By Dr. James M. Dahle, WCI Founder
There are more than 400,000 insurance agents in this country, and almost all of them would love to sell you a whole life insurance policy. If you buy a policy with premiums of $40,000 per year, the commission would typically be somewhere between $20,000 and $44,000 for that agent. As you might imagine, that commission can be highly motivating, especially given the median insurance agent income of $49,840. To make matters worse, many of the worst policies offer the highest commissions. Unfortunately, the vast majority of policies sold are sold inappropriately and the vast majority of those selling it are salesmen masquerading as financial advisors.
As a result of this ridiculous conflict of interest, agents can often throw out some serious myths in an effort to persuade you to buy their product, which might explain the damning statistic that 80%+ of those who buy this product get rid of it prior to death and polls of actual real life doctors on this site and our Facebook group show that the vast majority of those who have purchased whole life policies regret their purchase. If this is all news to you, then go read Everything You Need to Know About Whole Life Insurance before continuing on with this post.
The numbers are similar but slightly lower in the ongoing poll on this site (which unlike the FB group permits voting to be done by those who sell these policies.)
Lots of people think I hate whole life insurance. I actually don't. I hate the way it is sold and those who sell it inappropriately. If you really understand how it works and still want it, then feel free to buy as much as you like. It really doesn't affect me one way or the other. But I'm sick of running into readers and listeners who DID NOT understand how it worked when they bought it, and once they do understand it, DO NOT want it.
How Whole Life Insurance Works
Whole Life Insurance can be set up in many different ways, but in general, you pay a monthly or annual premium for either a defined period of time, or until you die. The longer the period of time over which you pay the premiums, the lower the premiums. Whenever you die, your beneficiary gets the proceeds of the policy. Since every whole life policy is guaranteed to pay out if you just hold on to it to your death, the premiums are much higher than a comparable term life insurance policy.
A whole life insurance policy, like other types of permanent life insurance, is really a hybrid of insurance and investment. The policy accumulates cash value as the years go by. That cash value grows in a tax-protected manner, and you can even borrow the money in there tax-free (but not interest-free). Upon your death, whatever you borrowed (plus the interest) is taken out of the death benefit, and the rest is paid to your beneficiary. (You get the cash value or the death benefit, not both.)
This investment aspect allows those who sell whole life insurance to find all kinds of creative reasons you should buy it and creative ways to structure it. The most extreme advocates may even argue that you don't need ANY other financial products during your entire life since whole life insurance can apparently take care of all your needs including mortgages, consumer loans, insurance, investments, college savings, and retirement.
The problem is that for every use of whole life insurance, there is usually a better way to deal with that financial issue. This post is the 38 frequent myths about whole life insurance propagated by its advocates.
Myth #1 – Whole Life Is Great for Pre-Retirement Income Protection
Whole life insurance is not the best way to protect your income, term life insurance is. Before you retire, you can purchase inexpensive term life insurance to take care of your loved ones in the event of your untimely death. A 30-year level-premium term life insurance policy with a $1 Million face value bought on a healthy 30 year old runs $680 per year. A similar whole life policy will cost more than 10 times as much, $8,000-$10,000 per year. That is money that cannot be spent on mortgage payments or vacations, nor invested for retirement.
Myth #2 – Whole Life Is the Best Way to Get a Permanent Death Benefit
Whole life isn't the best way to get a permanent death benefit—guaranteed no-lapse universal life is. There are a select few people who need or want an insurance policy that will pay out at their death, whenever that may be. This can be useful for some unusual estate planning issues. However, there is a better product that provides this and is much less expensive than whole life insurance. It is called Guaranteed No-Lapse Universal Life Insurance. It does NOT accumulate any cash value but simply provides a life-long death benefit. It only costs half as much as whole life insurance, so you won't be surprised to learn that the agent's commission on this sale will be far lower.
Call me cynical, but I suspect that might be one of the reasons you've never heard of guaranteed no-lapse universal life. Whole life insurance provides a guaranteed death benefit that is PROJECTED (but not guaranteed) to grow slowly so that if you die at your life expectancy or later you'll leave behind a little more than the original policy death benefit.
Death Benefits and Inflation
A whole life policy I looked at recently projected the death benefit of a $1 Million policy, bought at 30, would be $3.17 Million at death at age 83. That sounds great, almost like an inflation protection of the death benefit. Except historical inflation is something like 3.1%. At 3.1%, $1 Million now would be the equivalent of $5.04 Million in 53 years. A whole life policy would be devastated by unexpected inflation, since the dividends are backed primarily by nominal bonds, whose values would be murdered in a high inflation environment.
Therefore whole life insurance is neither the best way to provide a guaranteed life-long nominal death benefit nor a guaranteed life-long real death benefit. So what is it good for? How about a guaranteed death benefit that might increase if the insurance company feels like increasing it? Would you be willing to pay premiums that are twice as high for that? I didn't think so.
Myth #3 – Whole Life Insurance Provides a Great Investment Return
Whole life isn't the best way to invest—traditional investments are. When you pay your whole life premiums part of the money goes toward buying insurance, part of it goes toward overhead and profit for the insurance company, and part of it goes toward the commission for the salesman. The rest then goes into the cash value portion of the policy.
Each year, the insurance company declares a dividend, and if there is $10,000 in the cash value portion and the dividend is 6%, then $600 gets credited to your cash value. The dividend is only applied to the cash value, not the entire premium paid, so the average dividend rate is in no way, shape, or form related to your actual return on the policy as an investment. In fact, the return on investment is generally negative for at least a decade. I recently analyzed a policy for a healthy 30-year-old male with a 53-year life expectancy. The guaranteed return on the cash value was less than 2% per year AFTER 5 DECADES.
