The Author in Pine Creek Canyon, Zion National Park
The posts on this website about cash value insurance continue to attract comments (mostly from those who sell it) like a knight in shining armor on a summit in a thunderstorm attracts lightning. Months or even years after I write a post the comments continue to grow into the hundreds. In a recent comment, one agent stated that whole life insurance was a lot like a Roth IRA.
Permanent Life Insurance Vs. Roth IRA
I've heard that comparison many times, but it is flat out wrong, so I called him out on it. This post goes in to more detail about the reasons why whole life insurance is not like a Roth IRA.
1) No Interest Free Withdrawals
The reason some people fall for this scheme is that the money in a whole life insurance policy does grow in a tax-protected manner, and when you borrow the money from the policy later in life (remember you can't withdraw the money, because that's taxable, so you borrow it), it comes out tax-free “just like a Roth IRA.” However, it is not interest-free. Just like when you borrow from a bank, when you borrow from an insurance policy you have to pay interest. It doesn't seem fair, I know, but that's the way life insurance works. You have to pay interest to borrow your own money. When you withdraw from your Roth IRA, you owe neither taxes nor interest.
2) Excessive Fees Lower Returns
Roth IRAs can be extremely inexpensive. There is no fee at all to open one at Vanguard. They also have no closing fees. The expense ratio for investments can be as low as 0.05% a year. Try comparing that to the typical whole life policy. The insurance policy not only has a number of “garbage fees,” but since these things don't sell themselves, the insurance company has to compensate its salesmen with large commissions (typically 40-80% of the first year's premium) in order to get any business at all. The more you pay in fees, the less that goes toward the investment, and the lower your returns.
3) Insurance Costs Lower Returns
Since whole life insurance is a hybrid insurance/investing vehicle, it requires you to purchase insurance, whether or not you want it. All the money that goes toward the cost of that insurance by definition cannot go toward your cash value, so your investment will grow slower, producing lower returns.
4) Complexity Favors The Issuer
It is very easy to open a Roth IRA. It's a simple proposition. You put in after-tax money, it grows tax-free and it comes out tax-free in retirement. You can put any reasonable investment inside it- stocks, bonds, mutual funds etc. Fees are clearly disclosed and, if you go to the commonly used mutual fund houses, quite reasonable. Insurance policy prospectuses, however, are hundreds of pages thick. Even the illustrations run dozens of pages. The fees are usually buried somewhere deep inside. I run into physicians every week who have been sold one of these policies who really didn't understand what he was buying. In general, complex financial instruments favor the issuer over the purchaser.
5) No High Rate Of Return Investments Available
When you invest through an insurance company (which is what you are doing with whole life insurance) you're stuck with the dividends that they want to pay you. Their dividends are limited by the investments that they use. These investments tend to be very conservative, often composed of 80-85% bonds. A Roth IRA, of course, can be invested in all kinds of investments with higher expected rates of return, such as US stocks, International stocks, REITs, small value stocks, emerging market stocks or even commodities.
6) You Cannot Stop “Investing”
With a Roth IRA, if you make less in any given year or just decide you want to blow your money on a boat, you can do that. Not so with a life insurance policy. If you don't pay the premiums, the policy will lapse. Proponents will argue that after a certain number of years, the dividends from the policy will be sufficient to pay the premiums. That may be true, but that period of time always seems to come much later than the initial projections. It may be 2 or even 3 decades before the policy can pay its own premiums, dramatically reducing your financial flexibility.
7) Different Asset Protection And Estate Planning Treatment
Roth IRAs and whole life insurance may be treated very differently when it comes to asset protection and estate planning issues. Depending on the state, some or all of your Roth IRA may be protected from creditors. The same goes for the cash value in a whole life insurance policy. In some states one is protected more than the other, and vice versa in other states. In some states neither receives much protection, and in other states both are completely protected. The point is they aren't substitutes for each other.
The same goes with estate planning issues. A Roth IRA passes to heirs income tax-free but subject to any possible estate taxes. It can be “stretched” to allow for additional years of tax-free growth for heirs. The cash value of a whole life insurance policy disappears when you die, and your heirs are paid the death benefit (minus any money you borrowed out of the policy) without having to pay income or estate taxes on it. Any additional earnings on that money, of course, would be fully taxable to the heirs. The money in both a Roth IRA and whole life insurance passes to heirs outside of probate. Both have their positive aspects, but they are very different.
