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.

While most WCI FB group members have never purchased whole life insurance, of those who have, 76% regret it.

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 [2022], 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 [2022] 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:
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.
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.
Tier One Capital is highly regulated and it is difficult for a bank to include riskier assets such as common stock(aside from that of the bank, which makes up most of Tier One Capital) and REITs in its Tier One Capital. When you are stuck choosing between low-risk/low-return investments, then you can understand why a bank might consider something like cash value life insurance with part of that money. However, individual physician investors investing for retirement have fewer restrictions on their investment options for their retirement. Most of them have significant need for their retirement money to grow. The returns available with cash value life insurance generally are not high enough for them to reach their goals. Even so, consider what a bank does with most of its Tier One Capital—it buys the only stock it can, it's own. If whole life insurance was so awesome, you'd think the bank would use all of its Tier One reserves to buy it. In short, doctors aren't banks, so doing what banks do isn't necessarily smart. Tier One Capital is highly regulated and it is difficult for a bank to include riskier assets such as common stock.
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% [2014]. 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:
#1 Safe
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.”
#2 Liquid
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.
#3 Tax-Advantaged
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.
#4 Creditor-Proof
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.]
WCI:
This is such and obtuse area to understand. Thanks for helping to try and explain it. However, I still can’t get it through my head how one has to continue paying in to the policy but then can also “borrow against it”. Wouldn’t you be borrowing money and then having to use some of that money to continue paying for the policy. The death benefit is easy to understand…I die, my beneficiary gets what is left over. But, I can’t wrap my head around how one could use this for a retirement investment….based on your above “1 million dollar policy” I would be borrowing 2-4 grand a month and paying 1 grand a month back to the policy? Is this right or am I missing something?
Thanks,
When you borrow from the policy, the insurance company is lending you their money and using your cash value and death benefit as collateral for the loan.
For example, let’s say that at age 65, you have a cash value of $800,000 and a death benefit of $1,800,000 (your policy started at $1,000,000 and increased as a result of dividends).
You now take a loan of $100,000 at an interest rate of 5%. At the end of year, you would owe $5,000 in loan interest. You can pay back some or all of the loan, then some or all of the principal or simply pay nothing back at all.
Let’s assume nothing. If you were to die, the insurance company would reduce the death benefit by $100,000 (the principal) and the $5,000 (loan interest), leaving the balance to your beneficiary or beneficiaries.
Of course, if you take a loan early in a policy and the interest compounds and dividends are reduced, this can ultimately cause the policy to implode with potential income tax consequenses.
Therefore, if you are going to take a loan on a policy and not pay it back, it is better to do it later in life and, as stated many times, plan on funding the policy to the MEC limits to better protect yourself in the event of a reduction in the dividend scale.
Thanks, this helps explain things somewhat, however it does not answer the question as to when I am 65 and borrowing against the policy (since I have hypothetically retired and am now using this as retirement income) do I continue to have to pay the approx. 1000 dollars a month toward the policy?
If I stop paying the 1000 dollar monthly premium does the entire death benefit go away? What about the Cash value portion?
Thanks,
When you are 65, the policy will have a large cash value and produce dividends…likely somewhere between 5-6%.
So if the cash value is, say 100k, it would produce 5k in dividends annually…these could go to the policy premiums. Ideally by retirement age your policy would be fully supported by the dividends.
Let’s say your policy premiums are $4500/year. Your policy is then growing at $500/year.
You could take a policy loan, say for 10k. The loan interest on that 10k might be 5%…or $500
So you can now spend your 10k and never pay it back. The interest and policy would be paid by the dividend.
In essences then you aren’t really taking a loan. You are taking out a portion of your cash (and insured) value but paying interest on it.
Two issues- 1-any cash value pulled out that is in excess of premiums paid is fully taxable as ordinary income 2-the policy is terminated once loans meet or exceed total cash value.
It is the fine print that kills you with Whole life.
If I was to borrow from my NWML whole life plan, the interest rate is quite competitive-NOT. 8%
That period is incredibly important in understanding your point.
Then you don’t understand your policy. Older policies are at 8% (but you taking a loan is tax-free and cash value is still growing). Calculate the net difference. For instance, currently interest rates are 5% currently for loan — however, with cash value growing the individual is only paying <1% actual cost to NWM for access their tax-free accumulation. Show me any loan you have access to with less than 1% interest my friend.
While the premiums are still due, you would be using the increase in cash value and dividends to cover the premiums.
Yes, the death benefit would go down but not below the amount originally purhcased (as you would not be making further premium payments) and your cash value would continue to increase (but you would not have the same amount of non-guaranteed cash value as if you continued to make premium payments out of pocket). You can think of it as a bank account that still grows in which you are making no additional deposits.
The reason that you would want to overfund the policy is to reduce the risk of the dividend scale decreasing which is likely and that will potentially impact the number of years in which premium paymnets are required.
Therefore, instead of stopping the payment of premiums as soon as possible based on the illustrated dividend scale today, it is a good idea to continue funding the policy out of pocket until the dividends meet or exceed the amount of the annual premium.
Another option would be to continue funding the policy until retirement or puchase a policy that is guaranteed to require no further premium payments after 10 years, 20 years or the age of 65 – regardless of dividend performance.
That’s exactly right. If the contract says you must pay the premiums to age 100, then the premiums must be paid if you want to avoid surrender with all of its tax consequences. They can either be paid out of pocket, or partially or completely paid by the dividend that the cash value in the policy kicks off. Of course, any dividend going toward the premiums IS NOT compounding inside the cash value portion of the policy or increasing the death benefit.
For this reason, spending the cash value of your life insurance should be one of the last things you spend in retirement, which negates the benefit of being able to get to it without penalty (or one of the work-arounds) prior to age 59 1/2.
Thanks for the great discussion.
I was wondering if you could post for illustrative purposes a side-by-side comparison of running values for monthly premium payments to a typical whole life policy versus putting the same money into a typical savings account, bond fund, or stock fund, to show how much balance is created over time.
Ask for the mutual fund company to show you their guarantees when comparing it along side the Whole, IUL/UL life policy. While you at it, ask them to disclose what the maximum sales charges are allowed by law, that just maybe could happen.
When WCI asks you to go directly to the guaranteed side of a life policy illustration, it only makes sense to do the same for a mutual fund company.
The only problem is that there is no guarantee from a mutual fund company. They cannot legally guarantee anything.
That is something that can easily be done. In fact, all of the insurance carriers will have ledgers that allow for that.
I’m sure that Bob can put something together assuming the gender of the insured, the underwriting classification of the insured, the current dividend scale for the carrier (including a reduced dividend scale, if preferred) and an assumed rate of return for the “side fund”.
He can probably also reduce it by the cost of the term insurance, as well as, taxes being assumed at a certain effective rate.
What would you like to see?
That’s correct. It is relatively easy to look at an insurance policy illustration. Here’s a whole life policy sent to me a while back with its illustrated numbers. It is a Guardian Whole Life 99 policy designed with paid up additions and paid annually to maximize the investment return. It is on a healthy 30 year old male from New York. The death benefit is $500K and the annual premium is $10,180.
Guaranteed Cash Value
Year 5: $35,977
Year 10: $95,531
Year 20: $235,498
Year 51: $869,076
Projected Cash Value
Year 5: $39,245
Year 10: $108,389
Year 20: $330,396
Year 51: $2,497,636
Investing in stocks/real estate and getting an 8% annualized return
Year 5: $64,499
Year 10: $159,271
Year 20: $503,125
Year 51: $6,823,914
Same 8% return, but subtracting out the costs of a $500K term policy ($375 per year for 30 years)
Year 5: $62,124
Year 10: $153,404
Year 20: $484,591
Year 51: $6,592,963
Hope that helps.
In the 8% return scenario you need to account for taxes in some way. The major selling point of the whole life crew is that your gains are tax free (instead you’ll pay some paltry interest on the policy loan)
I think that, for most people, even after the effect of taxes is considered, whole life is still bad. But it won’t be a lopsided as what your numbers suggest.
The above assumes that no one would really consider whole life until after all of their tax-free options (IRA, 401K, etc.) have been exhausted.
If you’re considering buying whole life instead of funding your Roth, then that’s some seriously bad judgement.
Well, it’s easy enough to adjust the numbers for taxes. How about we use 15% for the dividends and 15% for the long term capital gains (we just sell the taxable investment at the end of the period). Further, we’ll assume no step-up in basis nor tax-loss harvesting nor donations to charity or any other benefits of a taxable account. We’re also ignoring both interest on the whole life insurance and the tax consequences of a surrender (although those would help you in the first decade!) We’ll assume 2% of the 8% return is qualified dividend,so something like a total stock market fund. We’ll also take into effect the cost of term insurance.
Year 5 $59,698
Year 10 $142,901
Year 20 $426,776
Year 51 $5,100,131
Sure, it looks worse, but it’s still twice as good as the projected returns on the whole life after 5 decades.
If the goal for your money is growth at any kind of a significant rate, whole life is not your vehicle. Those lower returns really add up after a few decades.
