By Dr. James M. Dahle, WCI Founder
A frequent technique used by life insurance salesmen to sell you permanent life insurance you probably don't need, is to invoke what is often called “the retirement tax trap.” I see these in books, in comments left by insurance agents on this blog, and in videos on the internet like the one below. Let me summarize this video and show you how this schpiel generally goes. If you want to test your “insurance agent defenses,” watch the video first and see if you can spot the fallacies before I point them out.
Taxes Are Going Up, Right?
The video begins with this statement:
Tax increases are inevitable.
That makes sense, right? We all think we're paying too much in taxes, right? We see the government getting bigger and running deficits and all that, right? However, we fail to realize that, with the salesman's help, we're making a jump between the government needing more money and our personal tax burden being heavier in the future than it is now. That not only isn't necessarily true, but it isn't even probable.
Think about your marginal tax rate now. I'm probably in the 33% tax bracket the year I originally wrote this [2014]. I then pay 15.3% in payroll taxes on the first $117K and 2.9% after that. Then I pay 5% in state tax. Total tax burden close to six figures with an effective tax rate in the 23% range. Let's say I retire to Florida at age 55 on $50K–$100K of taxable income? What tax bracket will I be in? 15% or 25% Federal, 0% payroll and 0% state. My marginal tax rate is lower, but more importantly, my effective tax rate is far lower since a much higher percentage of my income is taxed at 0%, 10%, or 15%. The overall tax burden is also dramatically lower due to the lower effective tax rate and the much lower income level.
Even if you just wanted to look at marginal tax rates, they certainly don't always go up. Historically, they go up and down and our current rates are in the middle of the historical range. So don't let the fear-mongering get to you.
One of the sillier techniques I've seen is to talk about how Social Security is in trouble and somehow use that to make you afraid of taxes in retirement. First, Social Security is easily fixed by slightly increasing either payroll taxes or the amount of income subject to the payroll taxes, and/or slightly increasing the retirement age, and/or slightly decreasing benefits. It's hardly an unsolvable problem. Second, Social Security is paid for with payroll taxes, which you don't pay on passive income (like rental properties), portfolio income (from your taxable investing account), or on tax-deferred (or tax-free) retirement account withdrawals. It's just pure fear-mongering. Back to the video.
The Tax Trap
The video next talks about the tax trap. It uses the following example.
You save $100 a month into a 401(k) and earn 10% on it over 30 years. After 30 years, you've contributed $36K. Your marginal tax rate is 20%. So you save $7,200 total in taxes contributed to the 401(k). There is now $226K in the 401(k). If you pull it out at that same 20%, you will have to pay $45,210 in taxes! What is worse, however is that your marginal tax rate in retirement could be 30% or even 40%. You could owe as much $90,417 in taxes. Which would you rather pay, $7,200 or $90,417? Tax qualified plans don't avoid tax, they simply delay it! Conclusion—pay your taxes now, buy life insurance, and get that same $226K tax-free!
It's breathtaking how much sleight of hand is involved here. First, there is no 20% bracket, but that's neither here nor there, since the example works just fine with the 24% bracket that actually exists.
Second, the example doesn't account for the time value of money. Money in your pocket now is worth more than money in your pocket later. If you actually apply that same 10% growth rate to the money saved in taxes each year, you're not just saving $7,200. You're saving $45,210. Wait a minute! That's exactly the same tax bill! Yup, that's right. If your marginal rate at contribution is exactly the same at retirement, the tax bill is the same whether it is paid now or paid later.
Third, the truth is that most people, including physicians, are going to be in a lower tax bracket in retirement. You simply don't need as much income in retirement because you're not paying as much in taxes (you have no payroll taxes for instance), you're not saving for retirement, you're not saving for college, you're not paying for your kids, you're not paying work expenses, etc. A physician making $250K now may have exactly the same lifestyle on $100K in retirement, and if they have some tax diversification from doing Backdoor Roth IRAs, a good chunk of that might not be taxable.
Fourth, if all you can save is $100 a month, taxes are the least of your worries. Even on an average American income of $50K per year, $100 a month is a dismally low 2.4% savings rate. If that's all you save, and you end up with this $226K 401(k), you're not going to be paying taxes in retirement at all. A 4% withdrawal from a $226K nest egg is just $9K per year. Add that to your Social Security and your tax bill will be indistinguishable from zero.