8) Must Be Insurable
One of the biggest issues with investing in a life insurance policy is that the worse you are as an insurance risk, the worse the investment gets. If you are unhealthy, have bad habits like smoking, or engage in risky pursuits like climbing, parachuting or SCUBA diving, then the insurance costs in the policy will skyrocket, if they'll even issue you a policy. You also have to go through blood and urine tests and give out detailed private information about your health and habits. All you need to open a Roth IRA is income and a social security number. Since you can't really save much for retirement without those things, it's a pretty lower hurdle to get over.
The bottom line is that whole life insurance IS NOT like a Roth IRA, and anyone who tries to equate the two is likely trying to earn a commission by selling you whole life insurance. To make matters worse, a lot of these salesmen don't even know that high earners can still contribute to a personal and spousal Roth IRA through the backdoor. Whole life insurance is a bad enough investment when used in addition to a Roth IRA; it's downright horrible when used instead of one.
Get a life insurance quote from one of our Vetted WCI Insurance agents.
What do you think? Have you heard agents using this line? What other differences or similarities do you see between a Roth IRA and whole life insurance? Comment below!
What is your view on 10 pay WL when used to supplement retirement? Lets take a 46 y/o Dr who is going to pump in 36,160 over a 10 year period and then not a single penny after. We now have a 800k death benefit. For these purposes I will be using real numbers and the guaranteed column only. In year 12 we will have our money back guaranteed. Since we are using guaranteed figures we will remain at 800k DB. At age 65 we have a little over 450k guaranteed. Now at retirement we have a bucket of money that we can access in the inevitable event of a bear market. Now I have the ability to take partial surrenders tax free up to my cost basis (therefore I am not borrowing the Life companies money and paying interest.) By not taking income from my equity based retirement account during a period of negative returns my overall “networth” in the long run will be about 3 times higher than If I were to just take money out each and every year. This is why I say rate of return on WL is irrelevant. It cant even be calculated because it is increasing the value of my other account(s). Not to mention the benefits I receive during the 10 years that I am paying in to it (waiver of prem to be exact.) If the policy includes a LTC rider that is even more gravy saving me about 4-6k a year in LTC premiums.
Also keep in mind that the commission on a 10 pay is significantly less than any other product. I know that is a big deal to you. And we only talked about guaranteed numbers from a company that has been at the top of the dividend scale over the last 100 years.
Disclaimer: I have not sold one of these polices with this strategy in mind. I have never even sold a 10 pay in my life. I understand to the best of my knowledge the overall idea and wish to simply get your thoughts on it.
As a general rule, I don’t like whole life as a retirement savings/retirement account strategy. Ten pay is better than whole life pay though. I’ve written more here:
https://www.whitecoatinvestor.com/friday-qa-what-about-10-pay-whole-life-insurance/
I disagree about the rate of return being irrelevant. Sure, it’s nice to have some cash value in retirement. But it would have been better to simply have a lot more money, and that’s what getting a higher rate of return on your investment gets you.
Most docs ought to be able to self-insure LTC needs. And waiver of premium on a policy that isn’t needed isn’t exactly a massive benefit.
You keep mentioning higher rate of return on your money but that is the only rate you ever seem to talk about. What about the other 2 rates that are just as important if not more? Rate of withdraw and rate of taxation? Just focusing on a study of the market in between 1973 and 1987 gives us a good understanding why rate of withdraw is just as important as rate of return. During this time the avg gross return was 11.28% (S&P 500)…not too shabby. The issue is during these years there were 4 years where the returns were negative. So with someone starting at age 65 in 1973 with a 2 million dollar balance (withdrawing 150k a year) if all they have to withdraw from are funds tied to the market then at age 79 they would be down to $900,642.
Now lets say they have a 10 pay for their never taxed bucket. If they can avoid taking money out of their 401k in the years following a negative return, they will instead have $3,353,353 still in their 401k at age 79. Keep in mind they can either take policy loans or partial surrenders up to their cost basis. Also they will only need to take 100k a year because they wont be paying taxes unlike the years they are withdrawing from their 401k (hopefully not in a higher bracket than they were in during their working years but thats another arguement). If you want to take it a step further during the years they are taking from their life policy they are reporting zero income so their social security is not taxed since they wont be over the provisional limit. Technically if they wanted they can collect foodstamps.