IRAs and 401(k)s are not “tax free”, they are tax-deferred. What do you think tax rates will be when you retire? Higher or lower than now? They are the lowest in history right now. Also, your happy day analysis is not taking into account that the market fluctuates. Bake in some down years (like 2001, 2008, etc) into the mutual fund investing scenario and you will see a much different picture of returns. I see we are confusing saving and investing here. I would argue that WL is more geared to saving (i.e. money you cannot afford to lose).
The myth that “whole life is saving not investing” is covered under Myths 5 and 12. The myth that whole life insurance is a great way to save on taxes is covered under Myth 6. I see you also don’t quite understand the benefit of contributing money to tax-deferred accounts at your marginal rate, then later withdrawing it at your much lower effective rate, even if tax rates remain the same, or even go up. It turns out it doesn’t matter much if marginal tax rates go up some before I retire. Run the numbers and you will see. You might also be surprised to learn that tax rates are not the lowest in history right now. There was an income tax during the Civil War, which was quickly repealed. The income tax as we know was instituted in 1913, with a maximum rate of just 6%. I’m not sure what your understanding of “history” is, but I’m assuming it goes back less than 100 years. But even if we just defined “history” as the last 10 years, it is pretty easy to see that our current rates are not the “lowest in history”. In fact, using that time period as “history”, we can see that we actually have the HIGHEST maximum tax rate in history right now. It turns out that a careful analysis of the last hundred years will demonstrate that the top income tax rate was lower than the current rate from 1913-1917, from 1925-1932, from 1987 to 1993, and from 2003-2013. That list, of course, ignores all the tax rates in history prior to 1913.
What you call “happy day” analysis, is simply analysis. The returns discussed have already “baked in” years like 2001 and 2008 (not to mention 1930 and 1974). Take those suckers out and whole life insurance would really look bad.
I’m not sure why someone would put money they cannot afford to lose into whole life, since they automatically lose a big chunk of it as soon as they put it in there (most of which goes to the agent’s commission.) In fact, in many policies, they will have lost money for the first decade, and that’s not even counting opportunity cost, and completely ignores inflation.
The returns with negative years are NOT baked in. Nor are fees. The numbers you show are straight FV calculations from Excel, in other words, linear. So that is happy day. Sorry. Second, rates during the Civil War is not relevant to the discussion. Why bring it up unless you want to show off. And you are incorrect with your data! Go to http://qz.com/74271/income-tax-rates-since-1913/ and see for yourself. You are also assuming I will be poorer when I retire than I am now. That is a highly perpetuated myth that is simply not true! Most people don’t “plan to be poor”. Lastly your final statement regarding “automatically losing a big chunk” and “losing money the first decade” again says that I should view whole life as an apples to apples comparison to other investments, which you can’t do. As far as “losing a big chunk”, guess how much you will “lose” in management fees from the mutual fund companies over 30-40 years of accumulation? A whole lot more than the first few years of commission on a policy. Hey, all this aside, I enjoy the debate! I will review the myths you indicated and see what I can learn. I appreciate the feedback.
If you feel this is a debate, we can continue. Let’s start with a few basics. First, what is the commission for a whole life policy? It ranges from perhaps 50% to 110% of the first year’s premium. So let’s say you have $10K per year you can “invest” in this policy. So the expense is $5K-$11K. Now, what if you invested that into the Vanguard Total Stock Market Index Fund. What would your expense be? Well 0.05% * $10K = $5. $5 vs at a minimum $5K. That seems to me about 1/1000 the expense. So I’m not sure how I’m possibly going to lose more to management fees than I am to WL commissions. Note that I haven’t even mentioned any of the other fees and expenses inherent in a whole life policy. That’s just the agent’s commission.
Second, I still don’t think you get the whole marginal rate vs effective rate thing. It has nothing to do with “being poor” in retirement or “planning to be poor.” The fact remains that a typical physician can have the exact same standard of living in retirement on a fraction of his pre-retirement income. I’ve blogged about this here:
https://www.whitecoatinvestor.com/percentage-of-current-income-needed-in-retirement/
So, now that we see you’ll have the same standard of living on far less taxable income, then you can see that that income (at least the taxable portion of it) will fill up the lower brackets. So when I contribute to a 401K, I save money at 33%. When I pull it out, I pay taxes at 0%, 10%, 15%, and perhaps even 25%, for a blended rate of perhaps 15-18%. Saving at 33% and paying at 15% is a winning formula.
If you anticipate more inflation-adjusted taxable income in retirement than you have now, then you might wish to use Roth accounts and do Roth conversions instead of tax-deferred accounts. No reason to buy a whole life insurance policy though.
I wasn’t the one who brought up historical tax rates. I was simply correcting the misinformation you posted on my website. I like the link you posted, but it seems to be proving my point, not yours. It shows that both our current effective rates and our current maximum tax rates are lower now than they have been for decent chunks of of the last 100 years (pretty much since WWII). I see nothing in that link that contradicts what I posted above. Perhaps you could point it out to me.
Last, the 8% returns are a reasonable estimate for long-term investment returns. That is 2% less than historical stock returns and 1.5% less than my actual 75/25 portfolio returns over the last decade. Since historical returns are GREATER than 8%, those bad years are “baked in.”
[Ad hominem attack deleted] 8% is a historical average return – yes, as an average it is a good guess. But you don’t earn money on the “average” in a linear fashion. You should know this!. [Ad hominem attack deleted.] Bye
Thanks for stopping by. Good luck.
An investment in stocks and bonds will beat the average rates of return from whole life insurance easily, and so much empirical evidence can substantiate this thesis. Simply equity and bond investments have a lot more risk than putting money in the whole life insurance, regardless tax rates and associated admin expenses that come with each form of investment.
Comparing the investments and insurance products is like comparing apple pie with fried chicken. Rogue insurance agents have tried hard to sell the insurance products as investments to naive folks and this is a blatant misrepresentation. Moreover, the same agents tend to show off the non-guaranteed scenarios (a lot more rosy) using historical interest rates to project the future outcome. And I must say that our host have been inaccurate in his presentation or numerical data used to support his position. Since we can’t predict but only forecast the future, our numbers can be wrong, and that is ok, because this isn’t a forum to discuss a scientific matter or a public policy.
There are so many inaccuracies in this forum from both sides. I Hope the readers don’t take any suggestions or comments posted here without first consulting/getting a second opinion from their financial advisers like lawyer, accountant, EA etc (not the rogue insurance agent). The damage could be fatal and expensive for those people if they made a mistake. We are talking about a legal contract and one’s lifetime savings here. Diversification is key; the more asset classes and a hedging tool (insurance) you have the better off and safer you will be. I believe a form of permanent insurance has a place in your portfolio (small) and most of your money should be in the investments. Since 2000 we have had 4 down markets (big and small) in 2000,2001,2002 and 2008, and those years surely dig our equity and bond investments, so you should have a hedge tool in case if you need the money during those years and you will not be forced to sell your investments in such a depressing market. This is in my view the most/pinnacle risk of equity/bond investments; getting out at wrong times, forced to sell in a down market and trying to be like a pro by timing the market. This aspect is far more important than discussing over rates of return or admin expenses. Most retail/casual investors lost money from getting in and out at the wrong time than inferior rates of return. Lastly, the loan provision from the insurance can temporarily mitigate the painful situation. This is just my view on diversification, and you can say heck I am all in equity/bond investments. That’s perfectly fine but be mindful of the risks. Good luck.
I agree that getting out at the wrong times, selling in down markets, and timing the market are bad things to do.
I disagree that whole life insurance is a worthwhile asset class to include in your portfolio, whether you call it hedging or something else. Bonds work just fine to moderate equity volatility.
Vanguard’s intermediate term treasury fund had the following terms in your cited years:
2001 6.07%
2002 14.29%
2008 13.49%
All for 10 basis points of expenses.
You suggest I am inaccurate in my presentation of numerical data. Let’s get specific. What’s inaccurate?
this whole argument falls apart once the assumed interest rate is adjusted. Then again, it is in the bill of rights that we all get 8% every single year.
If the long-term return on stocks is much lower than that, you’re really not going to like the returns on your whole life policy. Assuming the insurance company stays in business, you’re unlikely to get more than your guaranteed return, usually in the range of 2% a year long term with no increase in the death benefit. I’m not sure what world agents live in that they think the investment funds of insurance companies will do great while equities go to pot. It’s called a Risk Premium for a reason. If the “interest rate” needs adjusted from 8%, it is just as likely to be adjusted up to historic rates of return as adjusted down.
I’m sorry, but I disagree.. and you dodged the argument. This strategy would fall apart if the investment analysis was re calculated using 5% and a more realistic tax( not all will be 15%.)and deducts term insurance costs + the TVOM on those term premiums. As you know, investment return for ins. company is a big piece of the dividend. However, there are two more important components ( mortality and expenses). Companies that have been in business for 150 years tend to know their overhead and having good underwriting practices takes care of the mortality component. You perspective of this is off base since you have never submitted a piece of business to underwriting. Let me tell you- I write about 150 cases per year and work my *** off to get these through. Many are declined.
Life insurance performance from a strong mutual company ( not daves insurance company) will have a low correlation with actual stock market performance. For example, Guardian declared a 8.5% dividend in 2001 and 7.25% in 2008. Obviously 2001 is before you started investing, but the point is anyone subscribing to your theory lost tons of money, and then again in 2008.
