Today we continue our series on whole life insurance. On Monday we learned about the basics of whole life. Yesterday, we learned it isn't the best way to protect your pre-retirement income, that it isn't the best way to get a guaranteed death benefit, that it provides low returns, and that insurance companies aren't any better at investing than mutual funds, pension funds, or intelligent individual investors. Today, we'll explore 5 more myths used by insurance agents to sell whole life.
Myth # 5 Whole Life Is A Great Asset Class
There are lots of asset classes worth including in a diversified portfolio, but whole life isn't one of them. Insurance salesmen generally resort to this argument once they've realized they can't convince you that whole life is a great investment in and of itself. They say that if you mix it into a portfolio of stocks, bonds, and real estate that it will improve the overall portfolio. However, you can call anything you want an asset class. Horse manure can be an asset class, but that doesn't mean you should invest in it. Think of it this way. If I told you I had an asset class with the following characteristics:
- 50% front load the first year
- Surrender penalties that last for years
- Requires ongoing contributions for decades
- Difficult to rebalance with other asset classes
- Backed by the guarantees of a single company (and whatever you can get from a state guaranty association)
- Requires you to pay interest to get to your money
- Guaranteed negative returns for the first decade
- Low returns even if you hold it for decades
- Must be held for life to provide even a low investment return
- Excluded from the investment for poor health or dangerous hobbies
would you buy it? Of course not.
Myth # 6 Whole Life Is A Great Way To Save On Taxes
Whole life isn't the best way to lower your investment tax bill, retirement accounts are. Many agents like to tout the tax benefits of whole life insurance, often comparing it to a 401K or a Roth IRA. The cash value does grow in a tax-protected manner, the cash value can be borrowed tax-free, and proceeds from the policy at your death are income (although not estate) tax-free. So some whole life advocates suggest you use whole life insurance instead of a retirement account like a 401K or a Roth IRA. However, a 401K or Roth IRA not only provides MORE tax savings and allows you to invest in riskier investments that are likely to provide you a higher return, but you also don't have to borrow your own money, nor pay interest for the privilege of doing so.
I've posted previously about the Three Ways A 401K Saves You On Taxes and on how Whole Life Insurance Is Not Like a Roth IRA. I've also posted about how tax-efficient investments in a Taxable Investing Account don't carry nearly the tax burden agents like to tell you they do. Are there tax benefits of investing in life insurance? Yes, but they are dramatically oversold.
Myth # 7 Whole Life Insurance Protects Your Money From Creditors
Insurance agents love to use this one on doctors, who can be paranoid about asset protection issues. However, they often don't mention (or perhaps even know) that asset protection laws are very state-specific. For example, in Alaska, only $12,500 of whole life insurance cash value is protected from creditors, but 100% of the money in your 401K or IRA is protected. West Virginia only provides an $8K protection. South Carolina protects $4K. New Jersey doesn't provide any protection. Many states do provide 100% protection for whole life insurance cash value, but you probably ought to look up your state's specific laws before falling for this myth.
Myth # 8 You Need Whole Life For Estate Planning
Cash value life insurance has some great estate planning features that can be very useful. However, the vast majority of people, including doctors, don't need those features. The primary benefit of life insurance is that you get a bunch of income-tax free cash at your death. This can help with a lot of liquidity issues, such as ownership of expensive property or a private business. If you have two children that you want to share in your estate equally, and most of your estate is the family farm, they would either have to sell the farm, cut it in half, or have one buy out the other in order to share equally. However, if you also had a life insurance policy with the same value as the farm, one kid could get the farm and the other could get the insurance proceeds. Likewise, in the fortunate event that you have a very large estate (more than $5 Million for single folks in the federal tax code, but can be much less in some states), the life insurance proceeds can be used to pay the estate taxes. This would be useful even with a single heir to prevent him from selling a valuable property or business at fire sale prices in order to pay the tax bill.
Some folks also like to put life insurance inside an irrevocable trust to decrease the size of their estate and avoid estate taxes. While you can put simple taxable investments into the trust instead (and would likely come out ahead due to higher returns), trust tax rates can be quite high, putting serious drag on returns for tax-inefficient investments, not to mention the hassle factor. It's important to point out that it isn't the life insurance saving money on estate taxes, it's the fact that you're giving away your assets before you die by putting them into the trust.
However, the fact is that the vast majority of Americans, even physicians, and even including physicians with an “estate tax problem”, don't need whole life insurance to do effective estate planning. Most people will die without any estate tax burden. Of those whose estates will owe some estate taxes, the vast majority have liquid assets that can be used to pay the taxes. Even if you want to reduce the size of your estate to prevent estate taxes, you can easily do so without purchasing life insurance. You and your spouse can give $14K each to any heir in any given year without any estate/gift tax implications. As an example, if you had 4 kids and they each had 4 kids and all 20 heirs were married, that's 40 people. 40 x $14K x 2 = $1.12 Million per year that can be taken out of your estate without paying any estate/gift taxes. It won't take long to get underneath the estate tax limit at that rate, no insurance needed.
Myth # 9 Whole Life Is A Great Way To Pay For College
Some agents even go so far as to suggest you use a whole life policy to pay for your children's college. Can you do this? Of course. You simply take out policy loans and send that money to the university to pay tuition. But you're better off saving up for college using a good 529 for multiple reasons. First, you often get a state tax break by using a 529 that isn't available for whole life insurance. Second, you don't have to borrow money from your 529, you just withdraw it. No interest payments required. Last, but certainly not least, consider the time frame of college savings. Parents generally save for college over a period of 5-20 years. By investing that money aggressively, they can expect a return of 7-10%. Whole life insurance has very poor returns for time periods of less than 20 years. In fact, many times the cash value return on your “investment” in whole life is negative for at least a decade. It's important to make sure your money works as hard as you do, and your money is on vacation for the first decade in a whole life policy. Whole life advocates will point out that if you died, the death benefit could still pay for Junior's college, but it is far cheaper to cover that risk with term life insurance.
Tomorrow we'll talk about 5 more of the myths of whole life insurance, but for now, let's talk about these five. Agree? Disagree? Comment below! Please reference which “myth” you're referring to in your comment and keep comments civil and on topic. Ad hominem attacks will be deleted.