Some of the most popular posts on this blog are about whole life insurance (WL). For better or for worse, nearly every reader of this blog is approached by an insurance agent recommending whole life insurance at some point in his life. I generally recommend you don't mix insurance and investing. Most people don't need a permanent death benefit and should buy a 20-30 year level premium term insurance policy. Those few who do need (or desire) a permanent death benefit should get a type of universal life insurance policy called a guaranteed no-lapse policy. Those buying a whole life insurance policy at this time should expect a return of 2-5% over the long run, with a negative return for the first 10-20 years.
WCI Reader Question – Did I Really Have a 7% Return on My Whole Life Insurance Policy?
I recently had an email correspondence with a reader who had read through the posts on the blog about Whole Life Insurance. He calculated out his return on his whole life policy and found it to be 7% after just 29 years. His initial email was asking me to show him where his error was because he was sure after what he had read that his return couldn't really be 7%. I quickly confirmed that, indeed, his return was 7%. He then said he wished he'd put more money into his life insurance policy instead of into the stock market, as his stock market return was closer to 3%. At this point, I figured we'd better get into the details to explain how this might be. As you might expect, he was comparing apples and oranges.
The Details of This Whole Life Insurance Investment
The Northwestern Mutual Whole Life policy was purchased in April 1983. A student of US financial history will recall that the early 1980s were a period of very high interest rates, and that market returns for both stocks and bonds were absolutely spectacular over the next ~20 years for stocks and ~ 30 years for bonds. He was comparing the return he got on the WL with a stock market investment that he made in mid 2000. Again, the student of financial history will recall that 2000 was the height of the tech stock bubble, and a particularly bad time to purchase stocks.
In order to compare apples to apples, you'd need to compare that whole life insurance policy with investments available in April 1983. So what was available then? Well, you could purchase a 30 year treasury that month with a yield of 10.48%, over 3% better than the return he earned. Even better, he could have sold that treasury at any point in the next 30 years at quite a premium. It's relatively easy to see what kinds of returns stocks and bonds have made over the last 29 years. Just to keep it easy, let's look at the Vanguard 500 fund and the Vanguard Long-Term Treasuries fund returns since inception (1976 for the 500 fund and 1986 for the treasuries fund.) Their returns were 10.51% and 8.6% respectively. I'd argue that if you used 1983 as a start date, the returns would be even higher, since treasury yields from 1983 to 1986 fell from 10.5% to 7.50 and the S&P 500 had returns of 22%, 6%, 31%, and 19% from 1983 to 1986.
So you could have invested in ANY combination of stocks and bonds in 1983 and had a better return than the whole life policy, by at least 1.5%. This isn't surprising when you consider what an insurance company does. It takes your money, pays the commissions, pays its business expenses including the insurance component, pays its profits (unless it's a mutual company), and then invests the rest. Since it doesn't have any magic investments, it can't get any better return than you can get without the insurance company, therefore your return MUST be less than what is available in the markets over the years the policy is in effect. It's a mathematical certainty.
I also found it interesting to look at the original policy projections from 1983. He bought the policy at age 20, and at age 60, the policy guaranteed him a cash value of $23,548, after 40 payments of $514. I thought that was pretty pathetic, a return of 0.65%, way below inflation. NML certainly wasn't taking much risk with this policy. The projected return was much higher, of course, projecting a cash value of $145,978 and a return of 8.06% by the time he hit age 60. After 29 years he isn't getting the 8% return that was projected, but he's doing a lot better than the guaranteed return!
A Whole Life Insurance Success Story
All told, I consider this a success story compared to the experience of most investors in whole life. He did just a few things right (used the dividends to buy paid up additions, paid his premiums annually rather than monthly, didn't cash out for nearly 3 decades, and kept the amount of insurance purchased relatively small to ensure he could afford to make the premiums) and thus has earned a return that is at least 3% better than inflation. Could he have done better just investing in the markets? Sure. But it certainly wasn't an investing disaster. The reader expressed a desire to have bought a $500K policy instead of a $50K policy. While I agree he would be better off with a $500K policy than a $50K policy, he would have been even better off just buying a 30 year treasury every year for the next 29 years instead of buying any policy at all.
Keep in mind that buying whole life insurance today may yield a very different experience than that had by this investor, especially given current interest rates. I looked at a recent policy for a 30 year old. It guaranteed a return of 2.18% after 29 years and projected a return of 4.81%. That doesn't seem like much of a reward for tying up your money for 3 decades. Permanent life insurance is still unattractive when compared to a reasonable portfolio of stock and bond index funds unless you either need or desire a permanent death benefit, especially if you aren't already maximizing your available retirement accounts. It is most reasonable as an investment for money you plan to leave to your heirs, although even then, it fails to outperform typical stock/bond portfolios.
My father was a business owner with a pretty successful business over his career. He bought a WL policy from Northwestern Mutual as well back in the late 70’s or so, very soon after college. I know he bought a few more (his agent approached me during my residency), all from NM. Over the last three years our family has been reviewing all of his financial documents and preparing for him needing to go into skilled nursing due to a stroke. One conversation matter was his life insurance portfolio. My dad has over $2 million dollars of life insurance, just a hair over $1.2 million is whole life. He had a $750,000 level 20 year term with Jefferson Pilot – and an annual premium of $2,170. He is in this 19th year and he does have the option to renew- at age 64. The premium will go to a minimum of $9,180 in the 21st year, and $11,400 in the 22nd year! And it’s only guaranteed for 5 more years, which I hope my father lives past. If we continue to pay this- we will pay almost $95,000 including the $40,000 my dad has already paid. And if he doesn’t die, we will never see that money again.