If they take partial surrenders then they owe no interest. At age 79 they still have 998k in cash value plus the 1.458 million dollar death benefit. Just looking at the difference it has on the 401k balance (not the overall clients wealth) you are looking at a difference of $2,452,711 or 272%.
This is why the “rate of return” argument is not the whole story. Of course we want a great return but its not the most important. Its not about how much you have, its about how much you can keep. The reason wealth is kept by the top 1% is because they do these things, and normal everyday humans are starting at zero generation after generation. We go to college, get a degree, get a job, have a family, make it up to 150k a year and we retire, and our kids start off just the same way we did. Some make it and some don’t.
Just for clarification the numbers used on the 10 pay were $36,160 a year in premium started at age 45. $1,000,000 DB. Guaranteed CV of $364,770 at year 10. $486k guaranteed at age 65.
Let me just clarify when I said they would have 998,000 in cash value plus their death benefit I was not meaning they would have both. Just simply meaning they would still have access to the cash value during the remaining years of their life plus the death benefit to pass on to their heirs.
To play devils advocate the above scenario does not take into account RMD’s. In a perfect world we would not be forced to withdraw our own money if we didn’t want to. The fact that the Gov wants to tax us so bad they tell us when we have to start withdrawing our own money is a red flag for me. But in all fairness the above example is not 100% logical.
With that being said you would still end up better off even when you factor in the RMD’s.
What the Life Insurance aspect gives you is leverage. You can do things that you normally would not have done because you have the life insurance to fall back on. For instance you can take a reverse mortgage to create extra cash flow in retirement. If you are not concerned with building wealth for your heirs and want to live the best retirement possible then why not? You have the Life policy to pay off the mortgage when you pass. You could also roll that 401k into an immediate lifetime annuity. Why would one do this? You can get out of the market and have a guaranteed income for life. If you live for 2 years after retirement and die then you have the life policy backing up that 401k money you beneficiary was going to get. However if you live for 25 years after retirement you are really enjoying life. Especially when you can get the annuity rate anywhere from 7-13% payout its around 7% now.
Hey Fred, if you want a second opinion on all of this stuff check out the Insurance Pro Blog, or my blog, will definitely get a different view, nigh opposite view, from the White Coater.
Lorin, I appreciate it. I like to look at all views so I will check those sites out. I like to hear all sides of the argument. Im a Fox news guy but I spend just as much time watching CNN and MSNBC. I know this world is full of salesmen so I like to hear the complete argument and then use my brain to figure out what I believe to be true or not.
Sadly, WCI knows more about finance than some of the financial advisors I come across. The same can be said about Life insurance. I really am glad I stumbled across his blog!
Why would you care about paying off the mortgage when you pass if you don’t care about building wealth for your heirs?
Your heirs will be just as happy inheriting a taxable account with its step-up in basis, or a Roth or traditional IRA with their ability to be stretched, as to inherit life insurance proceeds.
I agree a SPIA for part of your assets can be an effective way to put a floor under your retirement income. But there is no reason for most to combine it with a permanent life insurance policy.
What? A 7.5% portfolio withdrawal rate isn’t sustainable? Say it isn’t so!
“Never taxed?” That money is taxed when you make it. Then you buy insurance with it. That’s hardly “never taxed.”
I agree it’s better to have a $1 Million insurance policy plus a $2 Million portfolio than just a $2 Million portfolio. But better to have a $4 Million portfolio than either. That’s the fallacy. The problem IS the rate of return. If you invest at a low rate of return, you end up with less money. Not my rules, just math. For example, let’s consider your guy who somehow can pour $36K a year into a whole life policy from age 45 to age 55, then lets it ride until 65. If he makes 10% on that money, he ends up with $1.6 Million. If he makes 3% on it (a reasonable estimate for 20 years in a whole life policy) then he ends up with $574K, 1/3rd the money. That’s the problem. It isn’t whether an investor hits retirement with a $1 Million whole life policy or a $1 Million 401(k). It’s whether an investor hits retirement with a $1 Million whole life policy or a $3 Million 401(k).
Wealthy people don’t get wealthy nor stay wealthy because they buy permanent life insurance. But if you think it’s a great deal and I’m totally wrong about it, buy as much as you like. It’s a free country.
Its obvious you live in the Dave Ramsey world of finance and investment. I suppose you can claim whatever returns you want when you have no license(s) or designations. So you want to talk about safe withdraw rate according to the Monte Carlo? 4%??? By the way I dont know too many people retiring with a $4,000,000 portfolio because of their investments.
