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Whole Life Insurance as Retirement Tax Shelter Question

Home Insurance Whole Life Insurance as Retirement Tax Shelter Question

  • Avatar WholeLifeWoes 
    Participant
    Status: Other Professional
    Posts: 3
    Joined: 09/06/2019

    Hi WCI,

    This topic has been beaten to death, I know. I’ve read every article about Whole Life Insurance (including the ones here), combed through the forum posts, understand that ditching whole life in favor of term and investing the difference is the way to go.

    My mother’s financial “advisor” sold me a MetLife WL policy as a tax-advantaged retirement investment vehicle. No children/spouse/dependents so I have no actual need for life insurance. $500k death benefit, $4965/year premium, with the idea of taking loans out beginning at age 65. Have been contributing to it for three years now. The current cash value is $4100, but I’m happy to ditch it at a loss if that’s the correct decision.

    I’m 27, working in tech. Earn between 500-600K/year and currently have $1M in Vanguard (contributing $100k+ annually). I max out my 401k, am ineligible for Roth IRA (due to income), and a Backdoor Roth IRA is complicated due to having converted a previous employer’s 401k into a Traditional IRA.

    My two questions are:

    1) Am I in the small demographic that WL is useful? Are there other retirement vehicles I should instead be taking advantage of? I suspect I’ll be bumping against the estate tax later in life.

    2) My back of the napkin comparison for the life of the policy is: $4965 compounded annually at 7% for 42 years (to age 65) is $1,225,245, minus 20% cap gains (I’m optimistic) is $980,196. The same calculation with 6% annual growth is $740,808. The non-guaranteed cash value of the policy at age 65 is $601,668. So even in the most extreme case, investing in a taxable account comes out significantly ahead. Is it more complicated than that?

    I’m happy to upload scans of the sales and in-force illustrations if requested.

    Thank you!

    #244228 Reply
    The White Coat Investor The White Coat Investor 
    Keymaster
    Status: Physician
    Posts: 4545
    Joined: 05/13/2011

    You can afford to keep it if you want it. But honestly, it’s only $500K. It isn’t going to do much for an estate tax problem.

    1) Probably not.

    2) No, it isn’t more complicated than that.

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #244268 Reply
    Avatar Peds 
    Moderator
    Status: Physician
    Posts: 4447
    Joined: 01/08/2016

    Nope.
    Dump and run.

    #244269 Reply
    Liked by jfoxcpacfp
    Avatar JBME 
    Participant
    Status: Spouse
    Posts: 531
    Joined: 03/26/2018

    if you have a 401k now, is it really a rare case where you can’t roll an IRA over to your current employer’s 401k? Do that so you can do the backdoor roth. Also since you clearly can save a lot look into the summary plan document of your 401k at work and see if you can do the mega Roth backdoor option (google that on this site).

    Dump whole life but if you’re currently not married and have no dependents, why have life insurance at all? just put even more into taxable

    #244277 Reply
    Avatar WholeLifeWoes 
    Participant
    Status: Other Professional
    Posts: 3
    Joined: 09/06/2019

    Greatly appreciated! I’ll ditch the policy ASAP.

    if you have a 401k now, is it really a rare case where you can’t roll an IRA over to your current employer’s 401k? Do that so you can do the backdoor roth. Also since you clearly can save a lot look into the summary plan document of your 401k at work and see if you can do the mega Roth backdoor option (google that on this site).

    Dump whole life but if you’re currently not married and have no dependents, why have life insurance at all? just put even more into taxable

    Click to expand…

    I transferred the old 401k to a Traditional IRA in Vanguard originally to escape that plan’s bad funds with high ERs. I’ll see about rolling it into my current employer’s plan, and do some research on the Mega Backdoor Roth.

    #244293 Reply
    Avatar afan 
    Participant
    Status: Physician
    Posts: 90
    Joined: 05/07/2017

    Between your retirement savings, social security if it still exists when you retire and the dividends on your taxable savings, you should have plenty to live on when you end your career. This means that you likely will have no need for liquidating your taxable savings and hence no need to pay long term capital gains tax. So you need not discount your returns to account for this.

    Six or 7% long term return on your investments might be optimistic. That could happen, but I would base planning on something more conservative.

    If you want to borrow against your savings to fund expenses in retirement, you could take a margin loan against your taxable account instead of borrowing it from a life insurance policy. That saves you the costs of the insurance.

    If you put your taxable investments in a total stock market index fund the annual dividends are around 2 percent and you would pay annual taxes only on that amount. These will be paid at the lower dividend rate, not ordinary income rates. In short, the tax bite is already quite low. Not at all clear that paying the costs of a whole life policy are worth it to escape this low tax rate. If you mix in some bonds, make them munis and you will pay no federal tax. The interest might be taxable at the state level depending on where you live. The insurance company will invest in bonds and bond like instruments, so its returns would be similar to your own bonds, before the costs of the policy. Returns will be less once the policy costs are paid.