Now out of the 1.2 million or so in whole life, my father has over $560,000 of cash value- much of which we may use to pay for his care. His agent did a projection of us withdrawing $35,000 a year (probably via loans)- but if he dies 10 years from now- there is still over $500,000 in death benefit for my mother.
The craziest part- I don’t know how Northwestern can survive; but when he had his stroke in 2012 they waived his annual premiums. They were scheduled to be ‘fully paid’ by age 65- but he hasn’t paid a premium since. And his death benefit and cash value keeps growing.
I have NEVER heard of a term policy doing that. I think this is a success story- regardless of returns. We now have options- thanks to his whole life. If all he had was term, we would either have to drop it because of affordability or hope he died soon to collect. Term is ONLY for temporary needs.
I have bought $2 million of life insurance, and I own $250,000 of whole life and then term. I will always have whole life, as I don’t care if I only average 1% above inflation- the fact is my money is safe, it’s guaranteed to grow, and I can use it for whatever I want. And when I turn 65 (if I don’t die first)- my policy is fully paid, like a 30 year mortgage. From my experience I think whole life is a great policy to own. I’m not too sure about GUL or the variable life, but I want guarantees with my money and I know whole life will do that for me and my family.
Glad you’re happy with it and that your family has this resource. It sounds like the waiver of premium feature was also pretty valuable for you.
It’s not clear to me if he still has a need for life insurance at this point. Is there no portfolio or pension at all above and beyond the $560K in the whole life policy? I’m also not clear on whether he would have $2M instead of $560K if he had used a more traditional investment.
He certainly still needs life insurance. His skilled-nursing care costs will be around $65,000/year and with even modest inflation will add up over time.
His financial planner recommended a few options; start taking withdrawals from his 401k (my mom is 61, healthy and still working as a PA at a university/hospital). Which means withdrawal $100,000 to net $65,000. He only has $700,000 in 401k plus some in a stock account, we can see how fast the skilled-nursing would eat that up. Two- sell the business (at a fire sell mind you); with no guaranteed buyer. Or three- take withdrawals of tax-free return of premium basis and tax-free loans plus his social security to pay for the care. No increase in taxable income for them, as well as leaving the 401k to compound until they’re 70 1/2 and have to start taking money out.
The insurance advisor modeled taking these withdrawals (basis and loans) for 15 years- and using the dividend to pay loan interest? And principal I think? He did run it at 1% lower than their current dividend rate (I’m glad he did this)- he could pull out all of his premiums, plus more- and still have $650k of death benefit at age 100. He won’t live that long- so yes, there is a life insurance need. His skilled-nursing will eat up assets, he has no LTC insurance. That life insurance will refund more than enough, and take care of some of the costs today.
Would he have had more in a ‘traditional investment’. Maybe? Who knows? Rate of Return is irrelevant in a family crisis. Options are key and that Whole Life Insurance provides many options. I love investing and I love saving 20% a year-but I see the value in this product. Sometimes boring gets the job done.
So he put half his net worth in cash value life insurance? Interesting portfolio. It seems to me like those whole life insurance premiums would have been better used to make a larger nest egg and/or LTC insurance to me. This seems more like making lemonade out of lemons rather than what I would call a “success story.” A success story is like the guy this post is written about- he wanted a 7% return out of his investment and he got it over 30 or 40 years.
As far as options, there are lots of options with whole life for sure. There are also lots of options when you have two or three times as much money. Buyer’s choice.
Drew,
How long has your dad owned the Whole Life policy, and how much have the annual premiums been?
WCI:
Your point regarding the fact that the gentleman could have had 2-3 times more money had it been in the stock market is generally accurate, and certainly true in his case, starting in the late 1970s when market valuations were very low (The Shiller PE was around 10 at the time).
The investor today is facing a different situation. With the Shiller PE currently above 26 (http://www.multpl.com/shiller-pe/), the likely average return over the next 10 years is 0-2%/year, rather than the 10% the market averages over the long run.
Assuming the market averages 2%/yr for 10 years, then does 10%/yr for the next 10, the average over 20 years would be about 6%/yr, or about the same as a well-designed whole life policy (on someone under 35), assuming interest rates move up again one day…otherwise the return would be closer to 5%.
You might argue that the stock market return is still better, but I would counter that the person with the growing cash value will be positioned to buy stocks cheaply when they drop, while the person already invested will only be able to hope they move back up before he needs to sell.
John Hussman has a very good principle that most of us have forgotten:
“Valuations control long-term returns. The higher the price you pay today for each dollar you expect to receive in the future, the lower the long-term return you should expect from your investment. Don’t take current earnings at face value, because profit margins are not permanent. Historically, the most reliable indicators of market valuation are driven by revenues, not earnings.”
I agree today’s investor is facing a different situation, but that is the same whether he is looking at stocks and bonds or whole life insurance. The guaranteed return on a pretty good whole life insurance policy bought today and held for the long term is 2%, with a 5% projected return. In the 70s, that was much higher.