I think the obvious answer readers should conclude is that it is impossible to know which strategy is 100% going to work( for certain, guaranteed) the best. You seem to be very confided that people will invest in indexed funds, pay low fees, and retire rich. It doesn’t work that way…always. There is no question every reader should probably be invested in the market. Also, if they are young and healthy, they should also be buying a significant amount of WL.
As an insurance agent who makes at least part of his living from selling whole life insurance, I’m not surprised to find you disagree with me and that you feel people should be buying a “significant amount of whole life.”
I do agree that if you expected 5% returns from your investments in the stock market and in real estate that whole life insurance would be far more attractive as an investment than it currently is. However, that is a ridiculously low estimate, so there is really no point in considering it.
Historical returns are 10%.
Rick Ferri estimates 5-7% real (so 7-10% with inflation) over the next 30 years. http://www.rickferri.com/blog/investments/portfolio-solutions-30-year-market-forecast/
GMO estimates -3.5%-6.8% real (so -1.5%-9.8% with inflation) over the next 7 years. http://www.ritholtz.com/blog/2013/08/gmo-7-year-asset-class-real-return-forecasts/
My own personal returns (75/25 portfolio) over the last 10 years (most of which was in the so called “lost decade”) have been 10%.
Why my returns would all of a sudden go to 5% over the next 50+ years (the length of time I would have to hold a whole life policy) is beyond me. However, if that is what you believe, then sure, go invest in whole life insurance. I’ll leave it to the reader as to whether they side with the guy who sells insurance for a living, or with most of the other people on the planet.
In discussing dividends, you’re falling into Myth #3. Dividends are not returns, primarily due to the insurance costs and policy fees. Long-term expected returns on whole life policies bought today are in the 2% (guaranteed) to 5% (projected) range. Send me an illustration that says otherwise. No one else has been able to do so because that’s just the way it is.
Your discussion of correlation falls into Myth #5. Just because whole life has low correlation with the stock market doesn’t make it a great asset class to invest in. Putting money under my mattress also has low correlation with stocks, and will have about the same returns as whole life insurance for the first decade.
Cherry-picking out a year or two when the stock market goes down and saying “See! Stocks suck and whole life rules because whole life doesn’t lose money” is also a silly variation of Myths 3 and 5. It would be just as silly to point out years like 2013 when stocks went up 15-50%, depending on asset class. An educated stock investor expects the value of his investment to fluctuate. That is called “shallow risk” and is part of the reason your long-term expected returns are so high. If you prefer not to run that risk, you can do so, but you’ll be exposed to a far more serious one, that of not meeting your financial goals due to not taking on enough investment risk. Before accepting lower returns on his investment, an investor had best consider the consequences. An investor who gets a 1% real return (a pretty good estimate of long-term returns on whole life,) will take over 7 decades to double his money. If a physician investor needs $4 Million at retirement, currently earns $300K a year, has 25 years until retirement, and chooses investments that only make 1% real, he will need to save $142K per year, over 47% of his gross income and nearly 2/3 of his net income, just for retirement. On the other hand, if his investments make 5% real because he took on an appropriate amount of risk, he needs to save just $84K, or 28% of his gross, a much more realistic figure. At 7% real, it falls to $63K, or 21% of gross. Telling people to invest in low return investments has very real consequences on their lifestyle now, and/or in retirement.
The next argument the insurance agent usually moves on to at this point is “You invest in bonds, don’t you?” Of course, bonds also have low expected returns. That is also covered in Myth #5. There is more that is unattractive about whole life insurance as an asset class than just its low returns.
Tyler- you’re free to invest your retirement money any way you see fit. If you love whole life insurance and think it is a great deal, feel free to buy it. But while I’ve argued endlessly with insurance agents (isn’t it weird how no one shows up to argue for whole life unless they sell it for a living) on the internet about whole life insurance over the last few years, I continue to get a handful of physicians emailing me every week as they realize they bought something they really don’t want. The fact of the matter is that most people, once they understand how whole life insurance works, don’t wish to own it. That is why it is an investment that is sold, not bought. Take away the big commissions and very few would own it. 80%+ of whole life insurance policy purchasers surrender their policies. No one can argue a surrendered policy was even a mediocre investment.
Even if 10% ROR was a reasonable average, what about the sequence of the returns. What if the losses come in the later years rather than early years? If the 10% is a slam dunk, why not rent a house and invest the difference. Why not rent (lease) a car an invest the difference? I’m obviously not going to be able to get you to change your position nor are you going to get me to change mine. I was hoping to connect and find common ground on some element of the analysis. My conclusion is that the only thing you like about WL ins is that it generates a lot of conversion for the blog and increases it’s ratings and relevance. Since you are making commission on this website, based on your logic we have to assume all comments and analysis are disingenuous . The revenue per hour yo spend on this is obviously low, but you could easily turn this site into 200K of extra income over time.
What common ground were you hoping to seek? Whole life is a terrible short-term investment due to negative returns. Whole life is a terrible long-term investment due to low returns. It’s good for a permanent death benefit that is likely, but not guaranteed, to increase slowly over time. The problem is very few people actually need/want that. But there are thousands of agents who need to put food on the table and put their kids through college. So they have to come up with other selling points for this product that is very lucrative for those who sell it, but a terrible investment for those who buy it. Whole life is flexible in that you can do lots of things with it, but it doesn’t really do anything as well as some other financial product does it. Anything whole life can do, something else can do better. That’s what this post is about.
Whole life insurance is a terrible solution to sequence of returns risk. A less aggressive asset allocation in the last 5-10 years before retirement and the first 5-10 years after, perhaps combined with a SPIA, works far better and can be bought by those with dangerous hobbies or poor health. Earning 3% on your retirement funds throughout your career just to avoid sequence of returns risk is idiotic. I’d rather endure a bad sequence of returns with a $2 Million portfolio than avoid it with the $500K portfolio I might have by investing in such a low return vehicle.
I would much rather not have to talk about whole life insurance at all on this blog, but since insurance agents continue to sell it inappropriately, I feel obligated to continue to point out its many weaknesses. If you don’t agree it is being sold inappropriately, how do you explain the fact that 80%+ of policies are surrendered prior to death? Once people figure out they bought a “pig in a poke”, they get rid of it. If you were hoping you would succeed where literally dozens of insurance agents before you have failed, and convince me that whole life is a good investment, or something most doctors should buy, or heaven forbid something I should buy, then I think you had far too optimistic of aspirations.
Isn’t it fun that I don’t actually have to turn this site into $200K of extra income? Thanks to a rather fantastic day job (? night job) I can afford to treat this website as a hobby. I’ve had a few opportunities that would probably generate that kind of income (mostly using the site as a referral portal to an associated financial advisory firm,) but felt they would sell out my readers, and that kind of defeats the purpose of the site. If the right opportunity came along, I’d certainly take a look at it. Until then I’ll sell a few ads and keep doing what I enjoy, writing and helping others. Meanwhile, readership continues to grow and opportunities continue to come along.
Tyler predicted the future! He knew you could make 200k doing this. Thanks for the support. LOL
Where you’re wrong is comparing it to an investment. It’s not an investment. It is life insurance. In your article there are 3 examples. Term, GUL, and whole life. Term = pay in case you die within the term. GUL = pay for guaranteed death benefit, but still premiums going out with no living benefit. Whole = pay for guaranteed death benefit and cash value accumulation tax-deferred and mostly tax-free. Stop comparing it to investing — it’s life insurance. Also, read the white paper from Ernst and Young – https://www.ey.com/en_us/insurance/how-life-insurers-can-provide-differentiated-retirement-benefits – they are not insurance agents 😉
When those selling it stop comparing it to investments, I’ll stop. Deal?
Not everyone sells it as an investment and continuing to dog it actually can cause clients to exit a strategy for Insurance that aligns to their goals. I had a client call to cancel a permanent life quote because she was told “it’s a bad investment”. At the beginning of our analysis I specifically stated this is for insurance purposes, recommended a term to meet 1 stated goal and permanent to meet the other. The death benefit for the permanent was half that of the term based on her stated goal. It also only cost 3x the premium of term. When I explained to her it is not an investment, I reviewed her goals and asked if they had changed. She decided they had so I quoted her a term for the combined total. I also reviewed with her that a savings strategy to meet that goal would tak until she was 82, and she runs the risk of not having that estate for her children between 67-82. If she didn’t live past 82 permanent is the better option to create the estate she wants. Given life projections she would live to 85, except for hypertension, which shortens the life expectancy.
So TLDR people blanket trashing permanent insurance without regard to individual financial needs and plans can cause clients to reject optio s that benefit them and their plan. Saying you’ll stop when bad agents stop is disengenious to professionals who actually care. It also shows a lack of understanding when it comes to needs basis and financial planning. Fyi I am a licensed insurance producer but I am not an agent of any onecompany, prefer no commission, or trail commission insurance products and believe all insurance has a purpose and should be used as a part of a complete financial plan.
