This is the last article in our series on whole life insurance.  This week we've learned how whole life works and that it isn't great insurance or a great investment.  We also learned about the problems in using it to save taxes, protect assets, and plan estates.  Yesterday we learned that it isn't a valuable luxury, isn't necessary for retirement planning, isn't a great way to buy expensive stuff, and isn't something you need to rush out to buy when you're young. Today, we'll explore 4 more myths used by insurance agents to sell whole life.

Myth # 15  Waiver of Premium Riders Are A Good Way To Protect Your Retirement From Your Disability

Whole life insurance isn't the best way to protect your retirement income from your disability, disability insurance is.  Recognizing that whole life insurance premiums are really expensive and would be difficult to make in the event of disability, the insurance companies began offering a rider that waived the premiums in the event of your disability.  Sometimes you don't even appear to have to pay extra for this benefit.  Those who fall for this tactic are missing a couple of points.  First, guarantees are not free.  Every guarantee costs you money in the form of a lower return, whether the insurance company charges extra for the guarantee or “bakes it into the policy” so it is hidden.

Second, disability insurance is complicated and the definition of disability is all important.  Most doctors who want disability coverage spend  a lot of money getting a really nice policy with a broad definition of disability including “own-occupation” coverage because they want to make sure the company is going to have to pay in the event of their disability.  The riders sold on whole life policies aren't nearly as comprehensive and are far less likely to be paid in the many gray areas that disabilities often fall into.  You will almost certainly be better off buying a bigger disability policy rather than a whole life waiver of premium rider.  Your disability insurance may also offer a retirement protection rider.  While these have issues as well (primarily in the way the benefit is paid out), they're better than trying to get your disability insurance from a whole life policy.

If you're planning an early retirement like I am, you may realize you don't need your disability coverage to protect your retirement contributions anyway, at least after a few years of heavy savings.  Consider having a $750K portfolio at age 40.  You figure you need $2 Million in today's dollars for retirement.  You plan to save heavily so you can achieve that at age 50 and retire.  What is the back-up plan if you get disabled and can't save all that money?  Your disability insurance doesn't just pay to age 50.  It pays to age 65.  So you don't need your portfolio to cover those 15 years.  You can also start getting Social Security payments by the time the disability payments run out.  Since you don't have to touch your portfolio, it can continue to grow.  If it grows at 5% after-inflation, by the time you hit age 65 it will be worth over $2.5 Million in today's dollars.  Don't buy insurance that you don't need.  But even before you have any kind of portfolio, the best way to protect your retirement savings is to buy MORE disability insurance, not to try to get it from a whole life policy.  Even if you could use the extra coverage to provide your retirement portfolio, you need to be able to put it into an investment with a high return, which whole life is unlikely to provide.  An aggressively invested taxable account is just fine since your main income if disabled, your disability insurance benefits, are tax-free.

Myth # 16  You Should Exchange Your Lousy Old Whole Life Policy For A Shiny New One

Since an agent gets a new commission every time he sells a new policy, even if he replaces an old one from the same company, he has a serious conflict of interest in making recommendations to you.  I interact with lots of insurance agents on this blog, and none of them agree with the others about what a “properly-structured” whole life policy is.  That means if you go to a second agent, he will almost surely tell you that there is a better way to do it.  However, for it to be worthwhile to exchange one policy for another the original policy has to be absolutely horrible, especially after a couple of decades.  The reason for this is that the poor returns on whole life insurance are concentrated into the early years.  I took a look at a policy recently.  This was set up as an investment with paid up additions for the first 25 years.  It was the agent's best attempt at maximizing the returns of a policy.  Here is how the annualized returns looked:

Guaranteed Projected
First 10 years -1.84% 0.98%
Next 15 years 2.55% 5.47%
Next 25 years 1.99% 5.13%

This demonstrates that the poor returns are highly concentrated in the early years.  With this particular policy, the returns actually decrease after 25 years because that is when you stop making paid up additions.  With a more traditional policy the third row would be slightly higher than the second row.  But the moral of the story is that you should buy the “right policy” first, and even a crappy policy that is more than 10 years old is going to be better than a brand new better policy.  This is also the reason that it can be a good idea to keep an older whole life policy, even if buying it in the first place was a mistake.  It's also noteworthy to see how little risk the insurance company is actually taking, since it isn't even guaranteeing that your cash value will keep up with inflation.