Valuations have some predictive power, but not nearly as much as advocates of valuation based techniques would lead you to believe. But if you think you’ll get the same returns over the next 20 years out of a whole life policy as a diversified portfolio of stocks, bonds, and real estate…no one is preventing you from buying it. But I wouldn’t bet that way.
And also keep in mind that the insurance company is investing in the same stocks, bonds, and real estate you are.
Aurelien- the total annual premiums were a total of $5,200/year- he bought a policy in 1979 and another in 1983. His total premiums paid in by my math was $192,400. And today he has $560,000. And I know he borrowed from it in the past and paid it back- that may have affected the net value?
I agree with your analysis of the markets. A Vanguard or Blue Chip portfolio- with the extra $5k a year would probably be worth more. We would have all been doing well had we bought, reinvested dividends, and held our holdings from the late 70’s through the 90’s. I agree the market is very inflated today (especially biotech, healthcare sectors), our World is globally connected and information is available so much faster today than it was in the 80’s. Investing is not the same.
WCI- investing sounds simple when you look backwards, but also when he was starting his portfolio mutual funds weren’t as accessible or popular in the 70’s and 80’s. He bought individual shares of stock in US companies- that’s what brokers sold. I do know he once owned Montgomery Ward and we all know that DID NOT return 8% every year, until today. Even though it did do well for a good period of time.
Drew,
Thanks for the info on the policy. For simplicity sake, I assumed that your dad bought both policies in 1979, so he paid $5,200 a year from 1979 through 2012. He’s since not paid due to his waiver of premium rider.
Based on a $560k cash value today, his overall IRR on cash value for this policy has been 5.4%/yr.
I’m guessing that this policy was not set up with cash value in mind. Is that accurate? I’d also be interested to find out how much the cash value has gone up each of the last few years, since your dad stopped making payments.
Sorry for a delay- been super busy and have not browsed on here in a few months. Last year, from remembering our review of his policies his cash value grew by $16,150. I’m not sure if it was set up for cash value purposes, but I doubt it. The agent did mention his policy was a ‘lifetime pay’ versus a limited pay. I know Northwestern Mutual offers one that you pay until age 65 and it is fully paid-up, which is what I own. I believe his have premiums to age 90 or 100. But like I mentioned, he is on a waiver of premium- and owes nothing. It has been a blessing. Regardless of rates of return, there is still a lot of cash that can be used for Skilled Nursing Care, and/or a death benefit to help reimburse for expenses when he passes.
Take a history lesson- do you remember what tax rates were in the late 70’s and 80’s? In 1982 the top Federal tax rate was 70%!! Yes T-Bills and CD’s payed good yield back then, but would you want to pay more than half your interest-yield in taxes? Whole Life (back then) was a good place for tax-deferred growth, with similar interest yields. (Do some homework on the IRS’ ruling of Modified Endowment Contracts in 1986). Secondly- term insurance was not a popular insurance vehicle- nor was universal life around yet. The options were limited to what we have today. His agent who sold him these policies said as a business owner it provided a source of collateral if he needed it for expansion.
I agree I wish he had LTC Insurance- but I think we would both agree he is uninsurable now. And again, “He could have a larger nest egg”- yea and you could have bought Apple on it’s IPO and held it until today and would probably be on a tropical beach, but you’re not. Hindsight is 20-20. No one talks about the mistakes they made in the market, it’s easy to boast and say you’ll get 10% every year.
When you’re a hammer everything you see if a nail. I’ve learned people tend to disregard and reject things they do not understand. Whole Life and life insurance in general is very complicated. Before I bought my policies I researched, studied, talked to advisors for months before I made a decision. I learned a great deal and have a better understanding of how they work- I wanted to be informed and feel good in my decision
Do I remember it? Nope, but it’s pretty easy to look up. The top federal bracket in the 1970s was 70%. In 1970, that started at a taxable income of $200K the equivalent today of $1.2 Million, about 6 times the average physician income, more if you count deductions. The typical bracket for a doc was pretty similar then to what it is now. That’s a bit of scare tactic if you ask me. The interest yields certainly were not “similar.” In 1970, NML paid a dividend of just over 4%. T Bills paid 7.87% that year.
Glad your policy meets your needs.
My biggest problem with the narrative around investments is that most people only discuss one half of the equation. You see, there’s two phases to investments, accumulation and distribution. And while stock market based products tend to outperform insurance products when it comes to accumulation, they are absolutely awful at distribution. Consider this, given today’s interest rate environment (noting that the situation changes when interest rates rise):
A whole life policy will accumulate at a net IROR in the vicinity of 4% (net of costs, fees and taxes) depending on the insured. A market based product will be something more like 7% (net of costs, fees and taxes). So when all you’re talking about is building the nest egg, sure, market based products look superior. However, market based products can only distribute about 3-3.5% of the nest egg per year over a roughly 25 year time frame (retirement). Whole life can distribute more like 6-7% of the nest egg over that same time frame.
So, the reality is not that market based products are superior because they accumulate a higher balance. It is actually that they HAVE TO accumulate a higher balance to replicate the same retirement cash flow.
