Long-term readers know I'm not a fan of whole life insurance. I have owned a policy in the past, but do not currently own one and honestly doubt I'll ever purchase one in the future. Long-term readers may not, however, be aware of an ongoing trend on this website. When I write a post on whole life insurance like this one, it gets a few comments from regular readers and then disappears down the list of blog posts. A few months later, as it starts gaining traction in the search engines, every few days a whole life insurance salesman, or simply someone who has completely drunk the Kool-aid, wanders in and tries to convince me I'm wrong. They are appalled by the fact that I don't agree with them that whole life insurance is the best thing since sliced bread. This makes for some intriguing and occasionally bizarre conversations that frankly typically devolve within a few posts into ad hominem attacks leading to the agent's IP address being blocked from the site. A few days later, a new agent shows up and does the same thing, ad nauseum, for years, on a dozen or most posts on this site.
However, recently I had two whole life “fanboys” show up who both claimed there were NO DOWNSIDES to a whole life policy. It was incredibly bizarre. I mean, everyone knows that just about anything has upsides and downsides. If the downsides outweigh the upsides for you, then you avoid it. And vice versa. So today, I thought I'd make a little list of the upsides and downsides of whole life insurance.
Upsides of Whole Life Insurance
# 1 A life-long, tax-free, death benefit
At the end of the day, a life insurance policy is life insurance. If you die while owning life insurance, you get paid the death benefit. This includes whole life insurance. Unlike term insurance, which rapidly becomes astronomically expensive after the term ends and you start getting to those ages where you are actually likely to die, whole life insurance is designed to pay out when you die, even if that's at age 95. If this is a benefit you want, and you want that death benefit to slowly grow (it's way cheaper to buy a Guaranteed Universal Life policy if a flat death benefit is fine with you), then Whole Life does that for you. All life insurance death benefits are tax-free to the recipient, just like when you inherit other assets like mutual funds and investment properties thanks to the step-up in basis at death.
# 2 The ability to borrow money against your cash value at pre-set terms
You can access this death benefit even before you die by borrowing against it, as long as the policy isn't a Modified Endowment Contract (most aren't.) The insurance policy dictates the terms of your borrowing. Depending on what's happened in the economy since you bought the policy, those terms may be very attractive or very unattractive, but they are pre-set when you buy the policy. Note that when you die, the amount you've borrowed is subtracted from the death benefit before it is paid to heirs. So any given dollar can only be used as EITHER borrowed cash value OR death benefit, not both. Of course, the loan is tax-free but not interest-free, just like borrowing against your house, your car, or your portfolio.
# 3 In some states, significant asset protection for the cash value in the event of bankruptcy
About half the states, including mine, provide 100% asset protection for whole life insurance policies payable to spouse or children. Partial protection is available in a number of other states. Before buying a policy for this reason, make sure your state actually provides significant protection. Bear in mind the likelihood of you actually being sued for a significant amount above your malpractice or umbrella policy limits is exceedingly small (I calculate my risk at <1/20,000 per year).
# 4 Non-direct recognition in some policies
In most policies, when you borrow money the dividend on the policy is based on the amount of cash value that is not being “borrowed out” of (technically borrowed against) the policy. This is called “direct recognition.” There are some policies, called “non-direct recognition” where the policy continues to pay dividends as though no money was borrowed against the policy. This is the most important characteristic of the policies that folks use to “Bank on Yourself” or do “Infinite Banking,” one of the few reasonable uses of a whole life policy. The other characteristics are “wash loans” (where the dividend rate on the cash value is equal to [or greater than] the interest rate on the loan and maximizing the use of Paid Up Additions, which have a lower commission rate than the regular policy.
People who do this are essentially trading a few downsides of whole life insurance for the ability to earn a little more on their savings in the long run, which can make a lot of sense when savings accounts are paying less than 1%, but not as much if you can get 5%+ in a money market fund like you could when I came out of residency. The only issue I have with the whole thing is the ridiculous amount of marketing and hype surrounding the concept which leads to people buying policies inappropriately and inappropriately structured policies being sold by agents. If you actually understand how it works, don't mind the downsides, and buy a policy that is actually structured well to do this, it doesn't bother me at all.
# 5 Life insurance cash value is an asset that doesn't appear on the FAFSA
This is actually a benefit, although not a very big one for those reading this site. For most of my readers, it doesn't matter that your cash value doesn't show up on your Free Application for Federal Student Aid (FAFSA) because your income does and that alone is enough to keep your kid from qualifying for any significant college aid. When you combine that with the fact that most “aid” is loans, this is a pretty minor upside, but upside it is.
# 6 Dividends aren't taxed
Whole life insurance dividends are considered “return of premium,” i.e. you paid too much in premium for the benefit and thus the premium is paid back to you. This “income” isn't taxed, because it isn't really income. It's like a rebate on a lawn mower. You can spend the dividends, use them to pay the next premium, or use them to buy more insurance. The third option is what most people do and is what allows for the tax-protected growth inside the policy and for the slowly increasing death benefit. This tax protection/growth is similar to a non-deductible traditional IRA, but pales in comparison to the up-front tax break given to you in a 401(k) and the tax-free withdrawals available in a Roth IRA, but it is an upside.
# 7 Works reasonably well in an irrevocable trust
Trust tax rates and estate tax rates are very high, so putting a whole life insurance policy into an irrevocable trust is a pretty good way to pass wealth on to your heirs IF you have an estate tax problem. Granted, very few high-income professionals have a federal estate tax problem these days given that the estate tax exemption has been raised to >$11M ($22M married), but the tax efficiency and simplicity of the policy, when put in the trust and left alone, is an upside.
Downsides
All right, let's move on to the purpose of the post, the downsides of whole life insurance.
# 1 The insurance is really expensive
Life insurance is designed to pay a death benefit in the event of death. You buy a $1M policy. You die. Your heirs get $1M. Life insurance.
If you die after buying a $1M term policy, your heirs get $1M. If you die after you buy a $1M whole life policy, your heirs get $1M. Same life insurance.
But the problem is that the whole life policy costs 8-10 times as much. 8-10 times the premiums. Same death benefit. Remember your heirs don't get the death benefit AND the cash value. When you die, they get the death benefit.