Last, agents love to make the assumption that somehow, magically, their insurance products are going to have the same return as a wisely invested 401(k). That's unlikely. For instance, a typical whole life policy purchaser should expect a long-term return on their cash value between 2%–5% per year. That $100 a month at 2% a year adds up to only $49,655. Would you rather have $226K in a 401(k) or $50K in a whole life policy? I can tell you which one I'd rather have, even if I, for some bizarre reason, had a 40% marginal tax rate in retirement.
The Access Trap
Next, the video goes into “the access trap.”
If you want to withdraw money from your retirement savings to pay for education, that money actually gets added to your income each year. Plus there is state taxes! Plus the 10% penalty for withdrawal before age 59 1/2! You might be pushed into the top tax bracket and be crushed by a 40%–50% tax rate!
Hey, here's a tip. Save for college in a 529 instead of your 401(k). You don't need an insurance policy to avoid this issue. Besides, even if you did decide to withdraw from your 401(k) to pay for education (a dumb idea by the way) you wouldn't owe the penalty. It's one of the covered exceptions to the 10% penalty rule. Besides, this guy saving $100 a month with a nest egg of at best $226K, is hardly going to be pushed into the 39.6% tax bracket by taking some money out of his IRA. I also love how the “solution” to this problem doesn't mention that you don't get to withdraw money from your insurance policy cash value. You have to borrow it, and pay interest for the privilege of using your own money.
The Distribution Trap
Let's get back to the video. It calls its next trap the “distribution trap.”
The government wants you to withdraw your money between age 59 and 70. Trap #3 Government wants you to withdraw your money between 59 and 70. What if you don't need the money? Can you let it accrue? The answer is frightening! Beware the 50% excise tax. Buy permanent life insurance instead to leave money to your heirs.
Yet more fear-mongering. First, the government doesn't want you to withdraw your money between ages 59 and 70. It does want you to wait until age 59 1/2 to start taking retirement withdrawals, but there are so many exceptions it is practically a suggestion rather than a rule. Second, the government doesn't want you to take all your money out of qualified plans by age 70. It doesn't care. The only rule is that once you are 70, you have to start taking required minimum distributions (RMD) which start at 3.6% per year. As long as you take out that RMD each year after 70, there is no 50% excise tax. None at all. The tax is completely avoidable. The solution to this dilemma isn't to buy life insurance. In fact, retirement accounts have wonderful estate planning benefits. You can name beneficiaries for them. Your heirs can “stretch” your IRAs over many decades, further deferring tax. In addition, if you do Roth conversions (decreases your estate, lowering any possible estate taxes) and leave them a stretch Roth IRA, your heirs can enjoy tax free income for many decades to come.
The Death Trap
Although it said it was going to, the video never did go into the fourth trap mentioned at the beginning, the death trap. However, I think it's pretty easy to predict where this one is going. It's going to be even more fear-mongering about estate taxes. The fact is that the vast majority of Americans, including physicians, aren't going to die with an estate worth more than $12.93M ($25.86M married) in 2023 dollars. You're not going to make that much or save that much. Even if you did, you're going to spend enough of it that there isn't $12M left. And even if you don't, with some rather simple estate planning you can get your estate down below that level without ever buying any life insurance to do so.
If you haven't been approached by an insurance agent selling whole life or a similar product yet, rest assured that you will be at some point. Don't fall for simplistic, irrational, and absolutely wrong reasons to buy it like “the tax trap.”
What do you think? Have you heard “the tax trap” argument before? Do you expect your tax-deferred accounts to become so large that your effective tax rate in retirement will be higher than your marginal tax rate in your peak earnings years when you made the contributions? Comment below!
[This updated post was originally published in 2014.]
Hi Jim,
Love your website and articles. Below is an interview from a local financial advisor (local to you). What do you think? Is he saying pretty much the same thing as the other insurance salesmen?
Thanks!
http://www.futuremoneytrends.com/trend-videos/interviews/401k-scam-garrett-gunderson-interview-author-killing-sacred-cows
Interesting you would bring up Garrett Gunderson. We may be doing a seminar together soon for Utah docs which will probably involve a little bit of Pro/Con type discussion.
If Garrett believes 401(k)s are “scams” then I disagree with him.
According to the video, Garrett’s issues are:
1)He doesn’t like mutual funds. I disagree. I think they’re a great way to get diversification and participate in market returns. He didn’t mention his alternative (real estate? cash value life insurance? annuities? individual securities?) but I assure you they all have their issues and mutual funds (especially low-cost index mutual funds) are a fantastic mainstay for retirement investments.
2)He thinks that tax rates are going up. I am agnostic.