Put a different way, a $600,000 whole life policy will last approximately as long as a $1 million investment portfolio when the same lifestyle expenditures are required. This is because policy loans don’t effect the accumulating dividend, and because there is no risk of a significant pullback in the account value at any given point in time like there is with market based products.
I ran an analysis of this for a 45 year old client. I analyzed retirement cash flow, NOT retirement account balance. In order to create the same retirement cash flow as the insurance product, his investments would have had to return north of 11% net of costs, fees and taxes over the next 15 years. Sadly, his prior financial advisor had only earned about 6.5% between 2003 and 2014, a period of 11 positive years and only 1 negative year.
It’s because of this that pension plans are largely funded with life insurance. Yes, they may also hold equities, but not nearly as much.
WCI, I’d be interested to hear your take on this. Let’s try not to argue facts, though. Ultimately, if I believe something is a fact, and you don’t, we’ll never come to an agreement anyway.
And let me add that I don’t just sell life insurance, I also sell traditional investments, but it all comes down to specific situations.
If you’d use correct facts, I wouldn’t have to argue them.
I’ll give you 4% for whole life in the long run. I think 7% is a little low for a market based, but I’d buy 8% so I think you’re in the right ballpark. However, your 3-3.5% is a little nutty. The 4% rule is quite easy to understand, and most of the time, a retiree can withdraw quite a bit more. So let’s call it 4.5%. Lower volatility does allow for higher withdrawals of course, and a “market investor” can get that using SPIAs during the withdrawal phase without ever buying cash value life insurance, but let’s ignore that. Let’s give you a 6% withdrawal rate on 4% growth and I’ll take a 4.5% withdrawal rate on 8% growth. Let’s assume $50K a year for 30 years. By my calculations, the market guy gets to spend $275K a year without the SPIA (more if he bought them) and the whole life guy gets to spend $175K a year. Garbage in/garbage out on any calculation.
I guess I’d rather use the “best” accumulation vehicle, then turn around and use the “best” distribution vehicle. In my book, that’s traditional investments for accumulation, and a combination of SPIAs + traditional investments for distribution. Still no role for whole life there, which is inferior in both phases to the best vehicles.
Here comes the argument, I guess. You think your facts are right. I think mine are right. I have to disagree with you because I think your assumptions are flawed and your math is wrong. Let’s start with the withdrawal rate.
A 4.5% withdrawal rate from a 60/40 portfolio (this is about as optimal as it gets during the withdrawal phase) fails approximately 15% of the time over a 30 year period according to this calculator…
https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf
Maybe you’re okay with that, but I’m not. That means that about 1 out of every 7 people who listens to you will run out of money before they die.
Furthermore, we are near an all time stock market high, so let’s assume that in the first year of retirement, someone’s portfolio drops 10% on top of their 4.5% withdrawal. Now, there’s better than a 20% chance that their nest egg won’t last their lifetime. Not good.
A 3.5% withdrawal rate is sustainable for a 30 year period approximately 97% of the time. That’s a lot smarter than trying to squeeze out much more.
Now let’s talk rate of return. I don’t think 8% is achievable when you’re talking net of fees, costs AND taxes. Granted, most people don’t pay the taxes on their investments out of the investment account, they pay them out of their income, but if we’re to keep the comparisons fair, the market based investment needs to be balanced out. This is why I use 7%, because if you gross it up for a 15% capital gains rate (which isn’t likely to last forever), the gross rate after expenses is more like 8.25%, still net of fees and expenses. If we don’t adjust the rate of return to deal with taxes, we have to adjust the contribution amount or the net withdrawal amount to deal with the tax that has to be paid at some point. That 1% difference in rate of return equates to approximately $1.06 million at age 65, which is statistically significant. My point is that your 8% assumption is awfully aggressive and makes a really, really big difference.
I ran an illustration on whole life using your scenario, 30 years funding at $50k/year. I used a 35 year old male and only a standard health rating. The cash accumulates to a little over $3 million, with a rate of return on the cash of 4.21% at age 65. It approaches 4.5% with better health ratings. My point here is that my 4% is conservative.
But let’s get to business on this. The individual who contributes to whole life for 30 years can access just about $180k per year for a 30 year period with a standard rating, and just over $210k per year with the highest health rating.
If you earn a NET of 8% (which I think is extremely unlikely after costs AND taxes) you are likely to accomplish this (99% probability of $180k income lasting, and 96% of $212k lasting). If you earn a NET of 7% (a lot more likely) you have a good chance of it happening still (96% chance of $180k income, 91% chance of $212k income), but 1 or 2 out of every 20 will fail. If you attempt to withdraw much more, you’re talking about 2, 3, or 4 out of every 20 failing.
What I haven’t mentioned yet is that the whole life policy still has between $1.5 million and $1.9 million of death benefit left after the 30 years of income! If you don’t want the death benefit, you can probably sell it to an investor for cash right now, probably upwards of 50% or more of the face value of the insurance for someone in their 90’s, or another $750k to $1 million.
So when it’s all said and done, odds are that the sustainable income is fairly similar, but the life insurance leaves something for beneficiaries (or a marketable asset to an investor) that ends up blowing a traditional investment away. Really, it’s not even close.