To make matters worse, thanks to all the moving parts and policy differences, the whole life market is not as efficiently and competitively priced as the term life insurance market.
# 2 You're buying unnecessary insurance
On average, insurance is a bad deal for its purchasers. That's because the sum of all the benefits paid out must by necessity be less than the sum of the premiums paid, at least when accounting for the time value of money. That's because the premiums must cover the commissions to the salesmen, the expenses of the company, the profits of the company (unless mutual), AND the benefits. Benefits must be less than premiums or the company quickly goes out of business. So the general rule is to avoid buying insurance you don't need. Basically, you should insure well against true financial catastrophes, and self-insure against everything else.
The period of life when you need insurance usually starts when someone else (usually spouse and/or kids) begins depending on your income and ends when you become financially independent. This is usually a 30-40 year period, but can be as short as 5-10 years or not exist at all. With whole life insurance, you're buying insurance that covers you for your whole life, including those periods of time when you don't have a life insurance need. Mandated, unnecessary insurance is a downside of whole life insurance.
# 3 Returns are low
This is probably the biggest downside of a whole life policy. If the long-term return on these things were 8 or 10%, I'd be writing all kinds of posts about why you should own one. Unfortunately, that's not the case. In a reasonably well-structured whole life policy that is held from age 30 to your death 50+ years later, the return on your cash value is guaranteed at around 2% per year and projected at around 5%. I would expect something between those two numbers. I find it very hard to get excited about tying my money up for 5+ decades in order to get a sub 5% return on my investment, even if it comes with a death benefit.
# 4 The crummy returns are front-loaded
Here's another huge downside, as many WCI readers have discovered. Your initial returns on these policies are not 2-5%. They're negative. Very negative. In fact, the cumulative return on the whole life policy I owned for 7 years was -33% or so. Did you see that minus sign? That's right. Ignoring the value of the death benefit (which in these years is very low given the cost of comparable term insurance) you LOSE money for the first 5-15 years on these policies. It is not uncommon at all for me to meet a doctor who has paid $30K a year for 3 years in whole life insurance premiums, decided he doesn't want the policy, and discovers the surrender value is only $50-60K or worse. $90K in. $50K out. That is NOT a very good investment return. Why are the returns so low early on? The main reason is the commission paid to the agent selling it. A typical whole life insurance commission is 50-110% of the first year's premium. So if the premiums are $30k, that agent was paid $15-33K to sell it to you. Now you know why he was working so hard. He got paid what you have to see 400 patients to earn just to sell a single policy. Mad at that agent who sold you your policy yet? Join the club. Fees to the insurance company and the cost of the life-long insurance benefit also contribute to the low early returns on the cash value.
# 5 Most policies seemingly designed to maximize commissions to agent
There are ways to improve the returns on a policy. As mentioned above, maximizing the use of “paid up additions” while minimizing the amount of “regular policy” decreases the commission, and thus increases return. But is this the way most policies are structured? Nope. Why not? Well, it's either because the agent wants to maximize his commission or is ignorant. Either way, it's not a good thing for you. This isn't so much a problem with the product itself as the way it is sold, which is the main beef I have with whole life insurance anyway. Speaking of which….
# 6 Most policies are sold inappropriately
Most whole life insurance policies are sold inappropriately. Thus, it isn't surprising to see that 80%+ of whole life policies are surrendered prior to death, as their purchasers realize they are inappropriate for their life. These cases usually fall into one of three categories.
First, the purchaser has a better use for their money. This occurs when a policy is sold to someone with student loans. Why someone would buy an “investment” with terrible early returns and 2-5% long-term returns while carrying 6.8% debt is beyond me. But I know why that “investment” is sold to that borrower (see # 5 above.) This also occurs when someone has a policy but isn't maxing out available retirement accounts like 401(k)s, 403(b)s, individual 401(k)s for the side gig, 457(b)s, Backdoor Roth IRAs, and HSAs. Even a defined benefit/cash balance plan with its generally lower returns (in comparison to a more aggressively invested and lower fee 401(k)) has far better tax benefits and asset protection benefits than whole life insurance. Whole life insurance doesn't necessarily make sense if you've maxed out your available tax-protected accounts, but it certainly isn't a good move if you haven't even done that. Likewise, a 529 has much better tax benefits (not to mention higher returns and dramatically lower costs) than whole life insurance when saving for college education.
Second, far too many purchasers of whole life insurance don't even understand how it works. They're shocked when they discover they're underwater after 2 or 3 years of making payments. That's not a bug, that's a feature. It's just the way whole life insurance works. Wait until they find out they have to pay interest to get to their money later.
Third, salesmen use half-truths like “tax-free income” to get people to buy the policies. If you took out a home equity loan on your home, you wouldn't describe the proceeds as “income” would you? But that's exactly how borrowing against a whole life policy works. The only thing tax-free about whole life insurance is the death benefit. In that respect, it really isn't very different from passing along a house or a car or mutual fund shares to your heirs thanks to the step-up in basis at death. In fact, if you surrender (i.e. cash-out) a policy with a gain, you don't even get the lower long-term capital gains rates on the gain. You have to pay at your ordinary income tax rates. And if you have a loss, you can't deduct it against your taxes (even if you exchange it into a variable annuity before surrendering, a strategy that some people used prior to recent tax law changes.)
# 7 ‘Til death do you part
Due to the low early returns and the nasty tax consequences of surrendering policies with gains, a whole life insurance policy is not something you should buy for just a few years or even a few decades. Before buying it, you'd better be sure you really want to hold on to this thing for the rest of your life because, like marriage, it's going to cost you a lot of money and hassle to get out of it. That doesn't mean that if you were sold a crummy policy inappropriately a few years ago that you should keep it. If you're in that situation (like tons of other WCI readers), either pay someone else to evaluate your in-force illustration or evaluate it yourself and then if your evaluation convinces you that it's still not a good investment going forward, dump it either through an exchange to a low-cost VA or by just walking away with your cash value, poorer but smarter.