3)He thinks the fact that overall tax rates are going up means that a specific person’s marginal tax rate in retirement must be going up. I disagree. Given typical savings rates, it is far more likely to go down, but you have to run the numbers for yourself. If you’re saving 40% of your income into pre-retirement accounts and it’s growing at 15%, then sure, it’s quite possible you could have gobs more taxable income in retirement than you have now. However, the solution isn’t necessarily to avoid 401(k)s, it’s to use a Roth 401(k) and/or do Roth conversions. At any rate, it’s a first world problem for sure.
4) He thinks that having less taxable income in retirement than you have now means you are “less successful” when in reality the goal is to have enough to meet your own goals. Many physicians can have the exact same lifestyle in retirement as they had before on 25-50% of the income since their income tax bill goes down, their payroll taxes go away completely, they don’t have to save for retirement or college, mortgage is paid off, they have fewer mouths to feed etc. Success does not equal income. You get to define what successful means. To me it means no drop off in lifestyle pre and post retirement. I don’t need the same income to maintain the same lifestyle.
5) He doesn’t seem to understand that tax brackets go up with inflation.
6) He thinks the income from a $1-2 Million 401(k) is somehow going to get people into a super high tax bracket. 4% of a $2 Million 401(k) is only $80K, that isn’t going to get you anywhere near the high tax brackets.
7) He fails to understand that a match is free money- not getting it is leaving part of your salary on the table.
8) He complains about 401(k) fees. I agree they are rampant and a problem, but they are coming down and lots of plans have low fees (like mine.) But it takes very high 401(k) fees (like 2% a year) to eliminate the tax benefit. Besides, when you separate you can roll it into another 401(k) or IRA with lower fees.
9) He is really bothered by “uncertainty” such as unknown future tax rates and rules. I am not bothered by that. I work with what we have and if it changes, I’ll learn the new rules and adapt as I always have.
10) He is anti-Roth IRA/401(k) for a bizarre reason- because Congress may change the rules later. I guess if you’re really worried about that, then I suppose you can just pay more taxes if the rules aren’t changed.
That’s just the problems I see in the first 6-7 minutes of the video. I assume there is something about insurance-based investing solutions later in the video, but didn’t get that far. Should be an interesting debate we have if this seminar comes together.
His preferred vehicle is real estate. In his book he actually talked about withdrawing a hundred thousand dollars to buy multiple real estate properties and claimed that you would be better off even after paying income tax and the 10% penalty because the properties would be “actually making money for you”. I had to stop reading at that point.
I think real estate is a great investment. It is certainly possible to get higher (and lower) returns with leveraged real estate than with stock index funds. It’s even possible that pulling all your money out of your 401(k), leveraging it up and buying investment real estate with it, and paying any applicable taxes and penalties will give you a higher return. Leverage works, but it works both ways. Just because you like real estate, and you like to use leverage, doesn’t negate the benefits of tax-advantaged accounts or of index mutual funds. There certainly is no reason a physician can’t both max out his retirement accounts, invest the contributions into stock (and bond) index funds, and still have some real estate investments on the side with a reasonable degree of leverage. The only scam with 401(k)s is the high, hidden fees that some of them have and the crappy investments that some of them have. The tax benefits and especially any match you get are very real and not scam-like at all.
What about buying real estate in your IRA and completely forgoing the 10% penalty and taxes until you take the money out of the IRA to live off of? You can buy investment real estate in IRA’s (Roth too), SEP’s, and 401k. The SEPs and 401ks would be for a small 1 doctor maybe 2 doctor office, not a 401k/403b at a large group or hospital.
I had this discussion with a builder friend of mine this last week. He wants to retire in the next couple years with a net worth of 1 million. He says that if he leverages it out and put 20% down on a few apartment complexes then he should be able to conservatively do a 35% return on his principle, making him 350k a year.
On paper the numbers look good, but the idea puts knots in my stomach to be leveraged out that much and retired. I do find it interesting what we each find comfortable, and what we consider risky.
A 35% return in real estate either requires an exceptional amount of risk, exceptional luck, or a whole lot of work. Think about it. If you could guarantee a 35% return on your money every year, you could retire after a half decade of work. It just doesn’t pass the sniff test.
The link to the video does not link to any video but to an ad for Publishers’ Clearing House Sweepstakes
3 lines above that is the video link. Click on the words “this one”
Sorry about that. The link-ad program we use randomly decided to link to the words “watch the video.”