I disagree that a sustainable income is similar. You may use whatever numbers you wish of course, as may anyone else who wishes to run a calculation like this. The fact remains that over 50 years or so, the guaranteed return on a whole life policy is on the order of 2% with a projected return in the 4-5% range, perhaps extending a little over 5% if you run the numbers on the death benefit instead of the cash value. If you think your return with whole life is similar to your return, after taxes, costs, fees etc with whatever traditional investments you’re looking at is very similar, then go ahead and buy it.
But what the purchaser must realize is there isn’t some magic in the policy that somehow makes additional money appear after retirement. That money must come from somewhere. If you choose to take more money out, there will be less at the end and the possibility of running out of money becomes higher. If your goal is to spend as much money as possible, then your best bet is to invest in the asset most likely to grow the fastest throughout accumulation, then purchase a single premium immediate annuity. When you die, you will have spent as much as possible and leave nothing behind. If your goal is to leave as much money as possible behind, your best bet is traditional investments (stock index funds, real estate etc) which benefit from the step-up in basis at death.
This idea that you can safely take out 6 or 7% a year out of a whole life policy and expect to leave just as much behind, on average, as with a higher returning investment is folly. Insurance agents love to jump on the bandwagon of all these folks who are paranoid and talk about 2%, 3%, 3.5% etc withdrawal rates What they don’t like people to realize about withdrawal rate studies is what happens in a typical situation. The focus is on the “success rate” not on the typical results, which is far more interesting. It turns out that most of the time, it’s fine to take out 5%, 6%, even 7% of your portfolio value. It’s only in the really bad periods that you’re limited to 4%. An adjust as you go strategy is the preferred method for most retirees and works very well. In a typical situation, if a retiree retires with $1M and only takes out 4% a year, he ends up with much more than he started with. Kitces showed that over 115 rolling periods, in only 12 of them did the retiree end up with less than he started with, much less run out of money. 2/3rds finish with more than twice as much as they started. The median is 2.8X what they started with. So half of the retirees have even MORE! So while 4% is the “safe withdrawal rate,” the average withdrawal rate that worked is over 6%.
The other sleight of hand here is that this 6-7% withdrawal rate that the whole life folks like to talk about is not the same % as discussed in the SWR studies, which is 4% adjusted up each year with inflation. It’s just 6-7%. After a few years, 6-7% of the original portfolio is less than 4% of the original portfolio adjusted for inflation. The devil is in the details.
Agents also like to say that high returns are very unlikely for the individual investor (so they should take what they can get from the insurance company) but don’t mention that the insurance company has to invest in the same environment as the investor. They don’t get a different stock, bond, and real estate market to invest in. If returns are low for the individual investor, they’re low for the insurance company too.
https://www.whitecoatinvestor.com/investing-in-retirement/
https://www.kitces.com/blog/the-ratcheting-safe-withdrawal-rate-a-more-dominant-version-of-the-4-rule/
But as I’ve said many times, if someone understands how these sorts of policies work, and really wants them for some relatively small portion of their portfolio, then it’s no skin off my nose. I have no dog in this fight.
If you’re not okay with something that looks like it works 85%, 90%, 95%, 98% etc and adjusting as you go, then I think your solution ought to be a SPIA, not a whole life policy.
I don’t think we’re going to come to an agreement on this, but I feel obligated to share a few last words, even though I know you’ve heard it all before. Clearly, you’ve been battling people in this area for some time, but for some reason continue to ignore the same things over and over again as though they don’t matter and seem to think that insurance advocates are intentionally deceiving people.
-You often talk about whole life having a guaranteed return of only 2% as though it’s a bad thing. The guaranteed return on a market based investment is -100%. You can lose everything. Of course, history shows that neither of these situations is likely, but let’s be fair about it instead of comparing market history to insurance worst case scenarios. That’s like saying a Chevy is a higher quality car than a BMW because they TYPICALLY run well for a long period of time, and somebody you know ONCE bought a BMW that had a defect. Let’s be fair about our comparisons.
-Projected returns on whole life are in the 4-5% range in TODAY’S interest rate environment, with dividend rates around 6% gross. Dividend rates with many companies were north of 8% in the last 15 years, and north of 11% further back than that. This would create a substantially higher projected rate of return which, of course, can be both good and bad depending on how people’s expectations are managed. Meanwhile, the market has averaged somewhere in the neighborhood of 10%, BEFORE expenses and taxes, with the vast majority of investments (80-90% depending where you look) underperforming the market in general. Yes, market returns are typically higher, but it isn’t as important as you think.
-Rates of return on death benefits are well more than 5%, by the way. For the scenario we’ve been discussing, it’s between 7.5% and 8%, depending on the health rating. This number, of course, is net of all costs and taxes.
-Also, what’s going to happen to the stock market given the demographic issues we have today? As baby boomers retire and are spending their money, it’s rather likely that the sale of securities will drive stock prices down. And when some retirees begin to run out of money, government benefits will become more and more necessary. And where will the money come from to pay for these things? There are only two places it can come from, the government can tax it or they can borrow it. Well, guess what, when they tax it, cash values in life insurance are protected, but investments aren’t. Wave bye-bye to the capital gains rate and hello to higher income taxes on people who can actually afford to save and invest. And when they borrow it, the insurance company will lend it to them at interest, creating profit for policyholders, not stock market investors.