The main problem with a life-long commitment to something like a whole life policy is that life changes. It's tough to project your income and family situation for the next decade, much less the next half century. While there is some flexibility to restructure a policy, by decreasing the benefit or using the dividends and cash value to make the premium payments, these actions generally decrease the benefits you bought the policy for in the first place. Plus, there is precious little flexibility in the first few years before much cash value has built up. One way some people minimize this risk is by getting a “7-pay” or “10-pay” policy that you only have to pay on for 7-10 years. It would be great to find a “1-pay” policy, but unfortunately, these get classified as Modified Endowment Contracts from which you can't even borrow tax-free.
# 8 Borrowing terms often terrible
As noted under the upsides, you can borrow against your cash value at pre-set terms. The problem is those terms are usually terrible. Like 8% interest. Interest rates are going to have to rise a long way for you to be able to get excited about using this source of funds unless your financial life is such a mess that you can't get money any other way in a timely manner. In which case, you probably can't make your whole life premiums anyway.
# 9 Many people can't obtain a policy
Due to poor health or dangerous hobbies, many people can't purchase a whole life insurance policy at any sort of reasonable price. No problem, say the agents. Just buy a policy on your spouse, kids, friend, or family member. The problem is now you're likely buying a policy on someone for whom there is no need for life insurance. It was bad enough before when you were buying a policy for periods of your life when you didn't need life insurance. Now you're buying completely unnecessary insurance. That doesn't come free.
# 10 Returns on tiny policies even lower
Speaking of buying insurance on your kids, I'm amazed how many people buy life insurance from the same company they buy baby food from. One of the big issues with buying life insurance on your kid is that the policy is typically tiny. This was the issue with the policy I was sold as a medical student. It had a face value of only $20K. Policies that small still have the same policy fees. Those fees make up a much larger percentage of the premium, dividend, and cash value, thus lowering your returns.
# 11 Leaving difficult decisions to your adult kids
I am frequently emailed by someone whose parents bought them a policy as a child and have now gifted it to them as an adult, along with the required ongoing premium payments. It always makes them sad when I point out that nobody needed that death benefit for the first 20 or 30 years of their life and that if their parents had just given them shares of a mutual fund they might have received eight times as much money. They get even more depressed when they see their in-force illustration and realize that their ongoing returns won't even be the 2-5%/year that a halfway decent policy might bring. If your kid has to email someone in 30 years to figure out what to do with this crappy policy you were swindled into buying, did you really do them much of a service?
In addition, it likely only offers a minimal amount of death benefit (especially after 30 years of inflation) that didn't preserve any significant amount of insurability for them (now that they're entering the period of their life when they actually have a life insurance need.) If you're the recipient of a policy like this, be sure to thank your parents for trying to do something nice for you. Don't mention what they should have done instead. Then surrender the policy, take your $1500 of cash value, and put it toward student loans or a Roth IRA.
The Bottom Line
Now, if you understand the upsides and the downsides of whole life insurance and you still want a policy, knock yourself out and buy as many as you want. It really doesn't bother me; I don't get paid one way or the other. I would guess 1% of doctors and an even lower percentage of the middle class wants a policy once they understand how it works. However, if the person advising you to buy a whole life insurance policy can't even see, much less articulate, the downsides of the policy, you need to go see someone else. In fact, if I were in the market for a whole life policy, I'd be seeing at least two agents AND one real financial advisor who wasn't going to profit at all from the purchase before making a decision.
What do you think? Did I miss any upsides or downsides of whole life insurance? Comment below!
[As usual, ad hominem attacks posted by insurance agents in this comments section years from now will be deleted and your IP address blocked, so don't bother. I'm the only one who will ever read them, so you might as well just email them to me so it will be quicker for me to delete.]
Some of us have been so convinced that Term Life is the only way to go that we forget there actually are potential benefits of whole life. This is a great reminder. As you say, we should all be versed in the counterpoints of our opinions and also be able to recognize the 1% who may benefit.
https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=2ahUKEwi_xMrjoMPeAhVs7YMKHTmABjsQFjABegQIBBAB&url=http%3A%2F%2Frurl.us%2FEQzz3&usg=AOvVaw1cOYEexRQxuRZzcm6-s4AF
Who are the 1% that whole life benefits? Thx.
https://www.whitecoatinvestor.com/appropriate-uses-of-permanent-life-insurance/
Mostly people who highly value one of the side benefits of WL so much they’re willing to give up a lot of investment return to get them. These are usually one or more of the following: death benefit, ability to borrow against it (usually BOY/IB types), and asset protection (seriously overblown in my opinion, but if it helps you sleep at night.)
https://www.whitecoatinvestor.com/appropriate-uses-of-permanent-life-insurance/
That last comment is my favorite: “just email them to me so it will be quicker for me to delete.”
That’s pretty much what I think of whole life insurance policies.
I do have a resident who had their medical school paid for by their parent’s (also a doc) whole life policy. I wonder if he realized how much it cost to borrow against it based on the numbers you were talking about above.
It seems pretty simple to me. Whole life is meant to do two things. A death benefit (for which term is much cheaper and equally effective) and investment features (for which money into just about any other account will be more efficient and effective in gaining returns).
Asset protection is a pretty theorhetical benefit that sure does cost a lot of money to get. I’m not a lawyer, but I bet there are other ways to protect your money if you are that concerned about it.
TPP
Yes, there are lots of uses for it, but there is usually a better product/method for every use.
Very well rounded post describing the pros and cons. I can’t imagine even the die-hard fan boys have issue with this post but of course I could be wrong since there is always one in every crowd.
I am shocked at the commissions that agents get selling a single policy. No wonder they push it heavily if they can get $30k/policy sold.
I am glad I never got roped into whole life insurance (one of the few mistakes I didn’t make in my financial life). I do remember one year decades ago my step dad gave me an insurance policy as part of a Christmas gift (this was in Canada where he was from). Have no idea what type of policy it was (I was in medical school), and if there is any cash value in it now. Don’t even know what steps would be needed to even find out about it since I have no recollection of the company name and no paperwork trail to rely on.
I just stumbled upon this comment. If you think it’s worth your time, you can call the life insurance companies and give them your name and date of birth and they’ll tell you if you have a policy with them.
There aren’t too many whole life companies in Canada. I’d start with London life, Canada life, and sun life to see if they have any information.
