Q.

My wife and I are both emergency physicians who max out our available retirement plans including backdoor Roth IRAs and are already putting as much into 529s as we would like. My advisor, a CFA, recently showed me an illustration for a 10-pay whole life policy illustration. In researching it I found lots on your site about whole life, but nothing specifically on 10-pay or 20-pay policies and would like to know your thoughts on them specifically. This illustration shows that I would make 10 payments of $20,000 and then at age 70 would have guaranteed cash value of $437,000 and a guaranteed death benefit of $800,000.  The projected cash value is $1 Million with a $1.8 Million death benefit.  Our actual life insurance needs are already covered with term policies. This is money I expect to leave to the children, but like the idea of being able to access it if necessary. What do you think? Does making a policy “10-pay” change your usual recommendation against whole life insurance for most doctors?

A.

The returns of whole life insurance can be improved slightly in several different ways. Paying annually, maximizing “paid-up additions,” and paying the policy up in as little time as possible without becoming an MEC by using a 7-pay, 10-pay, or 20-pay (meaning you only pay premiums for 7-20 years instead of your whole life) are all ways to improve the expected return. So yes, buying a 10 pay policy not only avoids life long payments but also improves the internal rate of return of the policy. You simply get to even a little faster. But it is still a whole life policy.

David Denniston Ad # 2I usually recommend against whole life as an investment or “another retirement account” primarily due to low returns. Since you don’t have any need for permanent insurance, you really should be evaluating it as an investment.  This is money you want to leave to the kids, but would like to have it available to you “just in case.” So an alternative in this case would be something like very tax-efficient stock index funds in a taxable account. Your kids would get the step-up in basis at death, so the only real tax cost would be the drag from distributions. If we assume you are 35 and will invest $20,000 per year for 10 years and then let it ride for 25 more until age 70, all at an overall return of 8% reduced by 23.8% taxes on the 2% yield, your money would grow to about $1,866,000, tax-free, at age 70.

Let’s compare that to the insurance contract.At age 70, the insurance contract is guaranteed to have a cash value of $437,000 (2.59% annualized return) and projected to have a cash value of $1 Million (5.38% annualized return.) Although it wouldn’t surprise me if you actually achieved that 5.38% return, I would plan on something about midway between those, about 4%, or $665,000 at age 70.  That’s about 1/3 of what you would have in the taxable account. If you decided to raid the stash, you could borrow tax-free from the policy but would have to pay taxes if you wanted to spend from your investment.  But even after taxes, you would be way ahead with the traditional investment. The death benefit and asset protection features are nice, but certainly wouldn’t be worth over a million bucks in opportunity cost to me.

I like the fact that the return is a little higher with a 10 pay policy (perhaps 0.5-0.75% higher than a traditional policy), and I like the fact that you don’t have to make payments for the rest of your life.  But you’ve still got all the other downsides of investing in a life insurance contract.  As I frequently tell people, this isn’t the dumbest thing to do with your money, but be realistic about what it is really going to do for you. Good luck with your decision.

[Update: Like most who really examine whole life insurance as an investment carefully, this reader decided to pass on the policy.]

What do you think? Do you have a 7-pay, 10-pay, or 20-pay whole life policy? Why or why not? Are you happy with your purchase? Comment below!