Lets just pretend that someone has done well for themselves and retires with 2 million in their 401k. Thats 80k a year. Oh wait, forgot about taxes. Hopefully the interest rate on the loan we were receiving all those years from the Government on our qualified plans stays at least where it is now. What happens if the experts are correct? You know the comptroller under Clinton and Bush who claims that tax rates will have to double by 2023 to keep the country solvent. Im guessing you are thinking they are going to take the money they need from the poor people who have nothing anyways? Oh yea…you are not going to need the same amount of money that you are living on now? House will be paid off, kids will be gone. Congrats you will be the perfect tax payer. Just curious, do you know what your major medical will be when you are retired? What about prescription medicine? How much is your cell phone bill? Did you ever imagine you would have a cell phone bill that expensive 20 years ago??
touching on the ability to say what you want when you want, if you did have an insurance license it would be stripped away in 2 seconds when someone reported you for claiming that life insurance is an investment vehicle. Life insurance is not an investment. You are not allowed to call life insurance an investment. Besides, investments can lose money. Now go ahead and try to find some clever way to turn that last statement around. If you surrender your policy that is your fault for being an idiot. If you keep the policy like it is meant for you to do, you will never lose your money. Bottom line…There is no argument you can make there.
The never taxed comment is just another example of how you like to twist and turn things to fit your agenda. You know (or should know if you are advising people on what they should do with their money) there are taxed now, taxed later, and never taxed buckets. Of course you are going to pay taxes. There is no way around that. Stop trying to manipulate things.
I do think you are wrong. I have heard the other side of the story from the likes of Bryan Bloom and Don Blanton. What they say makes sense to me and they don’t have to twist and manipulate things to make an argument. I came here looking to hear the other side of the story, but nothing you have said has really had any substance to it. Its clear you are stuck on rate of return like most people.
You want another example of how you twist statements or don’t divulge the whole truth??? Lets look at #6. Can you not take policy loans to pay the premiums? Convenient how you mention dividends can pay the premiums which they can and in most cases do, but you can also take policy loans to pay the premiums in the early years. Let me guess, you would argue that you can take policy loans to pay the premiums but at some point you will have to start paying that back and “investing” (here we go with that again) So with that theory you wouldn’t start investing again in your roth when you were able to??? People backfill polices all the time. By the way, if you did happen to be in a situation where you had to stop “investing” after lets say 10 years, and you died, what would have the better rate of return for your money then??? Do i even need to mention the waiver of premium?
Im not asking you to be Pro whole life. Im asking you to prove the guys that are Pro Whole life wrong. You start this blog out with No interest free withdraws. If you don’t care about the death benefit then why would you care about any interest on the withdraws? Not once did I see you state the fact that the loans don’t have to be paid back. This is yet another example of the twisting of facts that I have constantly seem from you. Of course its better that you do pay it back just like if you saved up money in your piggy bank and then made a purchase you would want to pay yourself back correct? But if you don’t who cares? The life company will just scrape it off the death benefit when you die. If you care about your family and want to leave them a legacy then pay it back.
Lastly, If you have a house paid off and no mortgage and you want to leave your family a nice inheritance then a paid off house and a life policy is greater than a reverse mortgage and life policy to pay off the mortgage. I am having a hard time understanding your thinking. Good attempt on manipulating that statement. I dont know of anyone who becomes wealthy when they inherit their parents house. Obviously you would take the reverse mortgage when you know that your heirs will be able to pay it off with the death benefit.
Like I have said. I have a whole life policy. I do not sell whole life. I came to this site looking for a view from the other side of things. I am sorry that my end conclusion is that you are wrong on many fronts. Just because i think you know more than most insurance agents does not make your opinions right.
Thanks for your time, but If I just want to have a discussion with a wall I can do that with my wife. Get a license or a series 7 if your way is right. You would make way more money than you will as a Doctor. We both know that series 7 wont last very long when you are going around telling people you can get them 10% year in and year out.
P.S. Thanks wise guy for letting me know its a free country. I spent 2 years of my life in Iraq doing my part. Next time I need a reminder I will be sure to solicit you!
Thanks for stopping by Fred. Thank you for your service. Enjoy your policy. I’m glad you are happy with it. If you’re just looking for an argument, then look elsewhere. I don’t need one 100+ comments into a post I wrote years ago. It’s beyond me why an insurance agent is coming to a doctor in order to help him understand how a life insurance policy works anyway. If you understand how it works and find the deal attractive, then buy as much as you like. But I’ve got three emails in my box today from doctors who just realized how their cash value policy works and they do NOT find the deal attractive. They feel they’ve been suckered. That happens several times a week. There are a ton of dissatisfied purchasers.