Great reminder post. We were in a Whole Life product and it turned out terrible (SURPRISE!). In fact, after I realized that I was getting hooped is when I started researching myself and found WCI…maybe Dr Dahle should send a thank you note! Anyway, a golden rule that I found was have insurance, and have investments but don’t have insurance and investments in the same product. Great article!
This is an excellent review. Whole life insurance policies are an old hybrid product of yesteryear. Today, there are so many more attractive options for younger investors (401k, Roth IRA, low cost mutual funds, ETFs, HSA, 529, cash balance pension plans, etc). Buy term insurance to protect your family and invest elsewhere. I own an old whole life insurance policy in an ILIT. It was setup many years ago when estate taxes where an issue (unlike today’s huge exemption). It has only had very mediocre returns and been a pain in the fanny. I would not recommend this strategy today unless you own a very high value illiquid asset (family business) you wish to pass to heirs. One additional downside is that if you hold these policies for decades until your demise, there is no inflation protection. The face value of the policy will not buy your heirs that much in future dollars.
I’m curious when you say “many years ago” how old you were at the time, and how close to the tax-free limit to estates in your state you were at the time.
I got a survivorship policy with my wife several years ago anticipating the estate issue, but never put it in trust, since the politics all seems to point to estate tax elimination or close to it.
It seems if you are in good health and not a Rockefeller, there’s no reason to put in in trust right away. Our attorney actually discussed simply have the policy ownership transferred to our kids at some point, although I’m not clear on how that is transacted, but it seems sensible since they’d be the ones to pay the tax anyway. Your opinion is of interest.
It was the early 90’s and the estate tax limit was 600k (1.2 m couple). The federal rate was 55% plus a state rate of 15%+ (as I remember). We had young children and with our assets and a one million+ life insurance policy, the estate would be over the limit. The thinking was that if the parents died and the children were orphaned, the government would take the life insurance money in estate taxes. Thus, the ILIT. Today, it would be an entirely different story. The ILIT is now an unnecessary annual hassle.
Thanks for sharing. I know others in the same position.
Another downside is your mutual company goes through a demutualization, you get some small policy credits, and then in a few years when the now stock company is bought out, your dividend rate is significantly reduced.
Great post. I generally thought along the same lines already, but with 10% of the detail.
I have a $250k whole life policy that I’ve had for years that I got when I was just out of college. I think I’m going to look at the pros and cons of cashing out versus continuing the $1000 annual premiums.
Chances are good it’s worth keeping at this point, but run the numbers.
Thanks WCI, When I read your book 5 years ago, I became aware of how predatory Insurance salesman can be on young physicians. I used it as a gauge to see if I had a “financial adviser prospect” who really had my best interest at heart. Even the ones recommended to me through our residency program pushed hard for whole life and wanted to put a rider on term policy to have the option to convert to whole life at a later point. Glad I read your book and became my own financial adviser, and have simple term policy which my goal is to eliminate ASAP as reaching FI is my main goal.
Yea, if an advisor is pushing whole life at your first meeting (or before you’ve paid off your student loans) I’d stand up and walk out, never to return. It’s a great gauge of the quality of advice you’re likely to get going forward.
Upside #1: YOU do not get the policy death benefit proceeds, it goes to your beneficiary(ies). Nice try though, but there is No upside for you.
Ha ha, good point.
Great article. Glad I have steered clear.
I do have a question about the federal estate tax exemption amounts, and how they are different for single vs married. Spouses rarely die at the exact same time. I assume when the first spouse dies there is no estate tax consequence for the remaining spouse to keep everything, but what about when the second spouse (now widowed rather than married) dies? Do they still get the $22 million exemption because they used to be married?
Yes. Cool huh? That’s a relatively new change that dropped the income of a lot of estate tax attorneys though!
Appreciate your post. I’m one of the early adapters of a Variable Life policy I basically bought twice. Once, 25 years ago from my uncle; and I rolled it over into a similar product 5 years ago, as advised by my then financial adviser. At the time, I was a “hands off” investor, trusting in the man behind the desk. After the transaction, when I realized that I simply paid a commission for the second time, I left his firm and have been on my own. Thing is, I’m already in at an accumulation value of 150k.
The policy has a guaranteed death benefit of 750k. I’ve run an illustration at 4% (3.31% net), with a max annual premium (7% fee) of 40,000 (less 7%) for 5 years, which would put me at age 62; and, compared that to five annual 40,000 contributions at 4%. Around age 80, the market beats the policy. Because the initial starting point of the policy is higher, the cash accumulation is more in my younger years.
So, am I crazy to fund this policy another 200k in five years?
A VUL is somewhat different from a WL policy. I don’t have enough information to give you good advice on whether you should keep it or not. The decision process will be similar to deciding on a WL policy though. These posts should help:
https://www.whitecoatinvestor.com/variable-universal-life-insurance-as-a-retirement-account/
https://www.whitecoatinvestor.com/how-to-evaluate-your-own-whole-life-policy/
https://www.whitecoatinvestor.com/how-to-dump-your-whole-life-policy/
Personally, I find the difficulty of answering your question (which recurs every year for most owners) a great reason to never buy these things and drop the ones you have bought, but yours is large enough it is worth running some numbers and getting some good advice about.
Kent Smithers from Wharton who hosts the “your money” show on Business Radio is also against whole life insurance in 99% of cases. I was approached aggressively by New York Life (late in medical school) and Northwestern Mutual (late in residency) and was fortunate enough to resist both times and just get laddered term policies.
But Kent Smithers always directs people in your situation on his show to go to http://www.wittactuarialservices.com
This guy Scott Witt is a fee-only actuary. You can get him to evaluate the question of whether to cash-in a policy like this or stick with it. Seems worth a few hundred bucks to get the right answer. Hope that helps.
Scott is also a great resource.
Regarding point #10 and buying whole life insurance policies for babies, I was disappointed to recently (Sept 2018) see Peyton Manning in a commercial promoting such a product:
https://www.youtube.com/watch?v=yuiw1Piazck
He’s funny. But what a bad product. My parents tried to buy one for my kids but I told them instead to please just donate to their 529.
Yes, I like Peyton but you won’t be surprised to learn his expertise isn’t life insurance.
After reading the article, there are some good points you make. But you touch on some keys factors to look for for that actually make a huge difference. Paid up additions are one. That should get more then one line because that changes the deah benefit significantly.