Even if you use the insurance company's optimistic “projected” values, you're still looking at a return of less than 5%. In reality, you'll probably end up with a return of 3%-4%. Considering you have to hold on to this “investment” for 5 decades, that doesn't seem like much compensation. If you have decades to invest, it is far wiser to take more risk with your investments and earn a higher return. An investment in stocks or real estate is likely to provide a return over decades in the 7%-12% range. $100,000 invested for 50 years at 3% per year will grow into $438,000. If it grows at 9% instead, you'll end up with $7.4 Million, or 17 times as much money. The rate at which you compound your long-term investments matters, especially over long periods of time.
Myth #4 – Insurance Companies Are Great Investors
Some agents believe that insurance companies can somehow get investment returns that you or I cannot find elsewhere and pass those great returns on to their policy owners. It can be illuminating to look under the hood and see what is really in the portfolio of an insurance company. In 2016, insurance company assets were invested 67% in bonds (almost all in run-of-the-mill corporate and treasury bonds), 1% in preferred stock, 12% in common stock, 8% in mortgages, 1% in real estate, 4% in cash, 2% in loans to their policy owners, and about 5% in “other.” Thanks to the index fund revolution, an individual investor can buy nearly all that stuff for less than 10 basis points per year in expenses. Active management doesn't work any better for insurance companies than for mutual funds.
As you might expect, the returns on a portfolio composed primarily of treasury bonds (currently yielding 1%-2%) and corporate bonds (currently yielding 3%-4%) aren't particularly high. So where do dividends come from? Part comes from the return on the investment portfolio, part comes from the fees of those who surrendered their policies, and part comes from “mortality credits,” which is basically money they didn't have to pay out to beneficiaries because fewer people died than they planned for (i.e., you paid too much for the insurance portion of the policy in the first place due to state regulations). There are no magic investments that insurance companies can invest in that you cannot without the company. Every additional layer between you and the investment just increases expenses and lowers returns.
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 401(k) 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 401(k) or a Roth IRA. However, a 401(k) 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 3 Ways a 401(k) 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 Alabama, only $500 of whole life insurance cash value is protected from creditors, but 100% of the money in your 401(k) or IRA is protected. West Virginia only provides an $8,000 protection. South Carolina protects $4,000. New Hampshire 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 $16,000 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 $16K x 2 = $1.28 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.
Myth #10 – Whole Life Is a Luxury You Want
Insurance agents will occasionally fall back onto this argument when it has been pointed out that a client doesn't really have any kind of a need for a permanent death benefit. They admit that the client doesn't actually need whole life insurance. Then they try to sell it based on having it as a status symbol or luxury. “Sure, you don't need it, it's a luxury.” A luxury is by definition something you don't need. I prefer my luxuries to be something that I really enjoy. So before buying whole life insurance as a luxury, ask yourself, “What do I really enjoy?” If it is owning whole life insurance, fine, buy some. But I bet most of us would prefer a luxury such as a nice car, a cruise with the grandkids, or perhaps a donation to a favorite charity.
Myth #11 – Whole Life Lets You Spend Down Your Other Assets, Providing Valuable Flexibility in Retirement
Whole life isn't the best way to ensure you don't run out of money, annuitizing some of your assets is. Whole life isn't the best way to deal with the second to die issue, properly structuring pensions and annuities is. Whole life agents like to come up with retirement scenarios that make you feel like you have to own or at least want to own permanent life insurance, especially for a married couple. For example, they'll talk about a pension that only pays out until the working spouse died. Or they'll talk about annuitizing some portion of your assets based on the life of only one member of the couple. Then they'll suggest that the proceeds of the whole life policy be used for living expenses by the second to die spouse. There is no reason to use a whole life policy in this way. If you want your pension to last until you both die, then select that option. If you want your annuity to last until you both die, then choose that option. Yes, it will pay out at a slightly lower percentage, but the difference between payouts is less than the cost of a whole life insurance policy that would cover the loss of that pension. It simply isn't the right solution to the problem. Does whole life insurance provide some flexibility in retirement? Sure, but the cost for that flexibility is too high.
Myth #12 – Whole Life Is a Great Way to Buy Expensive Stuff
Whole life isn't the best way to buy expensive stuff, saving up for it is. There are some really creative insurance salesmen out there advocating for systems such as Bank on Yourself or Infinite Banking. The basic scheme is this: by structuring your policy appropriately with paid up additions, you get a lot of cash value into your policy in the early years, such that you break even in 3-4 years rather than 8-15 years. You also buy a policy that is “non-direct recognition.” This means that when you borrow from the policy, the insurance company continues to pay dividends on the amount that was in there before you borrowed it out, so the policy dividends essentially cancel out the interest payments due on the loan. Now, rather than going to your savings account or to a bank to borrow money when you need a car, a refrigerator, or an investment property, you borrow from your whole life policy at essentially no cost. Further, the cash value in the policy that you don't borrow will grow faster than the money in a savings bank.