Thanks! Garrett actually sold me a whole life insurance policy about 15 years ago when I graduated college (I am from Utah as well and Garrett and I went to college together…SUU!). We know each other well. I cancelled the policy several years ago. I also did a real estate deal with him that was probably the worst investment idea I was ever part of (he knows I feel this way, a capital lease…I still don’t understand how it works). With that said, Garrett is a good guy but I think I have diverged from his investment philosophies. We are friendly but no longer do business with each other.
Congratulations on your separation.
I think that if a small fraction of the attendees of WCI’s point/counterpoint with Garrett are readers of this blog, Garrett will be (rightfully) skewered on stage. If Garrett reads this blog, WCI may win by no-show…
Each financial product either life insurance, stock, bond and etc has its own place in our portfolio and they all can fit nicely in our diversified portfolio. Of course, each will not deliver the same financial return for a reason (no risk, no gain).
I respectfully beg to differ with Jim because each one of us has our own milieu, risk tolerance, size of assets and etc. I may be inaccurate in my assessment (forgive me), I evaluated Jim’s overall comments/posts; He emphasizes mainly if not mostly on costs in choosing investments. For example, aside from unscrupulous insurance agents, Jim’s pet peeve on insurance products is high commission paid or fees paid financial advisers or fund managers etc. If the cost is the reason, we don’t need a fund manager or adviser, we can save a few thousand dollars annually by picking our own stocks and avoiding ETFs or mutual funds. However, some of us need those professionals and some of us are just happy with dull, boring and not sexy financial products like insurance, bonds or CDs. People have a different risk tolerance, and people with huge net assets don’t need asset growths but only focus on the capital preservation maybe with a little icing on top with 2 to 3 percent annually.
Whole or universal life insurance can be nicely used as a hedge to your more aggressive investments. Most CPAs hate permanent life insurance products, and they even curse at the subject, including me for a long time. But, I changed 5 years ago and I am more receptive now. I have been aggressive with my retirement funds, picking my own company stocks. I have employed a concentrated strategy, investing in fewer than 8 companies in different industries. And I have used my index universal life as my defensive strategy because it has three benefit triangle, guaranteed minimum return, death benefit and tax free distribution (almost). My strategies aren’t for everyone. Equity investing (stay away from derivatives) is easy, and you can find almost all the tools that the pros have online free. Just follow what Warren Buffett has said; be greedy when people are fearful and vise versa. It is easier said than done, because most of us don’t have the right temperament and emotion of an investor.
I have a client, a wealthy and retired widow, with 2 million dollars in a Chase saving account earning .15% annually. She has persistently refused other options. What can I say!. In conclusion, each financial product out there can be useful to you if you know how to use it.
Thanks for your lengthy comment Nansan. There is more to investing than costs, but costs are a very important aspect of investing. Every dollar by which you can reduce your costs, all else being equal, is a dollar you get to keep and spend on something that makes you happy. Far too many investors don’t pay enough attention to costs.
I disagree with you that a concentrated strategy of stock picking is a good idea. The evidence against that being a wise investing method is overwhelming in my opinion. In fact, in my experience most stock pickers neither read the investing literature nor even know how to calculate their own return. Not saying you don’t, nor that you’re not a very talented stock-picker, but the odds are dramatically against it.
While I agree that people whose net worth vastly overshadows their needs and desires don’t need much of an investment return, that is not true for the typical high-income professional that reads this blog. Earning 2-3% on an investment means it isn’t even keeping up with inflation- you’re losing money every year. That’s not acceptable for most. We simply need real growth out of our investments in order to meet our investing goals. My biggest beef with whole life insurance isn’t the fact that the costs are high (although they are) but rather with the fact that your money grows so slowly due to the poor returns (partly as a result of the high costs.) IUL and VUL improve that a little bit, but I prefer to keep my investing and insurance separate.
IUL isn’t necessarily an improvement. It will perform slightly better or slightly worse than a UL (not always better).
I always find it amusing that the insurance agents can’t understand why every single non insurance folks (CPAs in this example) feel that permanent insurance is a bad idea. That’s bc its the truth. It doesn’t matter if whole life is sexy or boring or whatever. That is just another useless description.
Yes in the world of investing, costs play a role as John Bogle has preached. Furthermore, most mutual fund managers or hedge funds managers charge insanely high fees for a mediocre return which can’t even beat a treasury yield (some do well). However, some people are too focused on the cost and miss on the upside potential. Namely, successful fund managers charge an arm and a leg fee, but their performance justifies the outrageous fees. I know this is rare but we shall keep an open mind.