A VERY important point you didn’t mention is what type of insurance company you purchase a whole life policy from. Allot of the down side and even some of the upside statements either would not apply or be much different if a large mutual insurance company was used to purchase the policy from. A stock based company pays a much lower rate, and doesn’t pay a dividend rate that a mutual company does. The top mutual insurance companies are also ” non dierct” so the interest/ dividend payments acrue with out penalty of loans.
I used to think the “mutual” thing mattered a lot in insurance, but in my experience it doesn’t matter as much as you would think. Unfortunate really, because it does seem to really matter in mutual fund companies. But if you look at what Fidelity has done lately in response to Vanguard, I guess that gives you a way to understand how for-profit companies have to either compete with the mutuals or go out of business.
I discuss paid up additions more extensively in the linked to article in that section. How long did you want this article to be? It isn’t an article about how to buy or structure a whole life policy that you’ve decided is what you want/need. It’s an article pointing out an agent who says there are not downsides to whole life is a dufus.
Even the non-direct vs direct thing is more controversial than you would guess. https://theinsuranceproblog.com/direct-recognition-vs-non-direct-recognition/ But if your purpose for buying the policy is BOY/IB, I’d definitely lean toward getting a non-direct recognition policy.
I’ve heard that the tax-free benefit to beneficiaries can lead to higher than 5% ROI. Is there any truth behind that? or is the 5% ROI already taking into account the lack of taxes? Another “pro” that salesmen have been touting to me is the lowered volatility for the equivalent ROI. You can get higher ROI on average, but standard deviations are high. So the argument is paying extra to get less volatility, or getting less returns for less volatility?
Yes, the projections on the death benefit are often up to 1% higher than on the cash value. Maybe 6% for a well-structured policy held for decades. If your main reason for buying a policy is a life-long death benefit, whole life is a good tool for that, but be sure to compare to guaranteed universal life, especially if you don’t need that benefit to increase.
And yes, those all assume no taxes paid on the growth or any amount borrowed against the policy, but don’t include the interest paid to borrow.
Yes, lowered volatility is worth something, but I’m willing to tolerate a lot of volatility for something I have to own for 50-60 years. I think it was Bogle who said an extra point of volatility didn’t mean much but an extra point of return was massive.
Just remember that the lowered volatility comes at a price- lower returns. And if you want to pay for a typical retirement after a typical career using low returning investments like bonds, CDs, and whole life insurance, you’ll need to save 50% of your gross income to do it. Most of us just need to take more risk than that, so we invest most of our long term assets in higher returning instruments such as stocks and real estate.
Thanks so much for the reply! I do have to have a look at universal life and compare the ROI there. Now that I think about it, why would you need a life-long death benefit to have “bond-equivalent” component…you’ll be dead, your kids will be in their 40-50’s (hopefully), whatever market volatility is there should be managed by the de-accumulation phase plan.
Recently realized that a lot of these conversations are early-career oriented. Learning that it is also useful to get a rough plan for the de-accumulation phase with some rough projections. That way it might help make sense of the whole situation in the overall picture and get a better feeling for what is a “want” vs a “need”.
I have gone from a whole life skeptic, to an optimist, to this final phase where, to your post’s point, it sometimes can make sense but you really have to have a very clear picture why. Unfortunately, very few people get this financial education. I guess caveat emptor, but the insurance salespeople really need to do a better job comparing to other products…
Steve,
I agree you have to have your goals spelled out clearly in these decisions. Sounds like you are trying to get overall return for your estate/beneficiaries, which means that, as WCI says, volatility as actually your friend over 4-5 decades, and a taxable account is ideal for stepped up basis without the drag of insurance cost.
I was sold permanent insurance for a retirement income hedge, which is what I thought initially you were getting at. The sales strategy for this is “tax diversification” ie taking policy loans at a very low rate as a bucket to reduce taxable income during retirement, just like pulling from your Roth or taxable account to fine tune your tax bracket.
And as I said in prior comments, the math on using a policy loan as a winning strategy is a close call or dubious at best. So I am backing out of my policy. Interestingly I just watched a podcast for financial advisors (Investments and Wealth Institute) and guess what none of the speakers mentioned as a good source for tax efficient retirement income sources: Life insurance.
Why would they do that? Do you expect a car salesman to talk you into riding your bike more?
I recently accepted a 80 yr term life insurance policy with Northwestern Mutual with the potential to convert it to whole life. I was given a premier health rating and would be paying an annual premium of $1,860 for a “beginner” $125k whole life policy (term policy can be converted to whole life in increments of $100k until age 65, making the term policy premiums decrease and obviously the whole life increase). This policy has premiums payable until age 65, and would reach a guaranteed $64,378 cash surrender value at age 65, projected cash value of $119,751 based on Northwestern’s averaged annual return of 4.9%. This policy does carry an ACB (accelerated care benefit) rider, which is a major benefit to my understanding.
I completely understand that investing my money elsewhere could yield a much higher return than the guaranteed cash surrender value of this policy. Would you still strongly advise against investing in a policy like this with an ACB rider? I’m interested to hear feedback.
Yes. Run. I don’t know how old you are but if you are <35, $119K is less than 4.9% compounded over 30 years. If you are 30 or younger even worse. Better to get hooked for $1860/year than larger amount but don't believe a word this salesperson is giving you. Don't buy anything more than term policy and better yet, get from someone not trying to sucker you. Welcome to WCI! Having ability to convert term to whole life is not the worst thing in the world (imagine rare scenario where you receive cancer dx when you have 1 year left on term then ability to convert to whole life is valuable) but don't overpay for it.
We typically buy our clients term life policies at about a 25% discount to the rates NWM has for their term life products, no reason to pay that high price for that product….
That’s my experience as well. They are not low cost providers of term life. Or really anything for that matter.
I have yet to have a reader bring to me what I would call a great financial plan, a great portfolio, or a great life insurance policy out of that particular institution.
I don’t like mixing investing and insurance in part due to increased complexity. Increasing complexity further by mixing in LTC insurance doesn’t help matters when you’re trying to figure out if something is a good deal for you or not. Chances are you’ll be able to self-insure your LTC needs as a new dentist already attuned to WCI, so by paying for a rider (whether the premium is separate or not) likely involves buying insurance you don’t need, which isn’t a great idea most of the time.