Telling people how a policy actually works isn’t trashing it. If they understand their policy and wish to keep it, then they should. But what keeps happening is I tell people how their policy actually works and most of the time they realize they were sold something they don’t actually want. That’s a “you problem”, not a “me problem.” You’ve got a client who didn’t really understand what you sold her. Why don’t you try explaining it before selling it next time? Then you won’t have to have these conversations later because they’ll understand what they bought and why.
More likely, if your client hadn’t been pouring cash into that whole life policy she could have reached her goals long before 82. A whole life policy isn’t needed to create an estate, even if it can be used to guarantee what is likely a smaller estate than she would otherwise have. If people are willing to leave a lot of money on the table for that guarantee, that’s their call. But they should be aware of the trade off they’re making. All I do is make them aware of it.
Your sources are way off in terms of how many people cancel their policies. If you surveyed the people that read this post, I’m sure 80$% will cancel and regret it 30 years from now. However, Below are the actual lapse rates for a few of the big companies for 2012. Can you site your source your 80% number, or is it made up?
New York Life- 6.3%
Guardian-4.6%
Mass Mutual-5.1
These numbers are based on their entire life insurance book of business. Some policies 1 year old and some 80+ years old. These numbers are inclusive of all life products. The term lapse rates were actually higher than WL.
Why would I need to make numbers up? The rates you cite are ANNUAL rates. If you lapse 6% of policies per year, how many people have lapsed within 20-30 years? That’s right, more than 80%. Since you seem to need a citation to believe something that I would hope would be common knowledge in your profession, how about this from LIMRA and the Society of Actuaries: http://www.soa.org/Files/Edu/edu-2012-c17-1.pdf
On page 19 you’ll see a chart. It says that in year one, 12% of policies are surrendered. In year two, about 10% are surrendered. It’s 7% in year 3, 6% in years 4 and 5. In years 6-10, it’s about 5% more per year. In years 11-20, another 4% a year have surrendered them. After year 21, it’s about 3% per year. Since these numbers obviously add up to more than 100%, you have to assume that these are the rates of surrender of those who still own the policy, not those who originally bought them. So you have to adjust a bit to figure out exactly how many of those originally issued have been surrendered.
After year 1, 88% are still in place.
After year 2, 90% of 88% are still in place, or 79%.
After year 3, 93% of 79% are still in place, or 73%.
After 5 years, you’re at 65%. Already 35% of those who bought these things have already surrendered them.
After 10 years, you’re at 50%.
After 20 years, you’re at 33%, so 2/3 of people who originally bought a whole life policy, no longer owns it.
After 30 years, you’re at 25%.
After 40 years, you’re at 18%.
After 50 years, you’re at 13%. So 87% of people who originally bought a whole life policy, didn’t hold it for 50 years. Now, a few of them died early, but for those who live to their life expectancy or longer, 9 out of 10 of them surrendered their policy before getting there.
It’s not my data. I don’t need to make up fiction because real life is bad enough as it is.
Term life lapse rates are almost irrelevant. I plan to let my term policies lapse as soon as I become financially independent. The sooner I let them lapse, the better deal they are for me. Whole life, on the other hand, is a terrible investment if you let it lapse. It’s bad enough if you hold it to death, but lapsing a policy, especially in the first 10-20 years, essentially guarantees a terrible return.
You really never thought about the cumulative surrender rates?
So what if the 80% estimate is off? What if it is 90% or 70%, or even 50%? The fact is that if half of the people who buy this thing that must be held for life to be anything but a terrible investment don’t stick with it for life, agents are doing an incredible disservice selling it to them in the first place. Agents are taking money out of the retirement funds and college funds of real people to sell them a product that is good for the agent but not for the client. I would be really embarrassed as an agent if more than 1 out of 100 policies I wrote were for permanent life insurance. It is just the wrong insurance policy for almost every one. It is just the wrong investment for almost every one. The exceptions are so rare, they can almost be ignored completely.
I have yet to meet someone who regretted cancelling a whole life policy. I’m sure there is someone out there, but I haven’t met him yet. I think it is highly unlikely that 80% who cancel their policies regret that move, but you can believe whatever you want. I don’t think anyone has done or will ever do a survey of those folks.
I don’t expect to convince you that your approach to financial planning and investing is wrong. I just hope to warn your future clients before they meet you. Your firm specializes in selling insurance policies to doctors. Do them a favor; sell them a solid 20-30 year level premium term life policy and a solid disability policy, and refer them to a fee only advisor to help them invest. You can still make a great living without suckering people into buying something that at least 50% of them will cancel at a loss, 30-40% will cancel with minimal gains, and 10% might eke out 1-2% over inflation by holding the thing until they die.
Tyler,
You may want to reconsider the use of your last name on this site. It is a small world out there. I am an existing client of yours. I purchased a DI policy from you that was appropriate. I have, up until now, been very pleased with that policy.
Your posting here, including your statement that young and healthy physicians and dentists “should also be buying a significant amount of WL” is setting off major red flags. I’m not quite sure what I will do next but I will certainly take anything else you present to me with a grain of salt.
Who get’s an 8% annualized return in the market? There is a difference between ROI, actual, and received.
You might want to try reading Becoming Your Own Banker by Nelson Nash. I have the vast majority of my savings built into high cash value whole life insurance. I break even after 2.5 years on my worst policy.
You wrote the same thing in four different replies. Maybe you should submit a guest post on the topic.
Well, I am for instance. From 2004 to now, my annualized return is 8.85% and trust me when I say I do know how to calculate it. I took a very close look at whole life insurance, determined it was very unlikely to pay me returns like that, and decided I needed to take more risk with my long-term money.
Hope investing in life insurance works out well for you.
Keep in mind that Guardian’s 2014 dividend scale is 6.25%. As a result, the (non-guaranteed)cash values will be overstated.
I’ve never heard of mortality credits being applied to life insurance. I’ve only heard that term used in regards to annuities. In those cases, the people who get mortality credits are the ones who live longer than average. The credits come from (are funded by) those who died sooner than average. I am no insurance expert, but I wasn’t able to find anything on the web linking whole life insurance and “mortality credits,”
The truth is that nobody knows where the dividend comes from. It is simply “declared” by the company and comes out of a black box. But you have to think about how the insurance company makes money. It has a portfolio, which makes money. It makes money from fees, such as surrender fees and other fees generally disclosed in very small print in the policy. It also makes money when it charges more for insurance than it costs them to provide said insurance. Perhaps mortality credit isn’t the best way to describe that money, as the term is generally applied to annuities. Whereas when people die early with annuities, those who didn’t get some credit for that, those who die early with life insurance get the “mortality credit.” If you can think of a better term to use, I’ll gladly substitute it.
It’s not a bad term. The dividend for a participating whole life policy is a function of the investment returns, expenses, and mortality experience (which, if positive–fewer policyholder died that projected–can be considered as a “mortality credit.”)
Saying there are 400,000 insurance agents in the US and all of them would love to sell you a whole life policy is like saying there are 800,000 physicians in the US and all of them would love to perform spinal fusion on you. Only a small fraction of the total insurance agents sell whole life policies of the magnitude you write about and the great majority don’t sell life insurance at all.
What number would you prefer I use? I don’t think using 1/10th of that number would lessen the impact of the statement any. At any rate, I’d LOVE to sell a few big whole life policies on the side. Selling just a handful of those a year would make for a fantastic income. The point of the statement is that potential purchasers need to understand that those who are selling these policies have an immense financial incentive to do so.
I believe its far less than 1/10th. My point is you imply that all insurance agents are greedy commission hungry hucksters. As in all professions and industries there are always a few bad apples in the bunch. I’d like to do a few heart bypasses and knee replacements for some extra income!
I’m sorry you take offense at my opinion of the vast majority of insurance agents. I hope you are not part of that majority. Feel free to start your own blog discussing how greedy fee-hungry surgeons are. Just think how many patients you could help avoid unnecessary CABGs and TKRs! In the mean time, if you have some data showing that the vast majority of life insurance salesmen aren’t inappropriately selling whole life insurance to anyone they can talk into buying it, I’m sure readers would be very interested in seeing it.
Answers.com suggests there are 1.2 Million life insurance agents, about half active. Let’s pretend the actual percentage of agents who would love to sell doctors a whole life insurance policy inappropriately is just 1% of those. That’s 12,000, or about 240 per state. That’s still enough that it is worth warning docs about, although I bet the true number is far higher. It isn’t that agents think they’re selling something bad to the doctor. Most of them actually believe their product is awesome.
According to the Bureau of Labor Statistics in 2010, which is the most updated information presently available, there were 411,500 insurance agents in the United States and I believe that is agents of all kinds including life, health, property, casualty, etc.
Please understand while I am a licensed insurance agent I would never sell or buy a whole life insurance policy and I do not object to you warning other doctors or anyone else of the perils of doing so.
You stated “there are more than 400,000 insurance agents in this country, and all of them would love to sell you a whole life insurance policy.” I merely wanted you to know this one would not.
I changed it to almost all.
I am also a licensed life and health agent, and I would not sell a whole life policy. My approach: Max out the Roth IRA, Fund the to the company match in your 401k, and then max fund an Index Universal Life policy to the MEC limits. Yes, I also suggest buying a 20-year level term policy. You should be saving 10-20% of your gross income.