Insurance agents love for their clients to start looking at whole life insurance as an investment, whether they call it that or not. That’s because the client has no need for a life long death benefit. So the agent has to take another angle if he wants to make a commission.
I have no need to manipulate anything. I don’t sell investments. I don’t sell life insurance. I don’t give a rip if someone spends every spare dime they have on whole life insurance. It doesn’t affect my income one bit. My income is plenty of money; I have no need to get an insurance license or spend a few hours passing the series 7 even if it paid me “way more” than being a doctor. I didn’t spend 11 years learning my profession because I thought it would make me more money than financial services.
Sir, your information is all well and good, but you forgot to mention when placing monies in a Roth IRA, you pay the tax on it immediately – that’s why you can supposedly take it out with-out encumbrances.
Yea, just like whole life insurance. You pay tax on the money when you earn it. Then you have the decision of what to do with it. if you put it in a Roth IRA, you can later take it out tax and interest free. If you put it into a whole life policy, you can take it out tax, but not interest free.
You have gotten a lot of emails about people that aren’t happy with their WL policies. Are these generally people that are only a few years in or people that have stuck it out for 20-30y when illustrations start to actually show significant dividend payouts? I’m interested to know how accurate the non-guaranteed illustrations actually are in comparison to actually outcomes? Do you know of any evidence to support one way or another? Thanks. Matt
I get emails from both. The specific circumstances I’ve looked at with long-term returns is that the policies generally performed between projected and guaranteed projections. This is mostly due to the fact that interest rates have been falling for the last 30 years. You may be interested in these two posts:
https://www.whitecoatinvestor.com/thoughts-on-permanent-life-insurance-returns/
https://www.whitecoatinvestor.com/a-whole-life-insurance-success-story-the-friday-qa-series/
Hi WCI,
I’m on the verge of purchasing an over-funded WL policy from Northwestern Mutual. I’ll give you my reasoning and please let me know if anything I am saying doesn’t make sense as I am an investment newbie.
At the moment I am funding my traditional 401K at 17%, Roth 401K at 13% and my ESPP at 10%. I have extra money in the bank that I plan on investing in a variety of ways (mutual funds though E-Trade, Peer-2-Peer lending, perhaps real estate).
I am considering taking $2000/year (for 39 years until age 65) overfunded WL policy. My thought is that so many of my investments are tied to the stock market, so if/when there is a down year during my retirement and my other accounts are weak I can take a loan from or withdraw money from the Cash Value to prevent taking out money from other accounts and wait for them to rise back up. Since the Cash Value part is guaranteed to get bigger every year I can use it to make sure I take money out of my other accounts while they are strong and not take them out while they are weak.
Is there a better tool to accomplish the same thing? I’m not scared of the roller coaster market. Quite the opposite, I’d just like to know the best way (or a good way) to take advantage of the the highs and lows. I should mention that I have no interest in the insurance aspect of whole life, no dependents.
Also:
No risk (assuming you can pay the premiums every year) while still significantly beating inflation (usually)
A method for diversifying my portfolio in something that will provide returns independently of the market.
First, buy whatever the heck you want. No skin off my nose. If you think whole life is awesome and understand how it works, buy as much as you like. You don’t need my permission.
Second, I have no idea what you mean when you say you’re putting “17%” in your traditional 401(k) and “13%” in your Roth 401(k) and “10%” in your ESPP. Are you maxing them out or not? If you’re not, then “investing” in whole life before doing so is almost surely a mistake. Whether you should be using an ESPP depends on what else is in your portfolio, how secure your job is, how quickly you can sell the employee stock, what the discount you get on it is etc. You list lots of investments but I’m not hearing a comprehensive written investing plan. Do you have one? If not, why not? If so, why not just follow it?
Third, I find the argument you’re making to invest in whole life insurance pretty weak. If you’re worried about stock market volatility, then invest in stuff that doesn’t go up and down with the stock market like real estate, bonds etc. You certainly don’t have to buy whole life insurance just for that. If you need a better way to have guaranteed spending in retirement, buy a SPIA in your 60s.
