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. ]
If he wasn’t talking loans then it was even a worse idea. You should ask him just for kicks. You will soon realize that he is no friend of yours.
Rex,
Just curious, why would the loan be better or worse than a surrender? On the loan I would have to repay the money with interest. On the surrender, I wouldn’t have to repay it (I’m not sure how the tax thing works if it would only be a partial surrender of less than the total surrender value – prorate?).
What do you mean phased out of IRAs? We’re all phased out of IRAs but we’re still using them. You do know about the backdoor Roth IRA, right?
SS there are multiple reasons for this but let me try to simplify it:
By doing what you suggested with permanent life insurance, you will guarantee that you have less money for your kids education then just putting it under a mattress. With permanent life insurance, to avoid taxes you have to remove less than what you paid in premiums. This by definition is less money that you put into the plan. When you consider 20 years of inflation then you have really lost a lot more money. This is one reason why if that is what he is suggesting with permanent life insurance, that he really doesnt have your best interest at heart. Now i imagine he actually is pretending loans are smart. They arent but they can have a small place late in one’s life. This doesnt matter if the company is direct or non direct recognition or whatever. The banking concept with permanent life insurance is a very bad idea.
I could go on but anyone who tries to pretend that permanent insurance is the smart way to invest either doesnt know what they are talking about or is pushing it based on getting a commission. You must need or at least highly value the permanent death benefit. That is what you are paying for. It isnt something most people need or when they think about it long enough even desire but that is the benefit of any permanent life insurance. There are different flavors which really just means different methods of crediting and guarantees. The rest is smoke and mirrors.
Everyone should calm down.
Not everyone in this world is out to get everyone else. I mostly agree to buy term and invest the difference,besides for income earners in the top 5% and crank away at saving in all retirement account ts available.
Physicians also code extra things to hit their rvu numbers and increase production. I have fellow physicians recommend surgery over other means bc that’s what they know and/or make their money. But I wouldn’t recommend not seeing a doctor even though some orall are greedy.
In sum…buy term when in doubt and save save save. Let’s all treat each other as we would like to be treated.
If your colleagues are recommending this and isn’t in the patient’s best interest then you hang around a bad crowd. I’ve been a physician for over 20 years and doctors who do such are uncommon.
There should be zero doubt…..avoid permanent insurance unless you need a permanent death benefit.
Hi,
I have a whole life insurance policy from company A and recently was interested in closing that account and switching to a lower cost term policy from company B. My insurance agent contacted me stating that I “regret” that decision. Can someone point me in the right direction?
Bob,
If you read the entire post and the comments, you should already understand what to do. The first issue however is do you need insurance and how much insurance. If you only have whole life and are younger with a true insurance need then it is very highly likely you are under insured. You would need to list your income and what you are trying to protect such as mortgage, how many kids and what ages etc to come up with an estimate but in general people insure 10 times their income in their 30s to 40s. Assuming you have an insurance need then very likely you do need term. Id go to term4sale and get an estimate. Id go with someone cheap such as banner but it depends on age and health. Now the 2nd question is should you surrender your whole life. If you dont need a permanent death benefit then you shouldnt have purchased it but you likely dont have a time machine. Once purchased you are pretty much screwed but here are your options after you get an inforce illustration from the ins co. See how many years you have paid and what the cash surrender value is. Vanilla whole life doesnt have premiums equal csv until around 14-16 years. As a general rule, if less than a year and you are still very healthy then cancel the darn thing immediately. If you have had the policy for a long time like 20 years then if you dont mind passing on money at your eventual death then keep it. If you are in between then look at your premiums paid vs csv. If you surrender completely, you get the csv and of course no longer have permanent insurance. You can 1035 the csv into a low cost vanguard annuity and keep the cost basis such that gains until reaching premiums paid are tax free. The idea is typically to surrender the annuity once you reach that point. Dont get rid of any permanent policy until you have already purchased the term assuming you need insurance. Buying permanent insurance is almost always a mistake, unfortunately immediately getting rid of it isnt always the right answer. I wouldnt use that agent again.
I bought a Global index universal life insurance last year. As agent suggusted, I deposit as much as the insurance company allowed. The company guarantee 1-13% return every year based on the SP 500. After reading the above, it looks I made a bad choice. Anyone has a experience on similiar product?
Sure. That’s one of the many variations of permanent life insurance out there. Why’d you buy it? Is there a product that can provide whatever you were seeking at a lower cost? The answer is probably yes.
As a Certified Financial Planner, I don’t understand why anyone thinks that depositing money into a permanent policy (when term is immeasurably more cost efficient), so that they can borrow their own money out (that’s why it’s tax-free), and then paying interest on borrowing the money (your deposited premiums) is considered a viable financial strategy.