I don’t know how old you are, but if you’re 26, pay $1,860 each year from now until 65, then ending up with $64K means a return of -0.76%. =RATE(40,-1860,0,64378) If you end up with $119,751, the return is 2.29%. Neither of those look like 4.9% to me, but if you’re okay tying your money up for four decades to make -0.76% to 2.29%, knock yourself out. At least you’re going in with your eyes wide open.
Personally, I’d go get a lower cost term policy, then surrender this one and never darken the door of that institution again, but it’s your money and your call.
This seems backwards. I am in my mid-30’s with a small child and another on the way. I want the highest death benefit NOW, when my portfolio is lower than it will be in the future, so my family’s lifestyle wouldn’t change if I died. This is why I have a term policy- purchased at age 33, I pay about $1100/yr for a $2 million 30-year term policy. I may even cancel before the 30 years is up if things go as projected with my current savings rate.
I have to laugh at myself for trying to diversify my savings by purchasing a term policy convertible to a permanent policy to borrow against for retirement income. As you have pointed out prior, few of us MDs will need that extra income (and I have pension to boot).
One expert, https://evaluatelifeinsurance.org/#six, has done extensive analysis to show this can compete against taxable account savings under a few limited set of assumptions. So if you suspect you might need supplemental income and want to tweak your tax bracket, this could be a reasonable use of a permanent insurance if using one of the discounters (eg TIAA). Longevity annuities, however, seem like a better investment for such an individual.
I think limited is a good description. But if you’re going to do this, make sure you understand the product inside and out and what is likely to happen down the road and what can happen down the road. I’m really not so much against whole life insurance as I am the way it is sold and marketed. If you understand it and still want it, go for it.
I think Mr. Hunt is a great person to go get a second opinion from about a policy before buying it or dumping it. He’s generally a little more positive about the value of cash value life insurance than I am.
But yea, limited circumstances against a taxable account are what we’re talking about. Not buying one while you have 6.8% student loans and not maxing out a Backdoor Roth IRA, an HSA, and a 401(k).
I think I spent hours reading Hunt’s white papers, if that’s the accurate term. At any rate, he is the first and only person I found to apply a rigorous analysis to the question, in spite the army of salespeople advocating the use of policies for retirement income (to supplement the usual vehicles) I would say a possible game changer would be if cap gains taxes increase in the future to harm the taxable account approach, which seems unlikely, or if income taxes in high tax states continue to increase. I believe he did not account for state income tax into his analysis, so I bet he will update it.
Again, I agree this is a privileged problem to analyze.
I can agree with much of what you wrote but I think some clarification needs to be made about the downside. For example, I agree that some policies are sold inappropriately. However, that’s NOT a downside of WL insurance, or any insurance for that matter. It’s a downside of working with someone who is unprofessional. Due diligence needs to be done on the financial professional with who you are working.
Tax consequences and the returns on the cash value often vary. Yes, sometimes very unfavorable but other times could be very favorable. I would argue that these don’t provide any more downside than a traditional taxable investment. Rather, it all depends on the goal, purpose, performance, risk, etc.
Lastly, “many people can’t obtain a policy”? That’s not a downside of insurance, that’s simply a fact. Just because someone has numerous driving infractions and can’t obtain automobile insurance doesn’t mean the inability to get auto insurance is a downside. It’s simply a fact.
Again, I agree with much of what you have written and don’t advocate purchasing life insurance for investment purposes. However, I do advocate clients (and advisors) do their proper research and homework on the variety of products out there. Overall, proper planning is the key. Insurance, like investments, real estate, trusts, wills, etc., is just a tool to be used to help complete a financial plan.
# 1 You sell life insurance for a living. I’m not surprised you think my “downsides” are lame. I don’t expect you to agree with anything I wrote given your profession. You are not the target audience for this post; you are the subject.
# 2 I disagree that the returns on whole life insurance policies are ever “very favorable.” I have yet to see one I’d describe that way. If you have one, feel free to send over the illustration. Bear in mind I’ve been telling agents to do this for years and I have yet to get one that offered more than the returns described above, which few who don’t sell it would describe as “very favorable.”
# 3 Anyone can buy a mutual fund, fund a retirement account, use a 529, or form a trust no matter what their health status or hobbies. That is not the case for a life insurance policy. That is a downside and a major reason why I don’t even think about using one for myself. That sir, is a fact.
# 4 I agree that insurance is just a tool. Unfortunately, whole life insurance is a tool that is needed/useful/wanted far less often than it is sold.
you can pretty much set your watch by the fact that a WLI salesman will crop up on a thread like this stating the WLI is a tool that can sometimes have uses.
not even WCI denies that in limited circumstances.
the question for the WLI salesman (i’m not expecting an answer) is the following: to what percentage of your clients do you issue a recommendation to buy WLI at some point during the relationship. this is a question i think they will dodge consistently or just simply not answer truthfully.
That’s one of the questions in my application for insurance agents to advertise on this site and you better believe their answer better be in the single digits.
I’ve tried to vet a few local FPs for my residents, have stopped trying and now just refer to Johanna to start.
Similar question, always pressuring for an actual answer. Answer is always some variation of “well every situation is different.”
It isn’t though.
You’d be amazed, well you actually wouldn’t be amazed at all at some of the hostility I’ve fielded from WLI salesman who correctly discern that I am actively blocking their access to 15 EM resident grads/year. Heck that might be worth a guest post!
Dear WCI,
One additional upside is that many permanent policies now include Long Term Care benefits as an alternative to costly use-it or lose-it LTC policies.
Personally, I would love to see a white paper analyzing 3 scenarios, DIY coverage of your own care (assuming we all can afford it on average), versus LTC policy purchased in your 50s, versus LTC rider on an life insurance policy. The last option is appealing from the point of view that you are not worrying about premium escalation, just LTC cost inflation. But I will wager the first is the most cost effective because the demographic using this option will have a lower risk of prolonged or costly care. And any complicated insurance policy provision will usually be as lucid as mud.