-It’s clear to me you’re a sharp guy, but somehow something hasn’t clicked as it relates to insurance, even though you’ve been brow beaten with it many times before. The “magic” is not about what’s in the policy, but rather comes from what’s attached to the policy. I know you know this, but you don’t seem to think it’s important, when it absolutely is. The reason the money can last is that you aren’t withdrawing it. You’re using the guaranteed line of credit that the insurer extends to you as part of the deal. The line of credit collateralizes the death benefit, not the cash value, so your compounding interest continues on the entire balance, with no adjustment for the “withdrawal” (unlike almost every other financial product in existence). This is incredibly significant, mathematically. Look no further than above when we talked about the difference between earning 7% and 8% over a long period of time. It added up to a 7-figure difference before, so is earning a spread on your borrowing instead of forfeiting the ability to compound interest by withdrawing insignificant now because it doesn’t support your argument? This is why the money lasts longer. This is the “magic.” Let me know when someone is willing to collateralize the future value of your investment account, and then we can have an entirely different conversation. I know that the general account of an insurance company isn’t all that much different than an investment portfolio, except that many of them are still holding bonds that are 20+ years old and paying really strong dividend rates, but that isn’t what’s important.
-You’re right about an adjust as you go strategy, it’s much more effective than just withdrawing and crossing your fingers. This is why it’s good to have an asset that isn’t correlated to the market that you can access when your market based investments suffer, so you don’t kick your portfolio when it’s already down. If all you have are market based investments, the only adjustments you can make are to your allocation and your lifestyle choices. This, of course, is the basis for Kitces research. People should only inflate their spending if they can afford to based on their investment performance. Well, I hate to say it, but very few people are going to have the luxury of being in this position. Most people will have to budget their retirement income to what they need, and that just might cause them to have to spend money faster even when they can’t afford to. When people retire and begin accessing their savings is critical. Flip a coin each year for the first 5 of retirement, and the whim of the stock market dictates your likelihood of success. Also, he seems to believe that we should rely more heavily on the extremely long term history of the market instead of the more recent bubble phenomenon which is quite obviously orchestrated by financial institutions and Wall Street in the first place. This is not a man I can place much faith in. If you choose to, go right ahead.
-SWR studies typically use 3% as a rate of inflation. Do you know how long it takes a 4% withdrawal rate to catch up to a 6% withdrawal rate with a 3% rate of inflation? 14 years!!! Hardly “just a few.” As you said, “the devil is in the details.”
-SPIA rates for a 30 year period certain for a 65 year old are less than 6% today, without an inflation adjustment, BTW.
-I know you’ll probably have a well thought out response to this and I don’t blame you. After all, this is your blog, and I’m just a visitor. I’ll stop squawking now, but appreciate the back and forth; it’s always enjoyable.
I haven’t seen a recent policy illustration that came up with a projected return of 7-8% on the death benefit. I’m seeing 5-6% at life expectancy.
As noted on this post, you could buy a policy in the 80s and get 7% out of it over the next 30 years or so. But you could have done even better just buying long treasuries.
I disagree on the demographic issues. But if market returns are poor due to demographics, they’ll be poor for both you and the insurance company. The government can also inflate the money supply (aside from borrow and tax), which will really hurt low return investing solutions like whole life insurance.
Borrowing against a policy isn’t nearly as unique as most assume it is. You can borrow against lots of things completely tax-free, including real estate investments, your home, and even your stock portfolio. The terms obviously matter and the devil is in the details. But keep in mind that in many ways, these other loans are even better than borrowing against your life insurance cash value (which is what you borrow against, not your death benefit-if you don’t believe me try borrowing a big chunk of your death benefit in year one of the policy) since they are not only tax-free, but the interest is tax-deductible to many.
SWR studies do not typically use 3%. Do you actually read them? It’s not called a 4% rule for nothing.
The fact that most people don’t save enough for retirement is a terrible argument for them to buy an investment with very low returns. That just means they have even less. That’s Dave Ramsey’s big beef with it and why he likes to call Whole Life “Payday loans for the middle class.”
Seriously though. This is the 8th comment left TODAY by a life insurance advocate (usually an agent). This happens every single day on this website. I can’t repeat the same thing every day to all of you who think you have some new angle showing why whole life insurance is the cat’s meow. If you think it’s awesome, buy as much as you like. I don’t really care. But you can give up convincing me it is a good idea for the vast majority. It isn’t.
Wow, long thread. I’m one of those “crappy” insurance agents you reference. I’m 50 and on myself have lots of term and lots of permanent coverage. My client that bought a WL policy 18 months ago in his 40’s and died 3 months later – his family experienced a 5200% ROR. Do you think she cared what type of policy it was? Ask a 73 year old client if he/she still would like to have life insurance and most will say “YES” – regardless of what they were taught (buy term/invest diff, you’ll be self insurance in 2008 and things like that). I’ve never put a UL, indexed UL, VUL etc in place and likely never will. But, WL has its place in just about everyone’s world. Our firm is 30 years old this year and we have a lot of happy clients with a lot of cash values, a lot of investments, a lot of good auto coverage, a lot of good ‘stuff’ to protect what they’ve worked hard to achieve. Try – for one day – to respect the good that some of us “crappy agents” do for the world 🙂
I disagree that most should own whole life for various reasons discussed ad nauseum in many areas of this website. If your client had used all that money he spent on whole life on term, his wife would have been much better off. Did you ask here if she was glad to have $1M when she could have had $5-10M?