Myth # 17 Whole Life Is The Only Way To Pass Money To Heirs Income Tax Free

Whole life isn't the only way to pass money to heirs income-tax free at your death.  In fact, it isn't even the best way, a Roth IRA is.  When you die, your heirs get an insurance death benefit that is free of income tax.  What agents often fail to mention, is that just about everything your heirs get from you when you die is income tax free.  Thanks to the step-up in basis at death, anything outside of a retirement account, including furniture, automobiles, stocks, cash, mutual funds, and real estate is all revalued on the day of your death.  Since the basis is now the same as the value, there are no capital gains taxes due.  Inheriting a retirement account can be even better, especially a Roth account where the taxes have already been paid.  You can take all the money out the same year you inherit it and not pay any taxes at all.  Or, you can “stretch it”, taking withdrawals gradually over decades until you die.  Meanwhile, it continues to grow tax-free.  You can stretch an inherited tax-deferred account too, but you do have to pay taxes on any money withdrawn from the account.

Myth # 18 With Whole Life, There Is No Way I Can Lose Money

People invest in whole life insurance because they like guarantees.  The insurance company guarantees that you'll get a certain rate of growth on your investment and it guarantees a death benefit.  The guarantees, however, aren't worth nearly as much as people often assume.  For instance, the guaranteed scale of any whole life insurance policy guarantees that your money will grow slower than the historical rate of inflation, despite sticking with it for half a century.  Before deciding to trust a single company with your life savings, you might want to consider what happens if it goes out of business.  There are state insurance guarantee associations that will cover the cash value and death benefit of your policy, but how much will they really cover?  You might be surprised how little it is.  In my state, only $500K in death benefit and $200K in cash value is covered, NO MATTER HOW MANY POLICIES YOU OWN.  Your state is probably similar.  No wonder agents are always talking about the long-term viability of their insurance company.  It really does matter!  Now I don't think the risk of any given insurance company going out of business in any given year is very high, nor do I think a typical purchaser is likely to end up with exactly the guaranteed growth rate.  But before buying, you should realize that investing in whole life insurance isn't the risk free proposition agents like to present it as.

Summing It Up

Whole life insurance is a terrible investment if you don't hold on to it to your death.  Since the vast majority of people surrender their policies prior to death, it is a terrible investment for the vast majority of those who purchase it.  If you want to invest in it, then you need to place a very high value on its unique aspects and not mind it's serious downsides.

The ideal purchaser of whole life insurance should:

  1. Need or desire a guaranteed, but possibly slowly increasing, life-long death benefit,
  2. Understand that the guarantee/contract essentially relies on the insurance company staying in business for as long as he lives for any policy of reasonable size,
  3. Live in a state that protects 100% of the cash value from creditors,
  4. Have some estate planning liquidity issues,
  5. Be in excellent health,
  6. Pursue no dangerous hobbies,
  7. Not mind having low returns on his investment despite holding it for decades,
  8. Have serious philosophical aversion to using traditional financing resources such as banks and credit unions (or simply just saving up for what you want to buy),
  9. Have already maxed out all available retirement accounts including backdoor Roth IRAs and HSAs, and
  10. Be willing to hold on to the policy until death no matter what changes in his financial life in the future.

The fact is that only a tiny percentage of the population, far smaller than the number of people who have been sold these policies historically, meets all or even most of these criteria.  Whole life insurance remains a product designed to be sold, not bought.

What do you think?  Agree?  Disagree?  What other myths do whole life advocates spread?   Sound off in the comments section!  Please reference which “myth” you're referring to in your comment and keep comments civil and on topic.  Ad hominem attacks will be deleted.

Update! This series has been extended to a Part 5 and a Part 6!