I hope most of my readers will be able to self-insure against this risk. I also fail to see a good argument to mix LTC insurance with life insurance. It just seems like another way to sell whole life to people who don’t need it.
I don’t see that as a significant upside and in fact, I see it as one more method a talented salesman can use to sell life insurance.
My wife an I each have 100k whole life policies and 800k term. We’ve had them for 9 years and each have approx. 10k in cash value. I view it as a very conservative savings account . Since I just lost 10% in my IRA with the downturn, our whole life still makes sense to me .
9 years? Only $10K? That’s not a very large policy. Any particular reason you think it is worth the hassle for that small of a policy? I mean, if you want to do that with $10K, nobody is going to tell you that’s crazy. You can surely afford it, but it is worth it? I wouldn’t be surprised if your return is very poor on a policy that size. What are your premiums?
I’m more concerned that you only have half a million on each of you in total life insurance. If you’re like most of my readers, that’s probably nowhere near enough.
Guess I’m on the other side of this discussion. My background: Retired Army, full pension, 100% Disabled Vet, Life Insurance Agent. I’ve got the IRAs, 529s, Mutuals, Savings, etc so I fully understand the importance of investing your money. My mom passed a few years back and didn’t have insurance. $15,000 out of my pocket for the funeral. That’s not the point of your article, but term will terminate and your family may find themselves in my predicament. Now for the numbers. To make things easy let’s assume Rob started his whole life insurance at age 25 and he purchased 25k face value for final expenses. By age 65 I’ve paid $13,891 in premiums. At age 75 I’ve paid $17,364. If I would’ve bought a 10 year term, by age 65 I’ve paid $11,000 because I had to renew at current age every 10 years. If I want to keep it going I would’ve paid $26,397 by age 75. Maybe a 20 year is cheaper. At age 65 I’ve paid $10,152. At 75 I’ve paid $23,260. As you can see, term is more expensive over the life of the policy if the reason for buying insurance still holds true, ie final expenses, unless of course you die by 65 and never enjoy your post working years. I’m using today’s figures so it doesn’t consider inflation, which doesn’t affect whole life. I also have never seen an agent make the types of commission stated in this article. I’d love to know the company offering that type of pay because I feel I’ve shorted myself.
Your illustration I think demonstrates quite well the psychological appeal of life insurance and the odd sales illustrations that make people like WCI pull their hair out. (I’m a dermatologist so I take care of a few people that pull their hair out)
I guess individuals would rather have a tithe into a policy that is at least partially difficult to liquidate in hard times , unlike a brokerage account. Financial literacy would cure this problem. Second issue is your illustration. Why would anyone buy sequential term insurance for a benefit at 75 or later? Comparing term v whole life in this illustration seems like a way to sell permanent insurance to someone who doesn’t need it.
I’m already bald so hair is the least of my problems. My reply simply shows options if you want insurance when you die. I would hope everyone wants insurance when they die rather than leave their grieving family with final expenses. I guess you could convert the term at some point, but I’m sure the analysis would show that it’s still more expensive. The reply also doesn’t suggest purchasing sequential term past 75. It suggests a cost should you continue past 65 to age 75. Everyone’s situation is different and I’d hope an honest agent conducts a needs analysis before selling any product, to include investment vehicles.
I’m already bald so hair is the least of my problems. My reply simply provides options and costs. It also doesn’t suggest purchasing sequential term at or past 75. It suggests purchasing it at 65 to terminate at 75 and shows the cost, should you choose to do so. Everyone’s situation is different, and I would hope an honest agent does a needs analysis prior to selling anything. I would also hope everyone wants coverage at death rather than leave their grieving family with the final expenses.
You know you can pay for a funeral with other assets, right? The funeral home will accept cash from your IRA or taxable mutual fund account.
Somehow I strongly suspect that buying term insurance for 15-30 years and investing the difference in cost from whole life would leave you with enough money to cover a $15K funeral. You don’t need life insurance once you reach financial independence.
Why can’t “Rob” just start a savings account to have a guaranteed fund for his funeral expenses? Everyone will die and therefore have funeral expenses. Guaranteed. If funeral expenses is what you’re worried about, start a savings account. Most readers here (myself included) have emergency funds plenty large enough to cover this, and quite frankly is the last thing on my mind when considering reasons for having life insurance. If you don’t want your family to worry about it, make sure your savings account has enough in it to reimburse them after your estate is disbursed.
Rob has one of those too, and it’s plenty liquid. He just prefers the insurance company pay his beneficiaries an amount in excess of the premiums.
“He just prefers the insurance company pay his beneficiaries an amount in excess of the premiums.”
WHY would he prefer this?
Why would he prefer this to his beneficiaries receiving more money from the investment account that he funded with what would have been life insurance premiums?
Exactly.
Stop being so logical, it confuses them.
Your mom died with an estate worth less than $15K and you, with a full pension and a full “understanding of the importance of investing” felt like it was a predicament to come up with $15K to bury her? And now you’re trying to use some convoluted example where someone kept a term policy until age 75 to somehow argue for buying whole life insurance? And you think inflation doesn’t affect the value of whole life insurance like everything else in life?
This is one of the silliest things I’ve ever had an agent write about whole life. It ranks right up there with “whole life has no downsides.” Thanks for demonstrating typical insurance agent thinking to the readers.
Ouch. I guess you win. You really showed me. Thanks for being adults and having a demeaning conversation with those of us less-logical than you. I’m gonna go help my 10 year old carve a pumpkin. Happy Halloween. Y’all have a good night.
Please stop selling insurance to people inappropriately.
“What nearly scared the life out of the whole life insurance salesman on Halloween?”
The truth!
Rob, if you’re going to try to ‘sell’ an audience on the benefits of your product, you should probably know your audience. I don’t know which company sent you here like a lamb to the slaughter, but ‘Oh no, how will I ever come up with 15k for funeral costs?’ isn’t something that keeps the typical reader here up at night. It’s sad that playing on irrational fears works to sell an overpriced product to the financially illiterate.
My reply simply compares the different policies as options to cover final expenses at the cheapest possible rate. You could convert the term at some point, but it would still be more expensive that starting with WL. The reply also doesn’t suggest purchasing sequential term at or after age 75. It suggests purchasing the final term at age 65 to terminate at age 75. Everyone’s situation is different, and I would hope an honest agent evaluates each situation accordingly and offers the best product for that person.