You would seriously recommend an IUL in these times? You must be high…. Who wants to buy a policy that will end before I die? On ANY Universal Life policy they are designed to kill themselves and literally blow up around age 65 to 70. You are doing your customers a disservice and you should have your license pulled…..
You might want to try reading Becoming Your Own Banker by Nelson Nash. I have the vast majority of my savings built into high cash value whole life insurance. I break even after 2.5 years on my worst policy.
Every agent I’ve ever met has tried to sell me permanent insurance and I’ve met dozens.
You might want to try reading Becoming Your Own Banker by Nelson Nash. I have the vast majority of my savings built into high cash value whole life insurance. I break even after 2.5 years on my worst policy.
When I was thinking about the whole idea of a permanent insurance policy the one feature that appealed to me was that you could borrow against your cash value to avoid paying taxes on appreciation. Can anyone explain to me why you can’t just do this with a taxable account.
In other words, what is the problem with this:
1. Invest in a mutual funds in a taxable account over the course of your career.
2. At retirement, instead of selling some of the funds, you would take out a loan from a bank and use the funds in the taxable account as collateral.
3. When you die (or when your loan value is equal to the assets in your taxable account), you default on the loan and the bank takes your taxable account.
Presumably over the years you would be paying some taxes on dividend income (which you would reinvest). But when you need the money you wouldn’t have to pay capital gains, you would pay a low interest rate instead.
Does anyone know why this can’t be done?
You’re dependent on the bank being willing to make the loan, whereas with a life insurance policy the ability to borrow at a certain rate is written into the contract. But yea, no reason you couldn’t do it.
Are you sure? I’ve asked a couple of professionals about it (one accountant and one financial planner) and they seem to think there is some sort of catch.
But if you’re right and this can be done, it seems like a pretty excellent decumulation strategy. Especially when one is very old.
Obviously, the problem is finding a lender as this is not exactly a standard loan. But it would seem reasonable that it should be possible to find someone willing to make a fully secured loan at market rates (Obviously, a permanent policy would have an even lower interest rate, but it has so many other expenses that you would be better off paying the higher rate and avoid all of the other costs associated with a permanent insurance policy).
What kind of catch are you thinking of? Keep in mind that if your estate has to sell the investment, it’ll have to pay income taxes on the gains. If you just leave it for heirs you’ll get the step-up in basis. Is that your catch?
I would say the hardest part would be finding someone to loan you the money with investments as collateral. Seems like there could be a margin call.
I don’t know what the catch is. I guess I think that if it was this easy, everyone would do it.
Would the estate even need to sell the securities? Is there away that you could just transfer shares in a mutual fund without selling them?
The margin call is not really a problem for a lender. Presumably the contract would be written such that once the loan value exceeds the value of the mutual fund holdings (which could go down), then the lender gets the holdings. The problem is for individual, as he now has no source of income (which means he needs to be careful about how much he takes out in loans, just like a whole life policy).
I agree that the hardest part would be getting someone to make the loan.
No, I don’t think you can transfer shares tax-free to anyone but a charity.
We’ll that’s the catch, then.
There’s no problem if you die first.
But if you take out too much of a loan, you would have to liquidate, pay taxes, and then pay the lender. Knowing this, the lender can really only safely give you a loan based on the tax-discounted value of your mutual funds. That’s defeats the purpose of the whole strategy.
Additionally it isn’t obvious that the policy rate would be lower.
Absolutely. You might be able to get quite a low rate on a loan secured by an investment. Margin rates right now are as low as 3.75%. https://www.fidelity.com/trading/commissions-margin-rates
what do you think of return of premimum term life insurance? which is a good reliable company to get term life insurance from?
I’ve written about how return of premium isn’t a free lunch here:
https://www.whitecoatinvestor.com/return-of-premium-is-not-a-free-lunch/
I’ve also written about how to buy life insurance here:
https://www.whitecoatinvestor.com/how-to-buy-life-insurance/
Thank you, WCI.
It makes good sense to secure a 10, 15, 20, 25, or 30 year level term policy (or a combination of them).
There are too many good term life companies to even name. Best thing is to look for A rates or better companies and then see who is most competitive from a pricing standpoint for your age, state of residence, health history, etc. One carrier may be less expensive for their top health rating but they could be 8th least expensive for a lesser rating.
Run quotes at my site, InsuringIncome.com. You won’t need to enter any personal info to see the best rates.
Good luck.
How would your comparison of whole life verses mutual fund investments change for somone in a 39% fed tax bracket, 11% state tax, with a capital gains rate of 20%? Is there a tax rate at which cash value may make sense?
Sure, but it’s higher than the rates that exist now. The real comparison is the capital gains rate, which even at 23.8% still isn’t that high. The best way to turn cash value life insurance into a good deal investment-wise isn’t to change the tax bracket, it is to change the investment by using a very low cost variable life policy with excellent investments. If costs are low enough, and the investments are good enough, then the costs of the insurance may eventually cancel out the costs of the taxes. But you still have to hold it to death and you still have all the other downsides of cash value insurance. One issue with the way agents present cash value insurance as an investment is they compare it to a straw man. They use a taxable account, but invest in it without any apparent concern or knowledge of how to do it in a tax-efficient manner. No tax loss harvesting, no step-up in basis at death, no donations to charity, no qualified dividends or capital gains rates on the taxes, no low turn over index funds etc. If you compare the cash value insurance to a taxable account invested aggressively but in a tax-efficient manner, it takes a long time for the tax advantages of the insurance to make up for the costs of insurance. Tack on a few fees and it never does catch up.
I am a conservative investor and want to retire with low risk. I thought 3-4% tax deferred return on a SPWL product is quite good for a portion of your asset (20-25%). At least a lot better than a 1-2% taxable CD rate for the past 3 years. The money I am thinking of using to buy some SPWL is the money in my CD accounts and not planning to use them in the next 10-20 years. I have already maxed out all my tax deferred retirement accounts (401K,IRA, etc.) and invested in aggressive stock funds. What do you think about this thinking?
Don’t expect 3-4% for just 10-20 years, but yea, the lower the return of what you compare whole life to, the better it looks. What you need to decide is whether the additional risk and inconveniences are worth the additional 1% return over CDs or treasuries. You also need to consider that CDs probably won’t be yielding 1-2% forever, but you will need to hold that WL policy until death to get a decent return.
First, is it less risky of a good life insurer in comparison to a local bank? I thought I have heard a lot more bankruptcy stories of banks, so, in my mind a good life insurance policy seems more stable, right? Second, I do not need the money for 25 years until I terminate the policy to collect the cash value (I understand to pay deferred tax on cash value increase above the principle) in retirement or pass it to my spouse/kids if I die before that. 3-4% tax deferred investment with minimum risk sounds not bad for a portion of my asset. Anything wrong with that thinking? Remember that I have already had 70% of my asset in other higher risk investments.
I’m not sure you understand how whole life policies work. If you want the tax-free benefit, you don’t terminate the policy, you borrow from it. That’s tax-free, but not interest free. If you just terminate it, any gains are fully taxable.
Second, the FDIC protects up to $250K per bank in case the bank goes out of business. Your state insurance guaranty association will protect up to a certain amount of cash value life insurance (surprisingly low in some states, it is $200K in mine.) So you could argue the insurance is MORE risky than the bank CD.
But the point is that both investments are very low risk and will provide very low returns over the long run. Personally, I don’t like tying up money for 50+ years to lock in 3-5% returns, but that might not bother you as much. I like my safe assets not only very safe, but also very liquid. One thing about whole life insurance is that it is a commitment for your whole life. Don’t plan on terminating your policy ever once you buy it. That usually leads to very poor returns, much worse than 3-4%.
I’m not sure you understand how a whole life policy can be designed. If you buy a run of the mill whole life policy from Joe Shmoe at State Farm, it’s garbage. However you might want to try reading Becoming Your Own Banker by Nelson Nash. I have the vast majority of my savings built into high cash value whole life insurance. I break even after 2.5 years on my worst policy.
I do. If you wish to talk about banking on yourself or infinite banking, you might want to do it here:
https://www.whitecoatinvestor.com/a-twist-on-whole-life-insurance/
I agree the average whole life insurance policy is garbage and that they’re slightly better if designed properly. But their returns are still inadequate for what I need to do with my money to reach my goals.
Infinite Banking is not an either/or, it is an and. I run EVERYTHING I purchase through my own policies. Then I buy my vehicles, rental properties, and stocks. It is far from my only investment, it is just the vehicle that I use to take over the financing function in my life. The concept was not created or meant to just be used for retirement by letting your money sit. It’s meant to be used in the manner I use it. I agree that if you bought a policy like that and did nothing with it, that it would not be sufficient.
Glad it’s working out for you.
Even State Farm policies can be structured to work well.
I have had a WL policy for about 1.5 years now. You said “don’t plan on terminating your policy ever once you buy it”, but is that still applicable to such a young policy? I wouldn’t think so, but just checking. Thanks!
I think you’re confusing the mindset I think you should have if you’re considering buying one with the decision of what to do with a policy you don’t actually want.