Besides investing in hedge funds, I couldn’t think of a more ridiculous use of your money.
There is a reason that the insurance companies have all those big buildings.
[Off topic and rude ad hominem attacks deleted.]
Hi guys:
Shoul I surrender right now? Then I can’t get anything back due to the surrender charge. Any suggestions? Thanks,
Before surrendering you should make sure you have adequate term insurance in place. If I were you, I’d surrender the permanent policy right after I did that. You’ll be out a year’s worth of premiums, but it’ll likely be a decade or two before you’re at a break even point. If it makes you feel any better it took me 7 years to learn my lesson. You learned yours in just one!
WCI,
Thank you. I will think about it
If you surrender in less than 1 year then frequently the agent has to pay the insurance company back the comission. Might want to consider that if actually under 1 year.
You really have 3 options (after term is in place):
1. surrender and learn your lesson. id typically recommend doing this in your situation.
2. keep the policy and make the most of it which means you will have a poor return over the long haul but its relatively low risk
3. at some point 1035 exchange the csv into a vanguard annuity to retain cost basis. this way your gains are tax free until you reach the point of total premiums paid. you have to be okay with having an annuity.
it always hurts to realize when you have made a mistake. ive too made the mistake of trusting the insurance agent.
This is a great thread. I am licensed to sell life insurance but have not been very involved in selling anything but term. I have researched and read a lot about permanent insurance and feel that whole life in most cases is a bad deal. I think it is wrongly sold to people who need a lot of insurance. I will say that Index Universal Life is a much better product if you can over fund the policy and blend it with term to keep premiums down. Not many agents talking about that since it hits them in the pocket. However, this is also not for everyone. I think one needs to take the company match in 401k fund and then consider one of these policies or a ROTH IRA especially if they do not qualify for ROTH. I am not a fan of those who advocate the BOY concept or this concept I mentioned ( IUL over ROTH or IRA ) in all cases. Everyone has their own unique situation. Just my two cents worth.
Index universal is similar to other universals just with a different crediting formula. The conclusions are still the same. Guess what happens when someone takes loans out in retirement but the market isn’t going up at the constant rate as illustrated…..the cost of insurance is of course rising, the 8% loan is adding up, and the floor is credited…..it crashes.
Almost nobody should purchase it but any permanent insurance if purchased should be over funded to the mec limit. Few agents present this bc it decreases their commission. That isn’t unique to index universal.
Almost everyone can back door Roth.
After that go taxable if you have used up 401k, Ira/Roth, HSA
Hi,
First post here.
I am a radiologist who has recently purchased a whole life insurance policy through my professional corporation. All saving/investment/retirement vehicles have been maxed out, so I decided to dedicate about 15% of my left over corporation after-tax funds to purchase a whole life insurance policy that will maximize payment into the policy for only 10 years (over funded to the mec limit), then let the policy pay the premiums itself. My intention is for my corporation to take out a 90% loan against the cash value in retirement (approximately 20-25 years from now) and then have the death benefit pay out the loan upon my death.
It sounded pretty reasonable from what I researched, and I had my accountant look at the numbers and he agreed that it was reasonable to allocate a portion of my portfolio into this policy.
My financial advisor said that he usually doesn’t recommend this insurance/investment vehicle (I know – “Don’t mix insurance with investment”) for the majority of physicians, but for a small percentage of high income physicians who have significant after-tax funds left in their professional corporations, then whole life insurance may be beneficial.
After reading this website and your posts, I am now a bit confused if I made the “right” decision. Am I missing something here?
One strategy that physicians might want to investigate is invest the after tax dollars in low cost tax-managed index funds. This strategy will eliminate the myriad of negatives outlined in previous posts regarding using life insurance products. Sure, you might have to pay a little in taxes on a yearly basis, but you won’t have to deal with the complexity of the insurance product that is indeed mixing insurance with investments.
These funds can typically pay out a small amount of the NAV as distributions, usually due to dividends and interest–anywhere from 0.5-2.0%. Due to the tax managed aspect, capital gains are minimized by tax loss harvesting within the funds.
Also, if you are still inclined to purchase a life insurance product, my advice is to pay no attention to the projected returns and only focus on the guaranteed return–this is likely what you will receive.
Heparin before i tell you that you made a mistake, let me say i made a similar one.
Just bc you maxed out other stuff doesnt make whole life a good decision. I like how there was a bunch of maybes in that sentence you either wrote or quoted about it being beneficial. That alone should tell you all you need to know. The truth is he made a bunch of money with bad advice and id consider firing him personally. Unless you need a permanent death benefit then its always better to avoid whole life. Unless your policy is guaranteed to have a limited pay period (and it doesnt sound like it) then with the direction dividends have been heading, you should expect to pay longer/more than what was illustrated and to receive less in retirement without crashing the policy.