So what's the problem? The problem is that you have to buy a whole life policy you don't need. You might break even sooner than you would with a traditional policy, but there are still several years of negative returns and in the long-term, the same low returns. Is it better to earn 4%-5% a year after 5 years or earn 1% a year starting in year 1? Well, for the first 6 or 7 years you're better off with the 1% a year savings account. Also, if interest rates go up from their historic lows, you're still locked in to this system for the rest of your life. It wasn't very long ago that I could get over 5% from a money market fund. It also seems to be very easy to finance a car at a dealership at extremely low interest rates. 0% or 1% are not uncommon. You're better off borrowing from them at 1% than from your policy at 5%. It's a similar issue with appliances and mortgages. You go through all this effort so you can borrow from yourself, then realize it's cheaper to borrow from someone else. Finally, if you don't need to make a purchase for 5 or 10 years, you've got time to invest in something likely to have a much higher return than a whole life policy. Are those who bank on themselves being scammed? Not necessarily, but they're generally oversold on the benefits of their scheme. Its advocates are primarily insurance agents looking to increase sales through creative marketing. Saving up is simply a better way to make big purchases than buying a whole life policy.
Myth #13 – Really Rich People or Businesses Buy Whole Life Insurance So You Should Too
Whole life advocates, particularly those who advocate using your policy as a bank, like to point out that lots of very wealthy people and lots of businesses (including banks) actually buy whole life insurance. While true, it is irrelevant for the typical person. Big businesses don't have access to the tax-saving retirement account options that a middle class individual does. Ultra-wealthy individuals have already maxed these out. When you have far more money than you can ever need, the return on your money doesn't matter as much. Bill Gates can afford to invest in something that provides returns of 2%-5% because he doesn't need his money to work very hard. That's simply not true for the vast majority of middle to upper class people, including doctors. As discussed above, ultra-wealthy people also have more use for the limited estate planning benefits and asset protection benefits of permanent life insurance. In short, the low returns inherent in whole life are much less of an issue for them than they are for you.
Myth #14 – You Should Buy Whole Life When You're Young
Whole life salesmen like to point out that whole life is a lot cheaper if you buy it when you're young. While it is true that the premiums are lower if you buy a policy at 25 than if you buy it at 55, once you take into account the time value of money and the fact that you'll pay the premiums for 3 extra decades, it isn't any better of an investment at a young age than at an older age. Actuaries are very intelligent people, and for a risk that is relatively easy to model, like death, they can price insurance quite efficiently.
Aside from the lower premiums, there are two other reasons why it seems better to buy it when you're young. First, that commission is spread out over more years, so it has less impact on your overall returns. But the alternative of not paying the commission at all is far more attractive. Second, it's possible that you will either become less healthy or take up some dangerous sport later in life. This is one of the serious downsides of using life insurance as an investment—not everyone can use it. Either they don't qualify for it at all, or the price of insurance is so high that the returns on the investment are even lower than they would otherwise be. I don't see that as a reason to buy it when you're young, I see it as a reason not to buy it at all. Can you imagine if Vanguard sent a paramedic out to your house to draw blood prior to letting you buy their S&P 500 fund?
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:
|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.
Myth #19 – Life Insurance Should Not Be “Rented”
This one is pretty easy to see through, but you still see agents using it frequently. Since everyone “knows” that it is better to own a home than rent one, the agent says something like “You wouldn't rent your home for the rest of your life would you? So why would you rent your life insurance?” Basically, the agent is referring to the fact that if you use term insurance after age 60 or so, it becomes more and more expensive each year, just like renting a home. But unlike a home, you don't need life insurance after you become financially independent. When you only need a home for a year or two or three, it is a better idea to rent than to buy. When you only need life insurance for a decade or two or three, it is also a better idea to “rent” than to buy. The opportunity cost of “ownership” is simply too high.
Myth #20 – Banks Own Life Insurance So You Should Too
This is a frequent one heard from the Bank on Yourself/Infinite Banking crowd. An underpinning of this school of thought is that the greedy banks are taking over the world so you should only do your financial work through the trustworthy insurance companies. To be honest, I don't have massive distrust for either one of these industries. Both industries have mutually-owned options (mutual life insurance companies and credit unions) where, like Vanguard, the customers own the company. The agents like to point out that banks actually own whole life insurance as part of their “Tier One Capital,” the money used to determine if the bank is adequately capitalized or not. This is somehow to make you fear that the banks know something you don't, like the financial world is about to implode and any of those using banks instead of insurance companies for their financial needs are going to go broke. Tier One Capital is a measure of a bank's financial strength. Banks use less than 25% of their Tier One Capital to buy single premium whole or universal life insurance on a group of employees. The bank owns the policy and is the beneficiary. When the employee keels over, the bank gets the cash. The bank is buying the policy primarily for the death benefit, not because the return is particularly high.
Myth #21 – Corporate CEOs Own Whole Life Insurance So You Should Too
Agents, particularly of the Bank on Yourself type, love to point out that the golden parachutes for many highly-paid CEOs include cash value life insurance policies. However, just as the financial situation of a bank is dissimilar from that of a physician, so is the financial situation of a CEO making $10 Million a year different from that of a physician. When you're making a gazillion dollars a year, rate of return on your money becomes much less important and thus the benefits of whole life (asset protection, tax, estate planning, etc.) become relatively more important. It isn't that returns on whole life magically get better. Again, if you are in a position that you only need your long-term money to grow at 3%-5% nominal per year, then feel free to invest in whole life insurance. Most of us, however, need higher growth. Remember that a doctor making $200,000 per year and a CEO making $10 Million per year are in very different financial circumstances and what works fine for one will not necessarily work well for the other.