Fourth, a $2K annual premium is a pretty small policy. That tells me you’re either not very convinced about this or that you don’t make much money (and therefore aren’t in a super high tax bracket so won’t see much tax benefit and also could run into trouble funding this later.) Either one tells me this probably isn’t a great idea for you.
Dave Ramsey calls whole life the payday loan of the middle class. I think there’s a lot of truth there. There are some acceptable reasons to buy whole life insurance, but you haven’t listed any of them.
Read more here:
https://www.whitecoatinvestor.com/appropriate-uses-of-permanent-life-insurance/
Thank you for your quick reply.
1. Not looking for permission and certainly not trying to lean anyone one way or the other, just trying to understand it myself and figure out if my reasoning is flawed.
2. I wasn’t very clear. Our company allows a maximum of 30% of our salary to be invested into 401(k) and/or roth 401(k) (sum of the two can be no more that 30% of salary or $18000, whichever comes first. $18000 in my case) I have not opened a Roth IRA. 10% of our salary is the maximum allowed to contribute into our ESPP, which I feel confident investing in (I’ll spare the details) You’re not hearing a comprehensive written investing plan because I don’t have one, haha. Sounds like this should be my first step in the investing/financial planning world.
3. I did a quick analysis of the WL illustration I was provided. after 39 years (when I expect to retire) the annual rate of return seems to be about 4.1% (this is based off of 2016 dividend rates, 5.45%, obviously the guaranteed column was much worse)
My reasoning wasn’t so much that I’m worried about market volatility but that an “investment” that will not lose value can be used to take advantage of market volatility. i.e. take money out when the market is down so I don’t take money from investments that happen to be in a down year. Right now I’m considering WL, perhaps because I’m ignorant to what else is out there that can accomplish the same task (which really is my motivation for my comment in the first place). It seems bonds and bond funds yield lower returns than the policy I was shown but maybe I’m looking in the wrong places. Bonds also aren’t guaranteed to not lose value.
4. You are right, $2K/year is pretty small, I can certainly afford much more. It is small for many reasons:
-I don’t consider it a tool I can use to take advantage of market volatility and I don’t need very much invested in it to do so.
-I don’t like that it is a forced investment, if things get really tough I can discontinue contributing to other investments but not this or I will end up losing money. I’m very confident that won’t happen, but still I’m considering a very small contribution amount just in case.
-I don’t like that it takes such a long time for it to start making money.
But, yes. I am nowhere near the $11M mark where I would get much of a tax benefit. Just middle class.
-I’m not convinced and don’t like tying up too much money into only one company (ironic since I’m investing so much in ESPP)
I suppose my question is, are there any investments that are likely to get ~3-5% annual growth after 30-40 years and are guaranteed to never go down at any given year?
I realize this is all based off of the assumption that the illustration I was provided is not completely off.
Thanks again, I appreciate your advice.
Typo
under 4.
“I don’t consider it” should be “I consider it”
2. Good job on your savings rate. Putting 40% of your gross salary away every year into any investment will help you reach financial independence very quickly. Get that right and you can get an awful lot wrong later and still be fine. That said, I think you’re making a terrible mistake to choose a whole life policy over a Roth IRA.
3. That looks about right. I usually see 2% guaranteed and 5% projected after 50 years. I think you overestimate the rebalancing bonus. I certainly wouldn’t buy whole life just to get that. Besides, how are you planning to rebalance, take out a loan and then pay it back after stocks go back up?
4. You don’t sound like you want this thing to me. Surprised you’re still considering it. But if you want an investment that never goes down (except in the first 10 years) and is likely to get you a long term return in the 3-4% range, then yes, I think whole life is a fine choice. Why you’d want to tie your money up for decades for returns like that is beyond me though.
One should also mention the policy isn’t guaranteed to beat inflation. Its just illustrating to do so currently. If one actually looks at in force illustration and uses the guaranteed column, then its below inflation. You have to look at the illustration and calculate it out (or have someone do it for you).
You also aren’t diversifying unless you don’t hold bonds. Keep in mind that’s what most insurance companies primarily invest in with WL. Your returns with them will take this into account. It is also why dividends have been decreasing for WL for decades along with bonds/interest rates.
If you thought NWM is different then the rest then I should also point out that only 2 WL companies further decreased dividends from 2015 to 2016 and NWM was one of those two. They aren’t magical.
If you don’t keep a policy until death (and thus value the death benefit/insurance) then all gains are taxed as income. Its pretty hard to come up with any argument for permanent insurance when someone doesn’t care about the death benefit/insurance component.