    If you hold the the policy long term then maybe you will get some return due to mortality credits increasing your dividends. Maybe not. But certainly not stock like.

    The design of the whole life is such that you cannot get all of the cash value out tax free during your life. If you withdraw all the cash then the policy ends and all your gains are taxable. There is a limit to how much the company will let you borrow. Borrow too much without paying it back and the policy ends, again a taxable event.

    With a taxable account your dividends are yours, no further complications, once you pay your taxes. You are free to spend them, although you probably will not need to.

    the guaranteed return on the whole life policy is probably terrible. It is only the prospect that they can generate returns on the high end of bonds that makes it look even remotely appealing.

    You already have a low tax rate on your taxable investments. That means it is not worth paying much to make it lower. You would have to pay a lot to make it lower with insurance.

    Since you are single now you have no need for life insurance at all. If you start a family it is possible you will be financially independent by that time, and have no need for life insurance to protect them. At your age, it is not a big gamble to figure you will, probably, still be insurable if you do have a family in a few years and decide you need insurance. If you want to protect your insurability, then you can buy the cheapest term coverage you can find. Or not bother.

    If you decide to dump the policy, you can do a 1035 exchange into an annuity. The total of premiums you have paid becomes your basis. You can let the annuity grow tax free until it catches up with your basis. You could then surrender tax free.

    If you want to dive into details, get an in force illustration for the policy and post the figures along with you state tax rate here or on bogleheads and people will help you figure out what implied return you would get for all the cost and complexity of the life insurance.

    It is unlikely you are better off with this policy. It is more likely that the only question is the best way to cut your losses and get out.

    #244563 Reply
    Avatar WholeLifeWoes 
    Participant
    Status: Other Professional
    Posts: 3
    Joined: 09/06/2019

    Between your retirement savings, social security if it still exists when you retire and the dividends on your taxable savings, you should have plenty to live on when you end your career. This means that you likely will have no need for liquidating your taxable savings and hence no need to pay long term capital gains tax. So you need not discount your returns to account for this.

    Six or 7% long term return on your investments might be optimistic. That could happen, but I would base planning on something more conservative.

    If you want to borrow against your savings to fund expenses in retirement, you could take a margin loan against your taxable account instead of borrowing it from a life insurance policy. That saves you the costs of the insurance.

    If you put your taxable investments in a total stock market index fund the annual dividends are around 2 percent and you would pay annual taxes only on that amount. These will be paid at the lower dividend rate, not ordinary income rates. In short, the tax bite is already quite low. Not at all clear that paying the costs of a whole life policy are worth it to escape this low tax rate. If you mix in some bonds, make them munis and you will pay no federal tax. The interest might be taxable at the state level depending on where you live. The insurance company will invest in bonds and bond like instruments, so its returns would be similar to your own bonds, before the costs of the policy. Returns will be less once the policy costs are paid.

    If you hold the the policy long term then maybe you will get some return due to mortality credits increasing your dividends. Maybe not. But certainly not stock like.

    The design of the whole life is such that you cannot get all of the cash value out tax free during your life. If you withdraw all the cash then the policy ends and all your gains are taxable. There is a limit to how much the company will let you borrow. Borrow too much without paying it back and the policy ends, again a taxable event.

    With a taxable account your dividends are yours, no further complications, once you pay your taxes. You are free to spend them, although you probably will not need to.

    the guaranteed return on the whole life policy is probably terrible. It is only the prospect that they can generate returns on the high end of bonds that makes it look even remotely appealing.

    You already have a low tax rate on your taxable investments. That means it is not worth paying much to make it lower. You would have to pay a lot to make it lower with insurance.

    Since you are single now you have no need for life insurance at all. If you start a family it is possible you will be financially independent by that time, and have no need for life insurance to protect them. At your age, it is not a big gamble to figure you will, probably, still be insurable if you do have a family in a few years and decide you need insurance. If you want to protect your insurability, then you can buy the cheapest term coverage you can find. Or not bother.

    If you decide to dump the policy, you can do a 1035 exchange into an annuity. The total of premiums you have paid becomes your basis. You can let the annuity grow tax free until it catches up with your basis. You could then surrender tax free.

    If you want to dive into details, get an in force illustration for the policy and post the figures along with you state tax rate here or on bogleheads and people will help you figure out what implied return you would get for all the cost and complexity of the life insurance.

    It is unlikely you are better off with this policy. It is more likely that the only question is the best way to cut your losses and get out.

    Click to expand…

    I appreciate all the great information!

    I do agree I have no need for life insurance. I’m not worried about the ability of a potential future family to support itself in that scenario, nor am I worried about my ability to obtain insurance in a few years if needed.

    The 1035 exchange to an annuity is a great idea. I’ll look into that.

    If anyone is interested, I’ve uploaded the in-force illustration here https://i.imgur.com/Bq1LpbR.png . My actual premium is $4965/year. I’m not sure why the paying-per-month rate is listed instead.

    #244597 Reply

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