Myth #22 – Banks Failed During The Great Depression, but Insurance Companies Didn't
This myth again preys on the fears of a global economic meltdown. In 1933 there were two holidays. The first was a “Banking Holiday” in which the banks were closed for 10 days as sweeping regulatory changes took place. The second was an “Insurance Holiday” in which for a period of nearly six months you could neither surrender your cash value life insurance policies for cash, nor borrow against them. Aside from this holiday, 14% (63 companies) of life insurance companies actually DID fail during The Great Depression. In fact, if they would have actually marked to market the bonds and mortgages they held, they would have ALL been insolvent. Reforms were put in place during The Great Depression that fixed many of the problems leading to bank failures and the banking holiday. However, these reforms were never put in place for insurance companies.
Myth #23 – After-Tax, Whole Life Returns Are Better Than Bond Returns
This one usually goes like this. “If you can buy a bond yielding 5% and are in a 45% marginal tax bracket, the after-tax yield on that is just 2.75%. A whole life policy with a “tax-free” internal rate of return of 5% is better.” This is an apples to oranges comparison. What is the 1 year return on that whole life policy? 2.75% sounds a whole lot better to me than a -50%. Even at 10-20 years, the bond is still way ahead.
I wrote about a physician who was pleased with his 7% return on his whole life policy bought in 1983 (don't expect to see that again any time soon). Except that he could have bought a 30-year treasury that year yielding 10.5%. 10 years later, as his whole life policy is breaking even and interest rates have dropped, the bond purchaser has not only already more than doubled his money just from the coupon payments, but the capital gains on that bond added another 50% to his return. That investor would have done even better purchasing equities in 1983, the start of an 18 year bull market. A bond, which can be sold any day the market is open, simply cannot be compared in any fair manner to an insurance policy which must be held for life to have any decent kind of return. Besides, most physician investors can hold taxable bonds inside retirement accounts instead of a taxable account anyway. That retirement account not only provides for tax-protected growth like a whole life policy, but also a tax-rate arbitrage between your marginal rate at contribution and your effective rate at withdrawal, further boosting returns.
Even if your only choice is between buying bonds in a taxable account and buying whole life insurance, keep in mind that even at today's low interest rates you can still buy Vanguard's Long-Term Tax Exempt Muni Fund yielding 3.17% . The guaranteed return on whole life insurance cash value, held until your life expectancy, is about 2% and the projected return is only ~5%. Realistically, you should probably expect a return of 3%-4% over the long term on that policy. Of course, if you actually wish to cash out of that policy instead of borrowing from it (and paying interest for the right to borrow your own money), the earnings are just as taxable as any taxable bond fund. And if you want your money in a mere 10-20 years, you're going to come out way behind with the life insurance.
Now, if you really understand how whole life insurance works and you think its unique features outweigh its significant downsides, then feel free to run out and purchase as much as you like. It truly does not bother me. I do not make any money if you buy whole life, nor if you decide to buy something else. However, if you are like most, once you understand it, you won't buy it and in fact, if you already have, you'll probably be looking for the best way to get out of whole life insurance. Don't feel bad. 80% of those who purchase these policies surrender them prior to death, 36% within just five years. You've got to ask yourself why so many people who were apparently intending to hold this product for the next 40 or 50 years suddenly changed their mind. I'm sure it has nothing to do with it being inappropriately sold to the financially unsophisticated by insurance agents facing a terrible financial conflict of interest with their clients. Whole life insurance is a product made to be sold, not bought. It is a solution looking for a problem that exists for very few, if it exists at all.
Myth #24 – Whole Life Insurance Keeps Assets Off the FAFSA
This is one is merely misleading. The statement as it stands is true. The Free Application for Federal Student Aid (FAFSA) does NOT consider whole life insurance cash value as an asset of the student or the parents. The problem is, for the typical reader of this blog, that it doesn't matter. Your income alone will keep your child from qualifying for any need-based college financial aid. So if you buy a whole life policy for this reason, you're likely to be disappointed.
Myth #25 – Term Life Expires Without Paying Anything
Another misleading argument. I'm always surprised to see people fall for this line, but they do. Do you complain when you don't get to use your car insurance for any given six month period? How about when your house doesn't burn down? Or you don't get cancer and get to use your health insurance? Then why in the world would you complain that your term life insurance expires and you're still alive. Term life insurance is pure insurance. If you die, it pays. If you live, it doesn't. As a general rule, since on average insurance must cost more than it pays out (since insurance companies have both expenses and profits), you should insure against financial catastrophes. When it comes to death, the financial catastrophe is dying during your earning years, before you become financially independent. So that's the only time period you need to insure against. Some people only fall halfway for this argument, and buy return of premium term life insurance. The same principle applies, of course. You don't walk away empty-handed when your term life policy expires. You had insurance for the entire term, which is exactly what you needed.
Myth #26 – Whole Life Insurance Is the Perfect Investment
This outright lie comes from the true believers. They argue that whole life insurance is safe, liquid, tax-advantaged, creditor-proof, and offers a competitive return. These half-truths all add up to one big lie. Let's take them one at a time:
Safe from the cash value going down, perhaps, but not safe from losing money. A huge percentage of whole life insurance purchasers lose money because they cancel the policy at some point in the first 5-15 years before they break even on their “investment.”
I guess it's more liquid than owning a website or a rental property, but it pales in comparison to the liquidity available in a savings account or a mutual fund that can be liquidated any day the market is open. Even inside retirement accounts, there is absolute liquidity after age 59 1/2, and fair liquidity even prior to that date. Most of the time with whole life insurance you don't even get your money, you just have the right to borrow against it at pre-set terms. You can get that with a HELOC.