Thanks for the quick response. I do understand how the whole life works. The policy I am looking at is one time purchase of $100K of SPWL. Base on the illustration, if I terminate the policy at year 25, I will get $210K guaranteed cash value (~3%, I will pay deferred tax on the $110K at much lower tax rate than my current 40% interest/dividend rate) or $340K projected cash value (~5%, think that as a bonus), the death value is much higher (2x cash value – pass to my kids tax free). I agree with you on some of the concepts of safe asset regarding to liquidity. Well, I understand there is costs associate with the whole life, but if you consider the added benefits of debtor protection, death benefit when catastrophe does hit and estate planning purpose, it still present good value in my asset diversification picture. I understand the downside of those products, but I think you should also look at its value and select them wisely (buy a good policy, not being sold a crappy one). What do you think?
Yes, if you’re going to buy one, you should buy a good one. Remember you don’t get the cash value AND the death benefit. It’s one or the other. If you terminate a policy, you do not get a death benefit at all. You’re talking about paying taxes on the gains, which is correct since this would be an MEC policy you would have to surrender/terminate to get your cash value. I don’t know why you seem to think you’ll be getting some kind of a tax break on the gains. You will be paying on the gains at your full marginal rate in the year you withdraw. In comparison to a taxable account, you’ll be paying far more in tax.
I doubt you’ll be getting much of an estate planning benefit with only a $100K policy. Will you be subject to estate tax?
As far as asset protection, how much cash value is protected from creditors in your state? Also, how much is guaranteed by your state insurance guaranty organization?
I really don’t think your plan is a good one. I think you would be better off investing in a municipal bond fund if you want something safe in a taxable account. Heck, if you’re happy with a pre-tax return of 3-4% for the next 25 years, why not just buy a treasury bond? The 30 year is yielding 3.88%. What is it that you think you’re getting out of a single premium whole life insurance policy that is such a good deal? My understanding of SPWL policies is that you really only want to use them for money you’re planning on leaving behind at death, not money you wish to spend in life.
What happens to the value of your 30 year treasury bond when interest rates go up? If long-term rates went to 8% what would happen to the value of the bond. If you invest in a limited pay whole life policy you could borrow or surrender your principal out to invest in the new 8% bond. If you had invested in a 30 year treasury bond you not only would have to pay taxes on your interest, but you would also take a substantial hit to your capital to liquidate your 30 year bond. I believe the typical investor would have significantly less risk to principal by using a properly structured limited pay whole life policy over a 30 year treasury bond.
Mansa,
Looks like you didn’t get a response, but I figured that you would like an answer. Let’s say that you invested $100,000 in a 30 year, 4% treasury bond. Then, 10 years down the road, you needed to sell the bond on the open market, during a time when the 20 year treasury bond rate was 8%. At that point in time, you would have received $40,000 in interest payments off the bond, and the bond would be worth $60,727.
Yes, if interest rates go up dramatically, your 30 year bonds, just like those owned by the insurance company, take a big hit.
Of course, the first year you buy a whole life policy it’s an awful lot like owning a 30 year bond and having rates go up 4%- a big chunk of your money disappears! The only difference is that outcome is guaranteed!
Yes, I do understand the cash value or death benefit not both, but the policy does provide both possibilities. Yes, it is a MEC from the beginning. The tax deferred growth is used in comparison to bank CDs/Munis you will have to pay tax on interest/dividends from time to time. In 25 years, my income tax rate will more likely be lower than now.
Beside the tax, I do feel sometimes asset protection, flexible estate planning (I do project to go over the 10M limit) and low/steady growth do outweigh the high risk and high return. Thanks for the information regarding to comparable alternative options (but those returns are not much better than 3-5%), I will investigate asset protection limit in NY.
Add: Here I just used $100K policy as an example. The plan is to buy multiple of them when my insurance rate is low. Some of the policies I may surrender and some of the other ones I can pass to heirs. Also, was the bond bubble just busted?
What taxes are you planning to pay on muni interest?
Yes, the “bond bubble” busted and may continue to bust. Consider what that is likely to do to the dividends of an insurance company, whose investments are primarily bonds.
If you plan on having $10M at death, your marginal tax rate in retirement may very well NOT be lower than it is now. 5% of $10M is $500K. Have you considered using your extra cash to do Roth conversions? That would help your estate tax issue and give you more tax diversification/flexibility in retirement.
Since your plan is cashing out of these policies and spending the proceeds, what estate planning benefit are you expecting to derive from the policies? Do you not anticipate the estate to have sufficient liquid assets to pay any estate taxes due?
Vanguard’s NY Muni fund is yielding 3.29%. Assuming you’re in the higher tax brackets there (perhaps 39.6% Federal, 6.85% State, 3.876% City) that’s like a pre-tax 6.5%. How in the world do you consider a pre-tax 3% (or at best, 5%) a better deal than that?
Buy insurance because you value the death benefit (or asset protection benefit- cash value is 100% protected from creditors in New York but only $500K is guaranteed by the state guaranty association), not as an investment. I mean, it sounds like you’ve got enough money that you can afford to not make great returns on a portion of it, but you’re not making a very convincing case for using life insurance as a retirement plan.
Why I can not post another comment?
I don’t see any pending comments. I haven’t edited or deleted any of your comments, although other readers are emailing me suggesting you are a “sock puppet”, i.e. an insurance agent masquerading as a physician investor. I’ll give you the benefit of the doubt though.
Insurance rates aren’t necessarily low for a whole life insurance product. They are simply actuarially adjusted for your age, health, and the time value of money. Yes, the payments are lower if you buy it at 30, but the cost is really the same whether you buy it at 30 or 50, as long as your health and hobbies are similar.
If estate planning is an issue, Ken should consider Universal Life Secondary Guarantee no-lapse 2nd-to-die.
BTW, when you take income distributions from your WL policy, it’s most often calculated as “to basis, then borrow.” Therefore, it’s certainly possible to take income without borrowing from the insurance company.
I agree that is a much better estate planning tool if there is a need for liquidity upon death or if the goal is to get the money out of the estate by buying the policy in an irrevocable trust. Agents and buyers alike love to throw out the “estate planning” bit. But they don’t talk about exactly how they want to use it for estate planning. If they need the money out of the estate, buying a policy that isn’t in an irrevocable trust isn’t helping. If they need a definite amount of liquidity at death (for estate taxes or simply splitting up the estate) due to having most of their net worth in a family farm or other similar valuable, but illiquid asset, then a guaranteed no-lapse policy is probably a better choice.
I have a different perspective that I think may benefit some of the readers. Before I make my comments to this post, I thought it would be important to disclose my background so that my thoughts can be considered in the correct context. I work for a small financial services firm and have a special contract with a large life insurance company. All my clients are Dentists. My income in 2013 was $224,000 of which 34K was from new life insurance policies written. Of the 34K in revenue, about half the policies were term and the other half whole life. It’s not a big part of my practice because my clients are so young and it isn’t the right time yet, but I do think it is important.
**see bottom for explanation of why I included my income.
Now that I got that out of the way, here is my criticisms of the post and comments.
It’s my observation that the argument against whole life insurance is almost always based on the idea or expectation that one could have done better with their money if they invested elsewhere. To compare the strategies, a 8% linear rate of return was used with different time benchmarks. In the end, the conclusion is that the projected cash value of life insurance policy is left standing in the shadows of the alternate investment.
The value of whole life insurance has little to do with whether cash value is bigger or smaller than the alternate investment. People are addicted to rates of return. For some, it is the only way they can comprehend a comparison. The simple truth to appreciating and taking advantage of the whole strategy lies in the death benefit, not just the projected CV. I read Bob Whitlock’s post and well as the WCI post and the death benefit wasn’t included as part of the analysis. The death benefit is what produces more retirement cash flow, not the cash value. Having a guaranteed account receivable, a promise to pay, allows someone to approach retirement distribution in a totally new light.
Consider this, you are a 65 year old retired dentist with a 65 year old wife/husband and you have been able to accumulate $x,xxx,xxx net worth over your career. These assets could be made up of 401K, IRA, taxable investment accounts, home equity, etc. Here is the challenge. How does one spend this money? Since Doctors spend so much time on training, most could spend more time in retirement than they did actually working. The life expectancy could be 30+ years for a 65 year old in the year 2044. Having no idea how long you will both live presents a big problem…how do I spend my money? How long does it need to last? What happens if I run out or live too long? What about legacy objectives, taxes, market risk? The result: People are locked out of their wealth. Retired people with $2MM are living like they are broke. They cut coupons and are always looking for deals. Maybe they even work a couple extra years “just in case.”They don’t go on the vacations they thought they would or spoil their grand kids. Many advisors would account for this problem by recommending you spend about 4-5%/year. This should be a safe bet so you don’t outlive your money and you can leave a legacy to kids or charity.
Consider an alternate couple. Same age and life expectancy. However, they retired with a reduced net worth of 150K because they wasted money on whole life insurance. They spent 500K on insurance premiums over 30 years. The cash value of the policy is only 750K and the market would have put them around 900K. . However, what they do have is 3MM of life insurance that will grow with dividends to 5MM by the time they are 90. The cash value is projected to grow from 750K at 65 to 2MM(including premium offset) at 90. The difference is they know how long their money needs to last. They can chose to spend down all their assets between 65-90 (amortize all income producing assets over 25 years plus assumed interest rate). If they are still living at age 90 and not drooling on themselves, they can now move to the cash value. If a spouse dies before 90, then the death benefit will refill the pool of assets for the surviving spouse. When the second spouse dies, their death benefit can be used for legacy purposes. They have decided that they can spend all their money over the next 25 years. This strategy will produce 2x the amount of annual income, without the fear of running out of money or missed legacy objectives.
