want to make the right decision on the merits, but can’t figure this out exactly. Despite the advisor’s conflict of interest, could he be right about buying a whole life policy under these circumstances for this specific use? Any thoughts are much appreciated as I’ve been thinking about this for weeks and the advisor keeps calling. Thanks.
Purchasing a Whole Life policy with the intent of using it specifically to save for college, in my opinion, is generally a bad idea. In most cases, you won’t even break even on your premium outlay for 10 years.
Since you have a young child, my guess is that you are also young. How are you going to take the money out of the policy to fund for the college education? If you do a partial surrender, you will need to continue funding the policy – possibly long after your cihild is out of college. If you borrow against the policy and you are young, the interest will continue to compound. This can cause major problems down the road – especially if you don’t plan on repaying at least the interest.
You should probably use a combination of 529 Plans and a custodial account to take advantage of the income tax benefits.
While some of what this “advisor” says is true, how many physicians do you know that qualify for financial aid?
If you want to make sure that the education is funded in the event of your death, make sure you have enough term life insurance Inforce.
Finally, You yourself said that you are not a fan of Whole Life insurance so why would you commit that type of money into something you dont believe to be a good investment?
Whole life is a tool. However, when all the guy can do is swing a hammer, everything looks like a nail.
But, if from one of the 4 big mutuals, it can be a good idea if the following are true:
-You have a long term need for a death benefit and would other own term insurance
-You are taking full advantage of qualified and roth retirement plans
-You are not going to defund the policy before retirement unless it is a real emergency
-You are comparing the 20+ year IRR to a taxable return of 8% or less, such as a savings account or bond fund. Do not bother comparing it to an aggressive investment inside of a tax advantaged vehicle, over the long run.
A bond fund inside of a Roth IRA is likely a better pickle jar vehicle than whole life, if you can get enough into the Roth environment. The only caveat to that strategy is that bond funds can lose value, where as you always know where you stand with whole life.
Lastly, in retirement planning, some whole life insurance is a valuable part of a portfolio when stocks, bonds, and other investments are suffering, because it never moves backwards. It enables you to avoid taking income withdrawals at the worst possible time, such as March of 2009.
Ill address each of these:
(1) not causing the child to lose financial aid eligibility
99% of people who have a large whole life policy have other assets that do count so you havent improved your financial aid eligibility. This is in particularly true for physicians bc we typically have a good steady income which will always affect eligibility.
(2) the same amount of money invested in the whole life policy will be available for funding college if we want it to be;
This is absolute garbage. A standard whole life contract wont even have cash surrender values equal to premiums for 14 years. If you invest the money in almost anything else, you will have more money for college at 14 years. Even an overfunded policy will under perform. If you take all the cash out then the policy crashes and you get a tax bill on top of this. Any gains are taxed at normal income and not the better long term capital.
(3) the money in the whole life policy will grow tax free; and
It grows tax deferred. You can access it tax free via a loan if you like paying 8% on your money. If you fund it monthly then there is another 8% charge for that as well instead of paying it yearly.
(4) if the child gets full ride scholarships or something similar and there’s money leftover in the whole life policy, the parents have the flexibility to use
If you have that much concern over the flexibility then use taxable account. You still will have more money and more flexibility.
Only buy whole life if you need a permanent death benefit or want one knowing that in all likelihood if you lived a normal life span per your insurance health rating that you will have less money for you and your heirs. There are no magical investments for insurance companies and to make good on their guarantees they invest in treasuries and bonds. When bonds produced 8% or more then whole life gave you 5-6% as a death benefit. It is typically a bad idea to invest so conservatively for the very long term (your whole life).
im also going to address this statement from rangerover
Lastly, in retirement planning, some whole life insurance is a valuable part of a portfolio when stocks, bonds, and other investments are suffering, because it never moves backwards. It enables you to avoid taking income withdrawals at the worst possible time, such as March of 2009.
This isnt really true. It is another type of market timing and can be a dangerous plan especially with the direction that dividends have been heading for decades (lower). If you take money out early in retirement then this loan can over time crash your policy. You will be paying 8% interest on this loan and if the policy crashes then you not only lose the death benefit but also get a tax bill. This only works well and realiably if you take loans out late in retirement since there will be fewer years until you die and less likely for the policy to crash bc of decreasing dividends and the costs of the policy loan. Many permanent policies have self destructed bc of loans.
Rex, it is definitely true that overly optimistic assumptions have caused quite a few catostrophic failures of insurance contracts. Anything that places one bit of risk or responsibility on the individual has to be monitored and managed.
However, overly optimistic assumptions have wrecked stock and bond portfolios as well. One down year at the wrong time can suddenly put a seemingly ample retirement portfolio on very shaky ground if the stocks and the bonds go south at the same time, as they did in Fall 2008-Spring 2009. We need some of those potentially higher yielding assets in order to outpace inflation if we can afford to take the risk, but we also need guaranteed funds for food, clothing, shelter, transportation, and healthcare. Whole life insurance can provide some measure of that, as well as the freedom to live out the bucket list if we get bad news early, without worrying about spending our spouse’s retirement.
I am not saying that your way won’t work. My main point is to dispell the negative sentiment that some seem to automatically have about whole life insurance. There is no doubt that the product is misused in a great many cases, particularly with lower income people. But the numbers bear out when you are in a 36% federal tax bracket, plus some state tax as well perhaps. That 5% bond yield gets cut to 3%.