Few understand just how minor the tax advantages of whole life insurance are. There is no up-front deduction like a 401(k). Unlike a real investment, there are no capital gains rates if you surrender a policy with a gain and you cannot deduct the loss if you surrender it with a loss (the usual case). You don't get to use depreciation to reduce the tax burden of your income like with real estate. Instead of being able to withdraw the money tax-free like with a Roth IRA, you can only borrow against the policy, and that's tax-free but not interest-free, just like borrowing against your house, car, or mutual fund portfolio. Sure, you don't pay taxes on the “dividends,” but that's because they're actually a return of premium (i.e., you paid too much for the insurance). The only real tax break associated with life insurance is that the death benefit is tax-free. But that isn't any different from any other investment, where you get the step-up in basis at death. In addition, whole life can't be stretched like an IRA. The tax benefits, such as they are, are limited to a single generation.
Too few docs understand just how low the risk of needing this protection actually is. I calculate my risk of being successfully sued for an amount above policy limits at 1 in 10,000 per year. Maybe half that now that I'm practicing half-time. So should I be so unlucky as to be that one person, I would declare bankruptcy and be left only with protected assets. In my state, that's my retirement accounts, my spouse's assets, $40,000 in home equity, and whole life insurance cash value. Your state may or may not protect whole life insurance cash value. Please actually check if you are so paranoid to actually buy whole life insurance for this reason.
#5 Competitive Return
Are you kidding me? Competitive with what? Whole life insurance generally has a negative return for 5-15 years (sometimes more than 30 for really terrible policies). Even a good policy held for 5+ decades only guarantees a 2% return and projects a 5% return.
If I were going to draw up the perfect investment, it would definitely avoid the following characteristics of whole life insurance
- Guaranteed negative return for years
- Requirement to interact with and pay a commission to an insurance agent
- Requirement to give samples of body fluids and submit to a medical exam
- Requirement to answer pesky questions about my health
- Requirement to avoid risky activities
- Requirement to pay interest in order to use my own money
It only qualifies as an “okay” investment in certain very limited situations. It's not even close to a perfect one.
Myth #27 – Insurance Agents Are Just People
This is one of my favorites to see in any sort of discussion with an insurance agent about the merits of whole life insurance. It usually comes when I point out that my problem with whole life insurance isn't so much the product as the way in which it is sold. Obviously, many of them take that quite personally since they've dedicated their life and career to selling this product inappropriately. So they point out that there are bad doctors or that insurance agents are just people trying to make a living. I don't have a problem with the sales profession. I don't even have a problem with people earning commissions for selling stuff. Cindy gets paid on commission to sell ads right here at The White Coat Investor. But if you seek advice from Cindy about whether buying an ad at The White Coat Investor is a good idea for you, you're a fool. Insurance agents are just people and people respond to incentives. An insurance agent has a huge incentive to sell you a whole life policy. The commission on a policy is 50%-110% of the first year's premium. Now you know why he's trying so hard to sell you a big fat doctor policy.
Myth #28 – No 1099 Income with Whole Life
This was a new one to me. I thought I had heard every possible argument for buying a whole life policy until someone whipped this one out. How much trouble is it for you to deal with a 1099? It takes me about 30 seconds using Turbotax. Certainly not a reason to favor one investment over another. Remember not to let the tax tail wag the investment dog. Your goal isn't to minimize your taxes or maximize your tax-free income. It's to have the most money AFTER paying the taxes due.
Myth #29 – What Does The White Coat Investor Know? He's Just a Doctor, and Probably a Crappy One
Sometimes agents start with this argument, but frequently this is where they end, with ad hominem attacks. Sometimes it's phrased like one of these:
So, exactly how does being an ER doctor qualify you to give financial and insurance related advice?
Do everyone a favor and stick to studying medicine.
You’re young, a doctor and absolutely sure that you know everything.
Obviously, medicine has lots of problems and doctors don't know everything, but if the agent's best argument for whole life insurance is an ad hominem attack, that's a good sign that you should have stood up and walked out a long time ago.
Myth #30 – After Maxing Out a 401(k) and Roth IRA, Isn't Whole Life Insurance the Only Tax-Sheltered Option Left?
This is the wrong question to be asking, but the answer to it is still no. Just because it is the only option presented to you by an insurance agent, doesn't mean it is the only option. Other options for retirement savings include defined benefit/cash balance plans, an individual 401(k) for self-employment income, a spousal Roth IRA, your spouse's employer-provided accounts, and Health Savings Accounts (HSAs). In some ways doing Roth conversions and paying off debt is also tax-sheltered. But most importantly, there is no limit on investing in a non-qualified mutual fund account (where long-term gains and qualified dividends are somewhat sheltered from taxes) or in real estate (where income is sheltered by depreciation and capital gains can be deferred indefinitely by exchanging).
Obviously investing in whole life insurance compares better to investing in a taxable account than to a retirement account (where there is no comparison from a tax, investing, or in most states an asset protection standpoint). But the real problem with this argument is that it is focused entirely on the idea that any tax-advantaged investment is always better than any fully taxable investment. That simply isn't true. It also mixes up the idea of an investment and an account, two things that financially naïve doctors sometimes have a hard time telling apart. (Think of the accounts as different types of luggage and the investments as different types of clothing.) The real question to ask yourself when you hear this argument is “Where should I invest after maxing out my available retirement accounts?” The answer is a taxable, non-qualified account. Now you're left with the question of what long-term investment to invest in—tax-efficient mutual funds, real estate, or whole life insurance? It's pretty hard to really compare the merits of those three investments and end up choosing whole life insurance given its limitations and terrible returns previously discussed.