I do respect what the good agents do for the world. I disagree that an agent who feels most of her clients need whole life is one of the good ones.
The client had plenty of term and a small part of WL for many reasons. And, you’ll be happy to know that I didn’t even get a commission on the product as he went through another carrier – I advocated more coverage. Period. The “plenty of term” is now what she will live a rather comfortable life on; thank you insurance industry. We are agnostic – be it stocks, annuities, mutual funds, life insurance, whatever, whatever. No one product nor methodology rules supreme. Thanks for the ending bash 🙂 I could say the same for an advisor who advocates 100% term that is thrown away dollars when the client is older and alive and wishes they had coverage. I tend to like term AND whole life and wish it were better explained to people in our world.
I find the vast majority of people, including docs, don’t need whole life. That’s why 80% of it is surrendered prior to death. My email box is filled with people who wish they hadn’t bought their whole life policies.
If you think most people need it, we have a fundamental disagreement.
So… making a FAIR comparison… what would this whole life success story’s return be when you INCLUDE THE DEATH BENEFIT that you consistently ignore in your posts?
Since whole life policies often have a death benefit that is often about TWICE the cash value, well, I wouldn’t be surprised if this gentleman’s policy has earned a total of 12 or 14%. Super curious….
I get it… you probably don’t have heirs and so you don’t value the long-term planning that many prefer to do so that they can leave unencumbered, income-tax free assets to children, grandchildren, spouses, foundations, etc. But many of us DO value long-term planning and intend to leave our adult children and charities we care about something as a legacy, so we value more than just the cash in a policy.
I wish that more people understood this incomplete way that whole life is represented, as well as the importance of permanent life insurance for many people. Term insurance is very profitable for insurance companies, it’s a lot like warranties that expire before you need them! I fear that people could be making important decisions on information that is quite biased (even though at times you admit your bias.)
I find your financial memory to be a bit selective, too. Of course, T-Bills didn’t stay at 10%, they are now paying less than whole life… WITHOUT a death benefit. Would you kindly compare the T-bill average over the last 29 years with this example of whole life’s 7% plus the death benefit?
Interesting that you belittle whole life’s guarantees while recommending assets with NO guarantees. Kind of a cheap shot, considering that whole life policies have NEVER paid “only” the guarantees, while stocks carry such tremendous risk, and other guaranteed assets (CDs, T-bills) consistently under perform whole life with maximum PUAs.
I’m also curious why you can’t accept the policy owner’s assertion that his stocks only earned 3%, and you have to come up with your own figures of what stocks “should have” earned? That’s about what real investor returns are, I think Dalbar says 3.5% over the last 20 years.
No, I don’t sell insurance, I just write about it. And like another of your commentors, I don’t consider whole life an “investment” – I consider it savings + protection. I learned a hard lesson in the last downturn how valuable liquidity and guarantees can be. Now I get why it’s essential to have truly adequate savings and protection before one “invests” in financial vehicles that have risk, can’t be controlled or predicted or leveraged, and where we must absorb fees, taxes, and losses if we have are forced to sell when a market is in a ditch (or our tenants stop paying rent).
If I was investing though (and not “saving,” I still wouldn’t do stocks, bonds, or T-bills, at least not for more than 20% of my portfolio… I’d focus on alternative investments paying 7-12% without loss of principle.
Thanks, Kate
Thanks for stopping by Kate. It’s clear that you’re a fan of whole life insurance. If you think it’s awesome, and your clients understand how it works and also think it’s awesome, then I’d encourage them to buy as much of it as they like. It really doesn’t bother me.
But unfortunately you’ve misrepresented the facts so I feel compelled to respond so that future readers of your comment don’t think you’re right.
First, the death benefit is not “often twice” the cash value. It is twice the cash value at one very rare incident in time. In the beginning, the death benefit is dramatically higher than the cash value. At the end (meaning life expectancy and beyond) it is more or less equal to the cash value. So at some point in there, it is twice the cash value, but not most of the time.
Second, if you wish to calculate the “return” on the death benefit, it would be best to do that the day after it is purchased. It will be so high that there is no investment that will even come close. Thus, someone who needs life insurance should buy life insurance. However, the return on the first annual term life insurance premium will always be higher than the return on the first annual whole life insurance premium for obvious reasons. So obviously it doesn’t make much sense to calculate the return on the death benefit and compare it to an investment. But it does make sense to compare the return on the cash value to an investment.
Third, your insinuation that I have no heirs seems to suggest something is going to happen to my kids between now and my death. That tells me you either don’t read this blog regularly or that you hate my kids. Your insinuation that I don’t plan to leave them anything because I haven’t purchased whole life insurance is also rather simplistic. You can leave your kids lots of stuff as a legacy without ever purchasing a whole life insurance policy. In fact, you’re likely to leave them more by purchasing a better investment. And those investments have the same tax-free “death benefit” called the step-up in basis at death. Either way, if your goal is to somehow insult me and threaten my family, you’ll discover that you have a short stay in the comments section of this blog.