Additionally there likely isnt any significant reason to have your company purchase it with after tax funds as opposed to just buying it as an individual. The only good thing i can say is that its better than buying one with pretax dollars like within a defined benefit or 401k. That is actually the worse thing you can do.
The bottom line is that you cant do better investing via insurance bc you have added the cost of insurance and you have added another middle man between you and the treasuries/bonds they have invested in. The tax angle doesnt make up for the low return over decades and the costs of those loans. Considering you are investing for a time period over your whole life, its actually longer than just retirement and thus such a conservative approach isnt going to provide the best return.
Rex:
[Rude comments deleted.] I realize that you think you know a good deal about the structure of whole life, but you seem to know very little. If you bought a product that was unsuitable for your particular situation, it doesn’t mean that you should [badmouth it.] [Rude comment deleted.]
[Rude comment deleted.] [You] are actually recommending that people surrender an asset that will always be there for them no matter how badly their other assets perform. If I can give any advice to anyone reading this, it’s to run from this website as fast as possible.
Editor’s Note: JohnFA- I don’t enjoy editing comments. I’ll just delete the next one like this instead of trying to get your point across in a civil manner. If you don’t like what you’re reading, feel free to browse on over to another website and warn all your clients about this one. If you’d like to debate ideas, that’s fine, but ad hominem attacks won’t be tolerated.
Im not sure all of what he wrote given the edits but per what is remaining if he wrote that whole life will always be there no matter how badly their other assets perform than that requires some clarification. Most of us invest in bonds/treasuries. If bonds/treasuries go under then one would quickly realize that guaranty only means if the company is able to make good on the promise (which they wouldnt be able to then). This is considered very unlikely, which i would personally agree with, but that statement of his/hers just isnt true. I really wish agents had a fiduciary requirement.
I basically said that I wish Rex had a fiduciary responsibility. I know that if he actually realized how much harm he is doing, he wouldn’t be posting this misinformation but unfortunately that isn’t the case. I am an IAR so I actually do have a fiduciary responsibility and have to carry a larger e&o policy. I am not coming to defend whole life because it doesn’t need a defender, I would like to point out though that someone makes sweeping generalizations about financial products, with absolutely no knowledge of the client’s specific financial or personal situation, it may not be advice that should be taken seriously. If there were a perfect financial product, everyone would already own it. There are just different products that suit different people and situations. In regards to bonds and treasuries, You are talking about something that pays a yield on a principal that can lose market value, unless held to maturity. Whole life is compounded tax deferred growth on a contractually guaranteed cash value and a contractually guaranteed death benefit. If one doesn’t know the difference between yield and growth or even average return, he probably shouldn’t be giving people financial advice. Comparing it to a bond is like comparing an apple to a banana. I don’t think it is productive to advice people against a fixed asset class with disability and death benefits while there are families that lost half of their life savings in 08.
The most bizarre part of this whole thread is actually the claim that whole life is only for the small amount of people that need a permanent death benefit.. Have anyone ever met anyone that would actually choose to leave less to their family than they potentially could? I actually have but certainly a small minority.. If you are paying for term your entire life and it expires at an old age, you will find that the term is exponentially more “expensive” over one’s lifetime. That expiring death benefit is a “cost” to your family because it is money they otherwise would have had. So when running the numbers for the “buy term invest the difference” scenario, don’t forget to add that cost, of the lost death benefit, to the term premiums you paid, the opportunity costs on what those term premiums could have earned as well as subtracting the taxes paid on your side investment.
sorry about the typos.
Actually only people who sold their investments lost money in 2008. Buts lets talk about the facts of whole life. According to research by LIMRA and the society of actuariers, less than 20% of permanent life policies are kept in force until death. About 1/3 are surrenderederd in less than 5 years, usually for almost a complete loss. Why do agents never realize the great harm they do to people with this? The worst part is likely a bunch are under insured with term at the same time in case of premature death. Please point to any study refuting this or any published data from the insurance companies on policies kept in force until death. I wonder why they dont show this?
Thus if people actually need a permanent death benefit, whole life has been shown not to work most of the time.
The rest of your bond statements dont apply. The guarantee is only as good as the companies ability to pay period. You just dont like that i showed your statement to be wrong. You actually havent shown any of mine to be wrong. You dont want to waste your time…….Yes that must be it.
Why dont you point to some actualy evidence supporting the use of whole life as an investment? Dont have any after all these years? You going to point to ups and downs in the stock market? I dont recall this blog recommending people to sell low.