Myth #31 – The Estate Tax Exemption Could Go Down
The idea behind this argument is a rebuttal to the argument discussed in Myth #8. In summary, that argument is that you need whole life to avoid estate taxes, which is silly given the vast majority of doctors won't owe any federal estate taxes. The next step is for the agent to argue “Well, the estate tax exemption might be decreased.” Well, I suppose that's true. Congress can change any law they want any time they want. But buying insurance or investing based on what could happen seems foolhardy. I mean, it is probably just as likely that the estate tax is eliminated as the exemption reduced. It seems to me the best way to plan for the future is to project current law forward, since most laws aren't going to be significantly changed. If they are, you can make changes at that point. At any rate, it isn't like whole life insurance is some magic panacea to eliminate estate taxes. The only reason whole life insurance reduces your estate taxes is by making sure you have less money due to its low returns! The thing that reduces the size of your estate is the irrevocable trust you put the insurance into, and you don't even have to put insurance into it if you don't want to.
Myth #32 – Whole Life Insurance Protects from Nursing Home Creditors
This one was particularly fun to debunk. Apparently, the idea here is to not pay for your own nursing home care somehow by purchasing whole life insurance instead of mutual funds. I'm not sure exactly how those envisioning this process think it will go. Maybe they think the nursing home doesn't ask for money until after you die or something, which is, of course, completely silly. But I think what they're referring to is the ability to spend down your assets to Medicaid levels, get Medicaid to pay for the nursing home, and still be able to leave a huge inheritance to your heirs because Medicaid somehow doesn't look at the value of your whole life insurance.
The whole process of Medicaid planning is a little distasteful to me to be honest. The idea is to hide someone's assets from the state so that the heirs can have them, foisting the cost of caring for the owner of those assets on to the public. But even assuming that you have no ethical problem with doing this, it's unlikely to work very well. Medicaid is state law, so it varies by state, but in Utah, a person can have up to $2,000 in countable assets and still qualify for Medicaid. Above that level, no Medicaid until you spend down to that level. If there is a spouse, the spouse can keep 100% of assets up to $24,720 and 50% of assets up to $123,600. Above that, Medicaid won't pay for the nursing home. Non-countable assets in Utah include:
- Your home if your spouse lives in it
- The value of one vehicle (including a Tesla)
- Funds set aside for a funeral
- Household and personal items
- Cash value of your life insurance policies IF the total face value of all policies is < $1500
So I guess if you want to hide money from Medicaid in Utah, then you could go buy a $1,000 whole life policy. Most states have similar policies regarding cash value life insurance. Even if there were a state with a higher limit than Utah, this seems silly for someone who should spend her entire retirement as a multimillionaire to be making plans to spend down to Medicaid levels for nursing home care. A far better plan to stiff your fellow Utah taxpayer (assuming you have a spouse who doesn't need care) is to upgrade your house and your car.
Myth #33 – WCI Doesn't Understand the Opportunity Cost of Borrowing Against Whole Life Insurance and Investing Elsewhere
This statement has been made without explanation, but the idea isn't that complicated (nor misunderstood by WCI). You can borrow against the cash value in your whole life policy and use that money for whatever you want. You can spend it or you can invest it. Lots of whole life fans use fun phrases like “velocity of money” to describe buying a whole life policy, borrowing the money out, and investing it in something else. The really talented salesmen get you to invest it (along with any home equity they can get you to borrow out) in yet another insurance product.
Is there a cost to not maximally leveraging your life in this manner? Sure, anytime you can borrow at a lower rate and earn at a higher rate you'll come out ahead. But leverage works both ways, and the risk is not insignificant. What is not often mentioned by those advocating doing this is the opportunity cost of plunking money into a low return life insurance policy and buying unneeded death benefit instead of a higher returning investment. For instance, consider two options. You can invest $10K a year into an investment that returns 10% per year or you can buy a whole life policy that won't break even for 10 years. After 10 years, the first investment is worth $175K and the whole life policy only has a cash value of $100K. That's a $75K opportunity cost that apparently the “insurance agent doesn't understand.”
With a properly structured policy, you can break even in perhaps five years (maximizing the use of Paid-Up Additions), and using the combination of wash loans (interest rate to borrow against the policy = dividend rate of the policy) and a non-direct recognition policy, this idea becomes “not terrible.” You still have the opportunity cost of the first few years in the policy, but that is balanced out by a higher return on your cash in later years. I have discussed “Bank on Yourself” or “Infinite Banking” previously in detail if you are interested. It's not an insane use of whole life insurance, but it isn't for me. If you really understand how it works (it's going to take working through a lot of hype to do so) and want to do it, go for it.
Myth #34 – Buy Whole Life Insurance for the Long Term Care Rider
In recent years, insurance companies are adding on a Long Term Care rider to whole life insurance policies (and universal life policies and annuities) and agents are using the fear of expensive long term care to sell them. I find this appalling. Not only are you mixing insurance and investing, but you're now combining two different types of insurance policies with investing. Given the track record of insurance companies with long term care, I think most of my readers should strive to get a place where they can self-insure the risk of long term care, but even if they cannot, I'd prefer a simpler long term care policy on its own than mixing it with an otherwise unnecessary and expensive insurance policy.
The benefit of buying this as a rider of a whole life policy is that the premiums of the policy are guaranteed—you don't have the risk of the insurer upping the premiums like you do with a long term care policy or upping the cost of the underlying insurance like you do with a universal life policy. Those guarantees are worth something.