Fourth, I’ve addressed issues with the Dalbar study elsewhere. Its primary use now is for whole life agents to trot it out and point out how crappy people are at investing and that they’d be better off buying whole life insurance. Well, the folks who can’t design and stick with a conventional investing strategy are the same folks who can’t design and stick with a good whole life policy. So compare the bad investors to the bad whole life purchasers, not the bad investors to those with optimized whole life policies.
Fifth, I’m sorry you weren’t financially prepared for the last downturn. I was and here at this website I teach others how to get their finances in shape so they can be prepared for the next one.
Sixth, your promise of alternative investments paying 7-12% without loss of principal is a thinly-veiled reference to IUL, indexed annuities and similar products designed to be sold, no bought, that I have debunked elsewhere. There are no real investments currently available that have long term returns of 7-12% and guarantee no loss of principal.
Seventh, you may wish to review this: https://www.translegal.com/common-mistakes/principal-vs-principle if you are going to continue to work in the financial world.
No, no threats here, I wish you and your family a long and healthy life!
Sloppy of me, I was only referring to the example in this particular post – a 29-year-old policy when I mentioned that death benefit is often around twice of cash value. (In a young policy, that would make for a tiny death benefit!)
So apparently, the real return for the gentleman’s family will be much higher than 7% (and I wish him a long and healthy life, too) It just continues to strike me as odd that people who aren’t fans of WL refuse to calculate what an actual policy will pay an actual family. I guess the death benefit is too high in the early years (and of course no one wants to earn that return anyways), and apparently it never reaches a point – even after 29 years – where it is considered an actual part of the returns of the policy, depending on who is holding the calculator.
You make a valid point about Dalbar (people who can’t stick with a strategy), though I am also disturbed (in my experience with financial reps) that returns of the market get misrepresented as the return someone should actually get in their 401(k) after taxes and fees, which of course just isn’t so. But I’m growing more and more concerned about the volatility there… the market seems to have higher peaks and lower valleys of late.
And no, I’m not a fan of IUL at all. I’m with you on this one – keep insurance and investments separate. I was referring to private equity funds that are structured and sometimes even contracted for monthly returns in the low double digits. (Unfortunately I’m not nearly at a point where I’m qualified to participate.) Technically there is always a risk, it’s a bridge loan product and I would only ever invest with a company that had not lost anyone’s principle.
Thanks for your good work, if I overlook your anti-WL bias, I think you do some pretty valuable financial education here and in your book.
Best
I just realized there is only one correct and accurate way to calculate the ROI of a particular WL policy – after the death benefit is paid!
Interesting article, I agree with the WCI that whole life is not a great investment vehicle. That said, it is not a terrible investment if it is properly explained and understood. It has a niche role in some peoples investment portfolio, and this article is a good example. Full disclosure, I sell WL or at least I can and do at times. I am not the biggest advocate of the product but it does have some benefits. There are a few things to consider when considering whole life.
1. Buy it from a mutual company as mentioned, not a stock company.
2. I believe a poster has already mentioned this, although I have not read many of the comments, only the blog itself. However, WL even in today’s market of low interest rates(low but rising) will give a return of 4-5%. As stated by the WCI, whole life polices have a terrible return the first several years. You also cannot get an expense summary on WL, like you can VUL, since whole life is a bundled product. However, it does play catchup some in later years. It is a nice conservative return as you get older, which is exactly when you need a steady conservative return. Personally, I am not that patient to look down the road when I am 55-65, that is why I have a bit of a personal bias with WL. There are some personalities and portfolio goals that it can work for, and I stay open to that.
3. It can serve as the conservative portion of a persons portfolio that would otherwise be reserved for bonds. To be clear, bonds can outperform WL in many scenarios, but they can also go horribly wrong since the price and yield are inversely related. WL has a place for the person that wants something that is completely risk adverse in their later years.
4. We went through 15 years of historically low interest rates, this made WL extremely unappealing. We are now paying the piper for all those years of low rates and quantitative easing, and it is possible that we could have an extended period of higher rates to battle that inflation. This is a possible case that could be made for whole life. If you currently own a policy, your rates will be going up and if you currently own a VUL(a product I prefer) more than likely your returns are not very good right now. There is also a good case to be made that the Federal Reserve will not have the fortitude the way it did in the early 1980s, time will tell.
5. I agree with WCI, do not squeeze your budget for a WL policy, if you have room and are comfortable with your more aggressive investments, then it can serve a purpose. If you are investing in mutual funds, index funds, etc, then you are well aware of the market fluctuations. Getting an average return of 9-10% means some years you will get 25% and some years you will get -10%.(just a hypothetical example)
If you retire at 65 and you are starting to draw from your nest egg, whole life can give you some flexibility. If the market takes a hit durning the early years of your retirement, you can leave the market investments alone and allow them time to recover. Do not add insult to injury by drawing down from an account that is already losing money. Instead draw down from your fixed portfolio, which could be whole life. Allow your market accounts to correct, and then start drawing them down. There is math that can show your money will last significantly longer with this strategy, I do not want to go down that rabbit hole at the moment. After all, we do not know where the market will be when we retire, we could be retiring in 2010 and all will be well, or it could be 2000 or 2008 and we may need some fixed investments to hold us over and preserve our money. This is where whole life can come in, it does not mean there are not other options to achieve similar results. It just means whole life can have a positive role in your portfolio, even if it is not my preferred product.