Thanks Rex,
You are right, the policy isn’t guaranteed to beat inflation. I suppose I’m assuming that the non guaranteed column which is based off of 2016 dividends is a likely scenario. Maybe a bad assumption since, as you point out, the dividends have been declining over the past few decades.
This second part is where I had the question. NWM seems to be paying out more than the 30-year bonds and bond funds I’ve seen (at least after a VERY significant amount of time) even with low dividends, which I believe they have had every year. Am I looking at the wrong bonds?
Thanks again, Rex.
No, but you’re mistaking the dividend rate for the return. A whole life company can pay you dividends of 6% on your cash value for a decade and you may only break even due to the insurance costs-i.e. a 0% annualized return. Whereas if a bond pays you 3% a year for 10 years and then matures, you have an annualized 3% return.
Not sure which ones you are looking at but let’s say you purchased in 1980 so an example of something held for a long time, at that time a 30 year tbill could get you over 12%. If you compare to a tbill today of course returns look great but it’s misleading. Dividends seem to lag by about 6 years meaning they could easily go down further. Once interest rates and bonds improve the lag likely will be similar. This assumes no change in cost of insurance (which has changed in WL in the past and is currently being increased by some UL carriers bc of low returns from investment piece) and persistence of current low % who keep in force until death since that affects things too. It’s not difficult for them to have a dividend for over 100 years given the factors in play. Keep in mind it’s a return of excess premium. They try to convince you that this is a “good thing” or just a way to get the tax benefits. In the end, the death benefits seem to be low bond like if held until death but then you need to care about the death benefit. In your “example”, if you “access” the money tax free mostly via loans then in a decreasing dividend environment it can go bust so you have still sequence of events risks.
This is an easy mistake in comparing the very different vehicles. Taxes on bond interest are often dramatically higher than long term capital gains since they are at your highest marginal rate (39.6%+3.8% ACA+State Income taxes vs. 20% Fed LT Cap Gains+3.8% ACA+State LT Cap Gains). Just the Federal taxes considered with higher earners corporate bonds could run 43.4% before any Cap Gains on the sale of the bonds are considered. If the bond in question pays 4% that would produce a net after tax return of 2.264% before considering state taxes, and assumes you were able to acquire the bond without any load or commissions. Knowing these facts, ideally you would own bonds inside of a tax deferred vehicle like a qualified plan (401k, IRA, Roth, etc).
That all said with long term bonds whether held in qualified or non-qualified accounts, can also leave an investor stuck holding the bond to maturity. If interest rates rise, the value of a bond can drop dramatically which means either hold it to maturity or be faced with a huge loss of principal on the sale. Many think of bonds as safe investments relative to stocks, however the risk or standard deviation of long term bonds is not that much lower than large cap stocks like those comprising the S&P. Personally, I don’t like to get lower returns without a proportionate reduction in risk exposure and neither would anyone who believes in Modern Portfolio Theory and Efficient Markets.
There is a false premise assumed oftentimes by advocates of whole life insurance and those who argue against that whole life insurance should replace equities or can compete with them. Equities are essentially to growing wealth, and advocating to dump market exposure entirely in favor of life insurance would be ill advised. That said, there is a valid argument for comparing mutual whole life insurance to long term bonds for a few key reasons. First, you can get the same tax deferral of bond interest inside of life insurance similar to bonds held in a Roth account. Second, you do not have the downside risk to principal inherent in owning long term bonds or long term bond funds since the cash value can not decrease once credited to the account.
To my point earlier that I wouldn’t accept lower returns without lower risk, this allows me to reduce the risk of holding bonds while getting similar bond like returns and tax deferral on the interest as well. It also has the added benefit of premiums being paid on my behalf in the event I were sick or hurt and couldn’t work. Not to mention I do not have to pay for term insurance to protect my family like I would if I invested in bonds in the traditional fashion. For my non-qualified investments, I invest 100% in passive equities and hold all my bonds inside my life insurance. Since I’m younger I have my 401k entirely invested in equities overweight significantly to Small and Value both domestically and internationally. My life insurance is safe money with lower risk than bonds, more accessibility than a qualified plan (which also charges interest to borrow from in the case of 401k’s), and has substantially higher returns than I could get in a bank CD or savings account.