Remember we're not talking about just an accelerated death benefit. This is just another way of self-insuring long-term care, but with a lower return on the investments used to pay for it. You're really buying two policies combined into one. But there's no free lunch here. You're either paying more for the combined policy, or you're getting less of something, usually death benefit. Most likely, you're also paying for a life insurance policy you don't need or wouldn't otherwise buy. That death benefit isn't free. The reason life insurance companies stopped selling long term care insurance and started selling these hybrid policies is that their actuaries were convinced they are more likely to make money that way. That profit has to come from you, there is no other possible source.
If you do decide you wish to purchase some sort of long term care insurance policy, it is entirely possible that a hybrid product is right for you, but just like health and disability insurance, the devil is in the details. Read the fine print and be sure you know what guarantees the insurance company is actually providing. Know about what is covered, what isn't covered, and whether benefits are indexed to inflation or capped. Or better yet, live like a resident for 2-5 years out of residency so you'll be rich enough to self-insure this risk and never have to make this decision.
Myth #35 – We Don't Say Put All Your Money into Whole Life Insurance
This argument is simply bizarre, but used by agents once the prospective buyer has refused to buy the massive policy they were offered at first. A small commission is better than no commission, I guess. Of course, you shouldn't put all your money into whole life insurance, that's a straw man argument. Also, if buying a policy is a bad idea, you're going to be better off if you buy a small one than a big one. But that's hardly a reason to buy a policy in the first place. Like any asset class, if it isn't a good idea to put a significant chunk of your portfolio into it, it probably isn't a good idea to put any of your money into it.
Myth #36 – Yes, We Have a Few Bad Eggs but Most of Us Are Ethical
This argument is used when I point out that literally hundreds or even thousands of my readers have been sold clearly inappropriate insurance policies. The problem is there are two options to explain this phenomenon. The first is that these agents are unethical. The second is that they're incompetent. Given the statistic that 80% of policies are surrendered prior to death and 76% of the docs I've surveyed regret their purchase, this is hardly just a “Few Bad Eggs” doing this. It's an industry-wide problem.
Myth #37 – You Should Buy Insurance to Preserve Insurability
This one is used to sell insurance to people that don't even have a need for insurance. The idea is to prey upon their fear of the combined risk of needing insurance AND not being able to purchase it. One example would be a 25-year-old single doc with no kids. No life insurance need here. “But what if you get diabetes before you get married and have kids? You should buy the policy now.” Uhhhh . . .no.
First, you may never have dependents.
Second, if you do need it, you'll probably be able to buy it at that time at a reasonable price.
Third, if you do become less insurable, you will still likely have options for some insurance through an employer or other groups.
Fourth, even if you become uninsurable through anyone, the risks must be multiplied. For example, let's say there's a 5% risk of you becoming uninsurable before you have a real insurance need. And the risk of you dying before reaching financial independence is 5%. To get your true risk of a financial catastrophe, you must multiple those risks. 5% x 5% = 0.25%. That is a 1 in 400 chance. Life is risky. You can't eliminate every possibility of something bad happening to you and even if you could, that wouldn't be a wise use of your money. Wait to buy insurance until you have a need for that insurance.
This argument is often even extended to children. If you're buying life insurance from the same company that sells you baby food, you're probably doing something wrong. Now, if you could buy a lot of future insurability for that kid very, very cheaply, that might be something to consider. Unfortunately, you can't really do that for several reasons:
First, you have to actually buy unneeded insurance. That newborn likely won't have any need at all for life insurance for 25-30 years.
Second, you're not pre-buying the policy that kid will need. You can't buy the right to buy a 30-year level term policy at age 30. You have to buy a whole life insurance policy. Which means you're also paying for insurance that will be unnecessary on the far end of life too, after the kid has become financially independent.
Third, you generally can't buy enough insurance, or even enough future insurability, to actually meet any sort of realistic life insurance need. Most of these infant policies are only $10K or so. That's basically a burial policy, and as sad as it would be to bury your kid, it's not a financial risk my readers should need to insure against. (I've even heard the argument that you should buy the policy so you can take a few months off work because you'll be too distraught to work, but that's what an emergency fund is for.) Even if you find a policy that allows you to purchase future insurability for a larger policy, let's say $500K, that's not going to mean much in 30 years when the life insurance need actually shows up for the first time, much less in 50 years when the kid is actually reasonably likely to die. At 3% inflation, $500K today will only be worth $200K in 30 years and $109K in 50 years. Better than nothing, but you went to all this effort and expense to preserve insurability and your kid still ended up with inadequate life insurance coverage.
Myth #38 – Whole Life Insurance Is a Great Investment to Put in Your Defined Benefit/Cash Balance Plan
I had this one pitched to me by a doc turned financial advisor of all people. The argument was that you could buy whole life with pre-tax dollars and then if you wanted to pull the policy out of the defined benefit plan you could do so. He felt this was an “advanced technique” for “high net worth folks.” I was flabbergasted. It was such a stupid idea I couldn't believe it. A defined benefit/cash balance plan already provides tax protected growth and asset protection, two reasons frequently cited to buy whole life insurance. You're now paying twice for those benefits. To make matters worse, should you die while this policy is in the defined benefit plan, part of the death benefit becomes taxable, negating another usual advantage of life insurance—a completely tax-free death benefit. But the main reason why this is such a stupid idea is when it comes time to close the defined benefit plan, which is usually done every 5-10 years or so in order to roll it into an IRA. At that point, you have to do one of two things.
First, you can surrender the policy and move the cash surrender value into the IRA. But what is the investment return on the first 5-10 years of a whole life policy? You break even if you're lucky. Not exactly a great investment for that time period, especially compared to a typical conservative mix of stocks and bonds.