If you can think with the end in mind (beginning of retirement), I believe it will impact investment and insurance choices. Most advisors are so laser focussed on accumulation, distribution is an afterthought at best.
I’m sharing my income for two reasons.
There are two types advisers/insurance agents/financial planners etc. that recommend or don’t recommend WL insurance.
1. The average- Those making less than 46K/year. They are easy to spot because they are wearing a belt from 3 loops ago, have shoe lases that are torn, and a suite that doesn’t fit properly. These people bastardize my industry on a daily basis and have no idea what they are doing. They don’t know where there next client is coming from and they will say whatever ever they need to to close a deal.
2. Those above average- That that are running a business and have more than enough clients. These people tend to have their income go up by about 25% year. They are not looking to peddle a product or make inappropriate recommendations. Their income is high enough that a particular sale doesn’t matter. They spend time and money on their education and end up with a bunch of letters after their name. Lawrence Keller is a good example and fits into this category.
The problem is the people in category 1 grossly outnumber the latter.
*Please excuse brevity and typos. Sent from iPad.
There are better ways to avoid running out of money in retirement. A SPIA guarantees you won’t run out of money in a much better way than life insurance. If your goal is to leave a set amount of money for heirs, guaranteed no-lapse universal is better than whole life. If your goal is to leave as much as possible to heirs, you’re better off in traditional investments and taking the step-up in basis. So what is whole life best for……..exactly. Nothing.
It isn’t hard to develop a reasonable plan to spend money in retirement. Nobody is locked out of their wealth. It doesn’t require a whole life policy to spend money in retirement. Millions of retirees are doing it every day. If you want to be sure to be able to leave money to your heirs, don’t spend it. You can’t spend all the cash value in a policy and then get all the death benefit. The death benefit will probably increase, but you still get one or the other, not both. Guarantees cost money. The fewer of them you need, the more money you are likely to be able to spend and leave to heirs.
Rate of return DOES matter. The higher your return, the more money you have to spend in retirement or leave to heirs. There is no magic insurance policy that somehow makes rate of return not matter. You talk about how awesome it is that $3M can grow to $5M over 25 years. That’s a rate of return of 2.06%. You can crush that just by buying a treasury bond.
Look, if someone understands how a whole life policy actually works and still wants one, fine, knock yourself out. But in my experience, the vast majority of the purchasers of this product don’t understand how it works, and once they do, they want to figure out the best way to get out of it. 80%+ of purchasers of whole life insurance terminate their policies before death. That’s a terrible statistic for a product that, if it makes sense at all, only makes sense if held to death.
One can’t invest a 3MM death benefit that hasn’t been paid yet ( because they are still living) in treasury bonds. They would have to surrender the policy CV of 750K pay tax on gains, and they never would end up at the 5MM. The calculation of 2% is off base.
I think we may actually be able to agree on one thing in regards to how people get hurt in WL insurance and how they get hurt in traditional investments.
There are only two ways for someone to loose on WL insurance policy.
1. When someone convinces them they made a bad move and they cash it in early and the surrender for a big loss.
2. Over 30 or so years, they loose in the sense that they could have done better.
The first point is avoidable, and the 2nd really isn’t a catastrophic/irrecoverable situation. They are still positive and didn’t loose principal and achieved a fair ROR for the risk taken. They are taxed favorably. They had a death benefit the whole time, avoided some term premiums plus the time value of money on those premiums, they had waiver of premium, the had suit protection in most states, and the death benefit at least kept pace with inflation( unlike UL,VUL, IUL) They also had liquidity in year two. Maybe not to their cost basis if early on, But someone with $xxxxin CV will have a check in 3 days in case of emergency…or opportunity. They don’t have to sell a stock at a loss/gain, or have a reason for a qualified account.
If we compare this to how people can loose with common planning:
1. They can do well for 10 or 20 years, but this doesn’t actually matter does it?In practical application hat matters is how they are doing the decade and the last couple years before they retire.
2. There are a lot of doctors still working at 70 years old. It isn’t because they bought or didn’t buy a WL policy. Among a lot of other reasons, it is because the equity market didn’t work out so good for them. Forget the 8% linear ROR, some in 1999 and 2008 would be happy just to be even.
3. Thousands of people lost all their money ( enron, Madoff, Jordan Belfort)
The upside and downside are both unlimited with traditional planning. The downside with a WL policy is guaranteed and you will never experience the unlimited upside of the stock market.
This is why someone should be balanced with their approach. Have human life value of term and WL, have real estate investments, have market (stock/bond) exposure, keep very liquid funds available.
That sounds like a Living Balance Sheet presentation.
A few comments on your comment:
Yes, they avoided some term premiums. So, by paying $10K a year they avoided a $500 expense. You want to talk about the time value of money, how about the time value of that $9500. Again, if someone needs life insurance during their accumulation phase, whole life is an inferior way to get it.
The death benefit is not guaranteed to keep pace with inflation, in fact it is not guaranteed to increase at all. Might it keep pace with inflation? Sure. Most people don’t actually need their death benefit to keep pace with inflation. The key is to have the value of the portfolio plus the value of the life insurance keep pace with inflation. If you want inflation protection, whole life is not the best way to get it.
If liquidity is important, there are better vehicles than whole life. And you don’t even have to pay interest to get to your own money. Again, whole life is not the best way to maintain liquidity.
Selling stocks at a loss is a huge benefit of a taxable account over a whole life policy. Tax-loss harvesting can lower your taxes. That’s not a bad thing.
Lots of doctors are working at 70 years old. Among other reasons, many of them are doing so because their portfolios didn’t grow fast enough to allow them a comfortable retirement because they invested in low rate of return investments like whole life insurance.
In practical application, returns matter more for the decade before and after retirement than at other stages. I agree. But I disagree that whole life insurance somehow provides superior risk adjusted returns at that time period any more than it does earlier in the accumulation phase or later in the distribution phase. Again, there is a better way to meet that need than whole life insurance.
If someone is still underwater from 2008 it is because they sold out at market lows and didn’t get back in for at least a couple of years afterward, not because they invested in stocks. Are you really saying whole life is a better way to invest because people lack the self control to stay the course in a market downturn? Seems a bit paternalistic, no? I guess if you’re so undisciplined or stupid that you cannot avoid selling stocks when they go down (as we know they will every 5-10 years) then yes, you might do better in a whole life policy, or perhaps just sticking the money under the mattress. The return is really the same for the first decade anyway.
The Enron/Madoff argument is even better. Buy whole life because there are people out there trying to scam you out of all your money. None of them are insurance agents masquerading as financial advisors seeking 50-110% of the first year’s premium as a commission, of course.
I’m not sure what you call “traditional planning” unless you mean not buying whole life insurance. If you are concerned about running out of money, insure against it by buying a SPIA. That eliminates your downside. No whole life insurance needed.
Do you have something else? Surely there is something which whole life does better than anything else? Lousy life insurance, lousy longevity insurance, lousy investment, unneeded estate planning, limited asset protection, limited tax benefit…..If it were truly a useful tool, insurance companies would not have to pay agents the entire first year’s premium to sell the thing.
Also, I have a lot of respect for WCI and the quality of this blog. It took me an hour to work out that simple response. I can’t imagine how much time he must spend on this blog for the benefit of the readers.
Come on, please do not suspect everyone who is interested in whole life as a sales agent. I have a good friend used to sell life insurance many years ago. The warning I remember from him about life insurance is “buy term and invest the rest”. For most of people that is probably true. But I think my current financial situation drive me to revisit this concept. The only policy I am interested here is SPWL, since my friend told me that is one of the most cost effective policy for buyers not the sellers. Very few insurance companies actually promote this type of policies now days. I guess that is because the agents are making less commissions selling those. Some of the agents I contact don’t even want to look into those policies for me. So, just want to make it clear that I am not a sales agent in sheep’s clothing. I think we are having valuable discussions about WL and other alternative investments. Let’s get back to your previous comments:
Roth conversion is a good idea and I did do some a few years ago and will keep doing it. I do have some tax exempt Muni bond fund but I consider them still a bit risky (down 20% in 2008-2009). The main reason that I am interested in some SPWL products is their multi-benefits, of course with some cost associated with. Asset protection is very important in my career (It is why we need tort reform!) . The last thing that I want is someone come and take away what I have worked so hard and so long for. The flexible estate planning (using multiple policies to choose for cash value vs. death benefits at the later age) is a good add-on benefit; and, yes, I do need additional insurance for the family. I understand the returns are a bit lousy for those policies but not too bad considering current interest rate and other high risk investment options. The cash value life insurance is also recommended on this website for certain types of families: (financial-advice-for-high-income-doctors)
Do you see my points now?