I really like this article. Quite fair and balanced with very valid points. I have always looked at limited pay whole life as the safest choice for long term coverage as compared to UL or VUL which could have rate changes and don’t usually have limited pay abilities.
With the use of HSA and Roth IRA and Roth 403B so many great ways to save money than just being in a WL policies. However, I see the value of them I always caution people to max out at 5-7% of their income because of the cash pinch in the beginning you talk about. I like paid for policies. I figure if it’s paid off while still working I don’t have to have any cash flow consequences going in to retirement.
Thank you for this article, again people need to know the pros and cons of anything they look at doing.
I agree limited pay (i.e. 7-pay or 10-pay) is the safest of the non-MEC permanent life insurance policies. I also agree this, like your student loans and mortgage, should be paid off prior to retirement.
I disagree that 5-7% of gross income is a reasonable amount to put into them. That would be 1/4-1/3 of what a good saver is putting away and 100% of what a mediocre saver is doing. That’s way too much, even if you like this stuff. Life changes, sometimes very quickly. I had a colleague who was suckered into buying one and had to dump it at a loss 3 years in in order to take a year long sabbatical to pursue a life-long dream and a wonderful opportunity. She actually considers that a blessing though since it kept her from “throwing good money after bad.” If you’re not already investing a substantial amount in a taxable investing account each year, there is no room in your portfolio for cash value life insurance as an investment.
Oh I’m not saying everyone should do that. I mean I see so many people doing 10-15% and I think that is way too much like wayyyy too much. Hence why I say cap it at 5-7% at max.
I also feel people need to get all their term insurance for death benefit first. Most don’t do that, and that’s more dangerous not balancing out their plan cause someone wants them to dive in to whole life too early.
Obviously if I think 5% is too much, I really think 15% is too much. I agree term in place first (and for most, only).
I think the downside is so much greater than the up side, that I don’t think it should even be legal to sell whole life. It would be good if congress passed a law banning it from the earth. There are so few people who might benefit, outside of the insurance salesman, that there is no reason for this product to exist. Just say NO!
Dr. Cory S. Fawcett
Prescription for Financial Success
I have purchased multiple WLI over past 40 yrs. I have even talked my kids into purchasing WLI. I have been lucky enough to have a long career and accumulated great deal of wealth by saving and investing in real estate and equities. Close to 15 % of my wealth is tied up in WLI. It gives me a piece of mind. Allows me to sleep well at night. Bond returns have been close to zero over past 3 yrs, and my WLI policies keep chugging along with nice ROI, beating inflation for decades. Most importantly, knowing that I had money tied up in whole life insurance, kept me sane and stay invested in stocks through so many corrections and bear market. I can say that staying cool, and controlling ones emotions is the best way to make money and WLI allowed me to do that.
I’m super happy you’re pleased with your purchase; most docs I run into are not. A few thoughts, mostly for others not you since you already have a plan you’re happy with.
# 1 Good policies purchased 40 years ago might have provided a return of 7%, so no surprise to see someone happy with them. This is mostly a function of how high interest rates were in the 1980s. You are unlikely to get that return buying a policy today.
# 2 I think bonds in the portfolio do a better job performing the functions which Ddrake uses his WLI policy for.
# 3 Note that Ddrake has “a great deal of wealth” and only 15% of it is in WLI. When you’re very wealthy, it doesn’t matter so much what a small percentage of your money is in, so feel free to use it to buy a condo or a boat or a whole life policy or whatever you want.
“# 2 I think bonds in the portfolio do a better job performing the functions which Ddrake uses his WLI policy for.”
Can you expand on that point a little more? I have been curious for a while, If it may be “close” to performing like bonds, would the added death benefit put it over the edge? ie instead of investing in Bonds, could that allocation be a WL policy and forgo bonds altogether?
I guess liquidity early is an issue. But when cash value gains traction some liquidity becomes available.
If we are gonna most likely die with money still in the bank, why not have a guarunteed way to help increase generational wealth?
Ive had buyers remorse in the WL policies I bought prior to finding WCI. The search for more info is what lead me here years ago. I am too stubborn to take a loss on them and just figured at this point they are a financial lesson and I’ve commited enough time to them to make it worth seeing them through for the initial upsides I was sold them on. Ugh.
Trying to turn lemons into lemonade here. Hence the question. If I keep them and subsequently forgo bonds closer to retirement in my portfolio, am I closer to a wash than I regrettably feel?
Generally the return is a little less than bonds. Take a bond return, subtract the death benefit, subtract out the insurance company costs, commissions, and profits and, over the long-term, that’s what you get. In the short term, it is much worse of course since those commissions and many of the costs are front-loaded.
So if all you are looking for is a bond-like risk/return profile for your portfolio, I think you’re better off with bonds than whole life insurance. Now if there is something else about whole life you really value….death benefit, asset protection etc, then maybe you decide to go down that route. But don’t buy whole life when you just want bonds. Bonds have higher returns and more liquidity.
Your question is different from “Should I buy WL?” Your question is “Should I keep the WL I already own?” Different questions with different answers. Because lots of the costs/commissions are front-loaded, sometimes it makes sense to keep a policy you should have never bought. Learn more here:
https://www.whitecoatinvestor.com/how-to-evaluate-your-own-whole-life-policy/
Thanks Jim!
I love this site with the timely and thoughtful replies from you.
I’m sure in planning this post topic you had to build it into your schedule given the amount of traffic and comments it can create in short order.
Well done ?
Mostly I just wing the timing of the comments. I certainly don’t cancel a vacation to do real time commenting.
My wife fit #11 downside to a T. We were “gifted” a whole life policy from my wife’s childhood the year we got married (while still in vet school). It was $50/month for $65,000 benefit (a few years of which had to be paid with student loan money). My father-in-law encouraged my wife to exercise options but thankfully she missed all the emails. Finally cancelled it this year and got ~$1500 back after paying ~$3600 since receiving our “gift”. She now has a 20 year, $750,000 term policy for less than half the price of the whole life policy. Thanks to your blog and podcast we made the switch, paid down student loans and put the monthly difference towards our student loans.
Classic example. Happens all the time.