Furthermore, in retirement I will be able to retain a higher equities exposure knowing that I have another account to distribute income from during down periods in the market. A significant portion that will be distributed without interest as a withdrawal. Interest and borrowing really comes into play when you want to access gain in the policy without paying taxes. I could certainly withdraw the gain as well rather than borrowing, but I can decide that at the time when I know the tax rates of the time.
I personally don’t see many reasons taxes will be lower when I retire than I pay now. Historically rates are still low, we have massive debt and unfunded liabilities, wars past/present/future, I plan to pay off my mortgage and have kids off the payroll which both will reduce my deductions, and I sure hope I’m living off a larger lifestyle budget in retirement than I am today. I put the minimum amount necessary into tax deferred 401k’s to get the match, and the rest of my long term savings goes into after tax investments and life insurance. Roughly 3% 401k, 5% whole life insurance, and 12% to after tax investments. Also, I can skip payments to my life insurance in the event I need to now that I’ve had them for a few years. I even have a Line of Credit secured against the cash value similar to a HELOC in case I need to tap my cash value that charges a lower rate than loans from the life insurance directly. I would be hard pressed to find someone to give a LOC against a Roth IRA, and I can’t put money in a Roth anymore without doing all the hassle needed for backdoor Roth’s. Setting up two accounts, funding them with $5,500 each, then converting both, then likely having to close the original accounts, and doing it all over again the next year is a lot of squeezing for not that much juice.
Are there costs to consider, of course. It costs more typically to buy a home than rent as well, but we all know that doesn’t take into account the potential growth in value and tax benefits of home ownership. I’ve yet to see a person advocating against whole life insurance (Ramsey, Orman, blogger, etc) consider the details above in their analysis. Not to mention I hope to be successful enough to have estate tax exposures to worry about, and owning permanent insurance that I bought decades earlier will put me in a much better position to protect my assets than had I bought term that expired in my 60’s.
I don’t expect to convince people who sell cash value life insurance for a living that maxing out a tax-deferred retirement account is a better deal than buying cash value life insurance, but it’s a pretty easy sell to anyone else that can do math and understands how the tax code works.
Once you understand that tax brackets don’t have to drop, and in fact can even go up significantly, and you are still likely to come out ahead by using a tax-deferred account, it seems pretty silly to invest anything in a non-qualified account (including life insurance) before available accounts are maxed out. If you don’t understand that, well, you’ve got some studying to do.
I find life insurance to have rather unattractive investment characteristics and I find whole life insurance to have rather unattractive insurance characteristics. If you think it’s the cat’s meow, feel free to buy as much as you like.
Regardless of all of the debate, drive through any city and look at the top of the buildings. You will see names of Insurance companies (among the banks). Somebody is paying for those buildings. These insurance buildings employ some very smart people who offer product with a tremendous profit. I am not smart enough to out smart them so I just invest in my Roth and use the KISS rule: Keep it Simple Stupid.
Great article. I was raised in the insurance world at the Guardian some 20 years ago. Gave them 8 years and I did learn how to sell snow to an Eskimo. That being said, this article is spot-on, not all-encompassing, but spot-on. Considering the threshold for estate taxes these days, that’s one less sale for them. In short, usually, a Roth with a level term works like a charm for most Americans. I know as much about insurance as you Mr. agent because I am still one. I have many regrets from the policies that I miss-sold when I was a young buck. Unless you have a special circumstance or have a need for permanent insurance, move along from it and take this author’s advice.
Interesting thread. Only invested in real
Estate my whole Life. No mortgages. No 401 k. No IRA. Lost $ in stock market. Got out 17
Years ago. Yah probably should
Have kept that Apple stock
Just own properties free and clear. But cash poor.
My friend tried to talk whole life to me. But he makes about 600k a year. I’m lucky if I make 50k a year as a realtor. Changes annually. And I make a little
Return off rentals. But they are more long term investments/retirement.
I have one in college. And a special needs toddler. I’m 45. So thinking Roth IRA and term insurance policy in case something happens to me to cover my little guy.
I know whole life is apparently a contender for a parent with a special needs child. But I don’t make the income. And I dont want to be tied to the monthly payouts if I’m having a bad year.
If you think my plan is a good one what term life would be ideal. And how long do I do it for ? 30 years or ? Just would love input as my whole life has been real estate but I need to diversify.
Thanks !
Jo
I think direct real estate is an even better investment for a realtor. Lots of synergy there.
If you need life insurance, then buy term.
Thanks for reply