Ken-Read my previous comment. Forget about the cash value and all the other noise for a second. Think with the end in mind. If you think about distribution first, I bet if will impact where you store wealth, create wealth, and how you insure yourself.
Well, I don’t want to pay annual premiums to get to 750K cash value in 30 years. But I do like the idea of spend more freely of other retirement wealth (401k, IRA, taxable account, etc.) with the understanding of a significant policy value will grow and will be able to leave a legacy if I want to. 3-5% return is needed to beat the inflation, otherwise, not a good deal.
If you want to spend freely without having to worry about running out of money, buy a SPIA. If you want to leave a legacy, don’t spend all your money and invest some of it for your heirs. I don’t understand why you and Tyler are under the belief that you cannot leave a legacy without life insurance.
You know I like SPIAs. I read an article from the Society of Actuaries that made the observation that annuities–a guaranteed source of income–allows you to be more aggressive with your other investments.
But many people don’t like annuities because it “locks up their money.” Also, do you buy a SPIA with life only or do you buy it with survivorship? Your spouse may prefer the latter…
You’re asking me if someone should buy a SPIA with life only or with surivorship? You sell this stuff for a living Bob. I would hope that you know the answer is that it depends. If your spouse has adequate means to live without that money, then buy it life only. If not, then survivorship.
I’m sorry people don’t like annuities. If you want a guarantee that you won’t run out of money, that’s what you need to buy. If you’re okay running that risk, then you can stick with traditional investments and a reasonable withdrawal plan like following the 4% rule or a variable plan depending on market returns. There’s no point in buying a whole life policy though. It’s not like that provides a guarantee you won’t run out of money nor does it provide the highest returns for risk taken like a traditional investment portfolio of stocks, bonds, and real estate.
Ken.. SPWL seems to fit your situation nicely. With the single premium you will pretty much rid away completely with any sort of waiting period so the product can begin to work for you right away. Not sure where WCI was going with the CD comparison, but it’s not even close. You’ll blow away cd returns in the custom whole life and that doesn’t even take a nice death benefit into account as part of a family legacy. Just be careful with estate tax laws as it seems your already aware of. Not sure who owns the policy in your case but definitely start looking into an ILIT (irrevocable life insurance trust) if you start approaching estate limits.
Someone who has a decent amount of product knowledge would never recommend anything other than a custom whole life to a client who is over 40 and in the position to reallocate some investment dollars via a single premium. Maximizing policy potential in year one actually “debunks” much of WCI’s debunking. The faster you can pay, the stronger the vehicle becomes. If a mec is an issue have them blend some term as a rider into the policy so you can pack it out as much as you’d like. And for the record, A custom pay whole life will pay out significantly less to the agent/advisor than a traditional one. Just wanted to mention that before WCI goes into his “high incentive” bit. I’m also not going to disclose my name or designations for that same reason.
Also, not every person in the industry is a bad apple. Two general rules of thumb is make sure the company has been writing business for 50 years, and if you are buying whole life make sure they are a mutual company (no shareholders typically means higher dividends for policy owners).
If we’re going to throw out statistics, let’s be accurate with them. That VG NY Muni fund I mentioned earlier did not lose 20% of its value in 2008 and 2009. In 2008 it lost 1.92%. In 2009 it made 13.02%. It’s worst loss in 13 years was this year when it lost 2%. I’m not sure “risky” is a term I would use to describe a fund like that.
If you value the additional options and asset protection more than the additional money you are likely to have by investing in something else, then knock yourself out. At least you’re making an informed decision and have decided to purchase asset protection and flexibility. Personally, I think the price is too high for the value.
I’d appreciate it if you would point out where on this website cash value life insurance is recommended for certain types of families. I’ll be sure to remove that recommendation which has somehow been snuck onto my website. In case anyone is confused on this point, I really don’t think anyone needs a whole life insurance policy and they are appropriate for an absolutely tiny percentage of physicians. A high income and a high net worth does not make whole life insurance a good idea automatically.
I’m still mystified why you would want to use a single premium whole life policy for retirement. I think SPWL is fine for money you know you will leave for heirs, especially in something like an irrevocable trust. But if you’re going to actually spend that money, you’re almost surely better off with a regular old whole life policy that isn’t a MEC, so you can borrow from it tax-free (but not interest-free) rather than cashing out and paying all the taxes. Talking about losing flexibility….
I don’t have the same NY muni fund you mentioned here, but looking at my muni fund that went down 15-20% in one of the worst quarters during last financial crisis is a gut-wrenching experience even though it came back if you only look at the whole year number. The 10 year return, even for VNYTX is a mere 3.7%; not much better than the 3-5% SPWL policy I am considering. For safe money that you want to put in bank CD accounts, 15-20% quarterly swing is a problem. You can only hope what happened in 2008-2009 is a once in a life time event, but who can guarantee that?
Why I am only looking at the SPWL here? Because I compared numbers, they have the lowest cost structure among all kind of WL varieties. Less cost is money in your pocket, right? I don’t like borrow money (infinity banking concept) from the policy (against death value), it’s a very tricky business. Multiple SPWL policies will function as efficient/flexible as a UVL. Please take a serious look into this if you have time, since it may benefit many people here.
Thanks for bring it up, I do need to take a look at annuities (there must be a good reason that Bernanke put his largest investment holdings in annuities), but I believe I can do it at a later age. My point is that we need to have an open mind towards those insurance products, right?
The article on your website recommending cash value insurance is here:
**Financial-advice-for-high-income-doctors**
“Consider Cash Value Life Insurance
Although it pains me to say it, as I’m generally one of the internet’s harshest critics of mixing insurance and investing, the higher your income the more sense investing in an appropriately designed cash value (whole life or variable universal life) life insurance policy can make. (For lower income folks, I think Dave Ramsey is absolutely right when he calls it the “payday loan of the middle class.”) High earners have maxed out available retirement accounts, are in and expect to stay in the highest tax brackets, have less need for high returns, and are more likely to gain maximal benefit from any estate planning and asset protection features. It’s still reasonable to invest in tax-efficient mutual funds or tax-preferred real estate instead of life insurance (especially if your costs of insurance are relatively high), but the difference isn’t nearly as vast as it would be on a typical physician income. Bear in mind that if you choose to invest in a cash value life insurance policy that it should be set up as much as possible as an investment from the beginning. That generally means minimizing the death benefit, overfunding it to the MEC line, minimizing insurance and investing fees and expenses, funding it annually (instead of monthly), having it “paid up” as soon as possible to minimize required future payments, and perhaps most importantly, ensuring only a reasonable percentage of your assets are going in to this investment vehicle.”
You need a new muni fund. That Vanguard fund mentioned earlier (sorry I gave the index returns and not the fund returns, the worst annual return was -3.69% in 2008) has a worst quarterly loss of just -3.69%, and that’s a long term fund. I’m not sure what kind of a muni fund you were invested in that lost 15-20%, but it doesn’t sound like it is particularly well run.
I’m not sure why you don’t think I’ve looked seriously at whole life insurance. Terminating a policy with gains turns the gains into fully taxable income at your marginal rate. You imply you’re going to be in the highest brackets in retirement, so we’re talking about a 50% marginal rate. So let’s say you buy $500K worth of insurance at age 40 and it grows at 3% for 30 years until age 70 (at which point it is worth $1.213 M), you then terminate the policy and pay taxes on the $713K in gains, for a tax bill of $356,500, leaving you with $856,500. What kind of a return on a muni fund would you need to grow $500K into $856,500? 1.81%. That’s less than the historical rate of inflation and half the rate of return of the discussed muni bond fund.
I mean, I can understand someone wanting to buy a cash value life insurance policy if they have oodles of money they don’t need to make good returns on. But buying an MEC and then actually using it for retirement funding is stupid. MECs are for legacy funding, not retirement funding.
The paragraph you point out states that “you should set up the policy as an investment from the beginning.” You are not doing that with your strategy because you are planning on a lousy after-tax return. SPWL may or may not have the lowest cost structure (wouldn’t surprise me if it did) but if you add in the cost of taxes upon terminating it, it sure as heck doesn’t. When a comparison to a municipal bond fund at a time of historically low interest rates makes your investment look bad, you’ve got to start wondering about it.
But that’s the fun thing about investing. You don’t have to convince me you’re looking at a great investment. You can do whatever you want. But if someone wanted to use a whole life insurance policy as a retirement plan, the key is using paid up additions to fund up to the MEC line, paying annually and then spending the money last in retirement as loans from the policy while holding the policy until death.
Wow ! Great post but what a concise, honest and true synopsis that last sentence was on the usefulness/logic for the only reason to use whole life. My income has limited myself out of most options ( heck I cannot even deduct the kids college tuition ) and I use the backdoor IRA. My ROTH and the practice are my primary retirement savings. The paid up additions to the MEC seem to be the key. The main thing I missed was the death benefit. I am under the assumption that with the PUA’s the death benefit increases also. Your example of a 500K policy for 30 years ( age 40 to 70)still has a DB of 500k but in actuality wouldn’t that increase to about 850K ? This seems to fit for the numbers and that would leave 350K to borrow out in late retirement and still leave 500K for the heirs. At that point I am getting my past 30 years premiums out and still leaving my family with 500K. Not great, but not bad
Those numbers are probably about right.