Second, you can purchase the policy from the plan. Of course, you have to do that with AFTER-TAX dollars. So while you initially bought it with the pre-tax dollars in the plan, eventually you're going to have to cough up after-tax dollars for the policy. And then what are you left with? A whole life policy you probably neither want nor need and perhaps even with associated premiums you have to make each year. Some deal!
Myth #39 – More Money Is Passed Through Life Insurance
This myth showed up in a comment on a post on this blog. I thought it was particularly creative, especially with the way it was combined with Myth #8 (You Need Whole Life to Help For Estate Planning) and Myth #25 (Term Life Expires Without Paying Anything):
More money is passed through life insurance than any other way. I’ve seen too many people out live term which is throwing money away and need life insurance and are at that time in life uninsurable. Life is really used well in estate and trust planning.
Surprisingly, this was the first time I had heard this argument. Being financially literate, of course I was able to immediately debunk it, but I suppose somebody might fall for it. There are two problems with this statement. First, it may not even be true. I looked and looked and looked for a study that showed what assets are actually inherited, without finding anything that actually quantified it. So if there is a study that actually says this, I suspect it is paid for by a life insurance company. Maybe it's true, maybe it's not, but I suspect it isn't given how few people have life insurance in force at their death. I suspect more money is left behind in houses than anything else. I mean, look at the net worth of people by age. Among retirees, the 50th percentile for net worth is $210K. That's got to be mostly house. The 80th percentile is $696K. That's about the average price of a house in my upper middle class neighborhood in a flyover state.
That jives with the average estate left behind at death:
- The average retired adult who dies in their 60s leaves behind $296K in net wealth,
- $313K in their 70s, $315K in their 80s
- $283K in their 90s
It seems very unlikely that the main inheritance most people receive is the proceeds of a life insurance policy given those numbers. How many retirees even carry life insurance? According to this, about 65% of those 65+. But 47% of those own less than $100K of life insurance. It is a well known statistic that fewer than 1% of term life insurance policies pay out. It isn't that the insurance companies aren't good for the money, it's just that people out live the term. A lesser known statistic is that 80%-90% of whole life insurance policies don't pay out either. They're surrendered prior to death, often at a loss since 1/3 of policies are surrendered in the first 5 years and over half in the first 10 years.
I did manage to find some UK data, however, which suggests my hunch (that people inherit more in real estate than life insurance proceeds) is correct.
As you can see, more than half of inherited assets are housing assets, so clearly more assets cannot be passed as life insurance than anything else.
Perhaps the agent wasn't referring to the median inheritance though. Perhaps he was referring to the total amount of dollars passed to heirs. I could find no data to support nor refute that notion.
Second, even if the statement is true, it is irrelevant. Given that THE PURPOSE of life insurance is to pass assets on to heirs, that's hardly an argument to buy life insurance for some reason besides the death benefit. As I've always said, if you want a life long death benefit that gradually increases throughout your life, then a whole life insurance policy is a great way to get that (although a guaranteed universal life policy can provide a level life long death benefit at about half the price and is probably a better solution for those who really need a permanent death benefit.) Bear in mind that you are likely to leave a larger inheritance by investing in stocks and real estate than buying life insurance due to the higher returns, and those assets, just like life insurance, provide a tax-free inheritance to your heirs. Life insurance only provides a larger inheritance if you die well before your life expectancy.
Myth #40 – You Get an Investment and Life Insurance
This one confuses a lot of people and they get really mad when they realize how whole life insurance works. They mistakenly believe that they get a death benefit for their heirs AND a separate “cash value” investment type account that they can use themselves or leave for their heirs. What they do not realize is these two pots of money are one and the same. That which you use for yourself does not get passed on to your heirs. When they discover this fact, they feel like the insurance company is stealing a bunch of money from them and their heirs.
In reality, when you borrow against your life insurance policy, you are borrowing against your death benefit. When you die, your heirs get the death benefit minus any outstanding loans. The amount of the outstanding loans, of course, can never be more than the cash surrender value of the policy, which gradually grows to an amount very close to the death benefit at your life expectancy. So really the cash value just tells you how much of the death benefit you can borrow at any time. You can either borrow this pot of money (death benefit/cash value/surrender value) and spend it yourself, surrender the policy and spend the money, die and leave the money to your heirs, or some combination of the above. But there isn't two pots of money. There isn't a $400K cash value and a $1M death benefit. There is just a $1M death benefit. If you spend $400K of it, your heirs only get $600K of it. So you don't get an investment AND life insurance, you get an investment OR life insurance.
Summing It Up
There you go. Forty reasons for buying whole life insurance debunked. Don't worry; the agents who sell this stuff will come up with more. Just hang out in the comments section over the next year or two and you can watch. Whole life insurance is a product designed to be sold, not bought and the only way to win an argument with an agent trying to sell it to you is to stand up and walk away. As Upton Sinclair famously said, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Maybe it should be called Whole LIE Insurance.
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:
- Need or desire a guaranteed, but possibly slowly increasing, life-long death benefit,
- 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,
- Live in a state that protects 100% of the cash value from creditors,
- Have some estate planning liquidity issues,
- Be in excellent health,
- Pursue no dangerous hobbies,
- Not mind having low returns on his investment despite holding it for decades,
- 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),
- Have already maxed out all available retirement accounts including backdoor Roth IRAs and HSAs, and
- 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.
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.
[This updated post was originally published as a series from 2013-2019.]