In summary, there reasons why someone would want to have whole life, and reasons why they wouldn’t want it. But each case is different, and as we know one size fits all doesn’t fit anyone very well.
While there may certainly be merits to owning a Whole Life Insurance policy (or at least that one could argue), the question posed was does this product work well for college education funding (compared to a 529 plan or other investments) and the answer to that is “NO” – plain and simple.
I agree with Rex on this one for sure.
I agree that permanent life insurance is a very bad idea for college savings.
I wanted to point out to rangerover a couple of things:
1) Bonds did just fine in the 2008-2009 market crash, especially treasuries. The Vanguard LT Treasury fund was UP about 15% in the 9 months from July 2008 to March 2009. Even the total bond market was up 10%. I’m not sure why you think bonds didn’t do a good job of protecting investors during that bear market.
2) There is no 36% Federal Tax Bracket. The top bracket currently is 35%. The average married physician with pretty average deductions is in the 28% bracket.
3) You seem to think there is a safe investment out there that returns somewhere near 8%. I don’t see it, either for you or the insurance company investing on your behalf through a whole life policy. If we’re going to talk about the merits of investing through an insurance company, we need to adjust our figures for the current interest rate environment. Rex is right that an investor investing through an insurance company should expect dividends that are 1-2% lower than the going rate on high quality long term bonds, which currently yield in the 2-3% range. We cannot use historical dividend rates on whole life insurance and then compare them to current rates on bonds.
I wish I could be more positive about the merits of using permanent life insurance as an investment but I confess that I have yet to see a policy that had sufficiently high returns to justify the expensive insurance and loss of flexibility. Most policies are sold to people who haven’t yet maxed out their eligible tax-protected accounts such as 401Ks, DBPs, backdoor Roth IRAs, and HSA, which as you mention, is an obvious mistake. I see them sold all the time to people in low tax brackets. (Mine was sold to me as a medical student. A salesman was trying very hard to sell one to my sister’s family, who hasn’t paid a cent in federal income tax in years.) Even if you treat it as an investment (minimizing insurance costs, funding it up to the MEC line and ensuring you only get a policy where the money you borrow from it is still earning interest in the policy), it still doesn’t make sense as a long-term investment.
The most telling argument against whole life insurance is that out of the thousands and thousands of very smart financial people in the world, I have yet to hear one recommend whole life insurance as an investment UNLESS he stands to personally benefit from its sale. Yet non-stock brokers recommend stocks and bonds all the time. Why is that?
Lastly, even you admit that someone buying one of these policies should have a need for a permanent death benefit. I submit that very few people who make enough money to be in a high tax bracket and have already maxed out their retirement accounts yet have less than the estate tax exemption amount (most doctors fit into this category) will ever have a need for a permanent death benefit simply because they have a sizable portfolio instead.
There are way too many people selling these policies compared to the very small percentage of people who could actually benefit from buying them. That’s the problem.
The only person that is actually likely to benefit from buying a policy as an investment is someone that for some reason cannot invest in a traditional stock/bond portfolio due to behavioral issues yet can somehow manage to pay the premiums on the policy for decades. That’s not a very flattering picture of the ideal client. Obviously there are a few situations regarding estate planning where a policy can make sense as well. But with current estate tax exemption limits, there are very few people in this category too.
Lawrence,
I was not referencing education, but whole life as an all around asset class. I can think of few scenarios where a young parent should be advised to purchase insurance in order to fund a child’s edcuation. Withdrawal of basis from a Roth IRA or using a 529 plan are much better ways, and a taxable investment account would be a second choice.
Whole life for education funding is one of the instances I was referring to when I said, “When all the guy knows how to do is hammer, everything looks like a nail.
I appreciate the lively discussion though.
Thats isnt true about 1 bad year. It isnt like the smart idea is to all of a sudden sell all your stocks in one year during retirement. Additionally it isnt all stocks in one’s portfolio. Over time one should increase their bonds.
The absolute truth about whole life is that any of these ideas about using it for more than a permanent death benefit are more myth than fact. You can cook the numbers/illustrations so they appear to work out for high net worth individuals but that doesnt make it the best plan and it rarely is. It only is a good idea when the person highly values having a permanent death benefit and that is the minority.
Why look at just one year of the stock market when decades have shown that whole life dividends continue to fall and there really isnt any reason to believe that is going to change soon.
You dont have to worry about spending too much if you take the premiums for whole life and invest them in a tax efficient index fund. Agents always like to pretend this allows a person to spend more in retirement and it simply does not. If you dont have the will power to do that then likely you would surrender the whole life (and that would almost always be a loss especially when you consider inflation).
Thank you everyone. The responses have been **extremely** helpful. I have decided not to do the whole life insurance.
One additional thing I did was compare the total amount after 20 years between regular investing with a 5% return, and investing the same in the whole life policy (advisor gave me a table of premiums, cost basis, surrender value, and death benefit). After 20 years, I would have more money in my own investment account than the surrender value in the table the advisor gave me. (I ignored the death benefit column as that wasn’t the purpose of the policy, but I even beat that.)
Some of you asked questions, and here are my responses:
– The advisor did not explain how the money would be taken out, i.e., whether it would be a surrender or a loan. My hunch is that he was thinking partial surrender because he never mentioned anything about interest payments on a loan from the policy.
– I have no need to have life insurance after the 30 year term policy expires.
– We are maxing out our 401k, and are phased out of IRAs.
Thanks again all. You saved me a few hundred thousand dollars.