A concentrated investing strategy isn’t for everyone. Some people should not even be in the speculative investments at all like stocks or bonds, because they don’t have the right temperament to be in. Six years ago, many people lost money because they sold or closed all together their holdings in an adverse economic environment and worried that Mr. market was going to wipe out their retirement funds. I witnessed a few of my elderly clients did just that although my persistent insistence to do otherwise, and I told them to give Mr. market time to cool its rage before selling. I failed to stop them, and years later they regretted. However, if we want to earn a spectacular return, we have to do a spectacular and bold strategy as Charlie Munger, Buffets’s sidekick, said if you cannot see your investment drop more than 50%, you shouldn’t be in market and your investment deserves a mediocre return. Again, this strategy isn’t for everyone, but the most successful investors employed a concentrated approach if the history is our guide. For me, this approach has served me well (so far). But no one size fits all strategy, you just have to pick what works for you, conservative, moderately aggressive or very aggressive. Be open mind!.
Same with insurance products, they aren’t for everyone just because people have their own milieus. I have found negative reactions of former and existing insurance policy holders aimed to the wrong direction instead of rogue insurance agents who breach their fiduciary duties, they have blamed and cursed at the innocent products. Investing in stocks and bonds can be lethal and dangerous but also beneficial and rewarding if you know how to take advantage of it.
Furthermore, insurance products are not for investments. Insurance products were created mainly for indemnification benefits for individuals and society. They evolved over the years because insurance companies have seen that people are looking a safety and guaranteed return. The price to pay for these safety and guaranteed return features is a lower and small return. You have to compensate the other party for taking risks. But most people want or succumb to promises of big returns and very little risks. Never happen!. Buy term and invest the rest. I had this idea until 2009. Some of us need the indemnification benefit of insurance beyond our age of 75. Term insurance doesn’t offer this. Permanent life insurance products come to our rescue, but they aren’t cheap. Therefore, to mitigate the pain, we buy early when we are healthy and young and let it slowly grows. Again, like anything else, insurance products aren’t for everyone. Some of us don’t even need insurance because we don’t have insurable interest in anything. But from financial perspectives, I strongly believe that if you want to be financial prudent and wise, a kind of permanent life insurance should have a place in your portfolio, not to make money but to manage risks. Insurance is the tool for a risk management. Anyway, I admire that Jim could find the time to host and post comments on this blog to help others. I will try to contribute in other areas maybe taxation. Right on Jim!
Do you seriously believe it is likely to pick a handful of active fund managers across various asset classes who will outperform a low-cost index fund in that class over the long run in advance? The odds of that are extremely low. Not zero, but close enough to it that I’m not going to try it, nor are many very successful investors.
I disagree that “successful” investors employ a concentrated approach. Did you see that forum of GTAT investors who lost their shorts last week? Due to their concentrated approach, many of them lost 12-25 years worth of retirement savings. Sorry, that’s idiotic. Is the risk less if you own 5 or 10? Sure. But it’s dramatically less if you own 5 or 10 thousand, which is the approach I advocate for public stock investing.
Don’t give me the “insurance isn’t for investments” line. That’s a cop out. When they’re being pushed as retirement vehicles, you also need to look at them from an investment perspective. If you need a death benefit beyond age 75, you’ve probably screwed up your financial planning somewhere (and are probably still working). There are better ways to get a life-long death benefit (if you’re one of the exceedingly rare persons who wants/needs one) than whole life insurance, such as guaranteed universal life. Premiums are about half the price of whole life. No cash value, but you can get the permanent death benefit.
I understand you abandoned “buy term and invest the rest” in 2009 for some reason but you haven’t made a compelling argument for permanent life insurance, either for the insurance aspect or the investment aspect. At any rate, there are a half dozen posts on this blog that have addressed this issue. I suggest taking the discussion there if you want to have it again. This series is probably the best place for it:
https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance/
“Namely, successful fund managers charge an arm and a leg fee, but their performance justifies the outrageous fees. I know this is rare but we shall keep an open mind.”
Really, find me one. No, honestly go find me a “successful fund manager” that has beaten an index S&P mutual fund (say Vanguard) by more than 1.5% during any 5 year period. Please, find me this Oracle.
The simple truth is that the VAST majority of fund managers under perform index funds and the few that outperform them rarely do so and when they do they tend to charge on average AT LEAST 1% more than the index funds will (i.e. “outrageous fees”) So really to be any better they would have to CONSISTENTLY outperform the index by greater than the sum of their fees.
So IF you can find this magic oracle let me know…
Beau, I don’t invest in ETF or mutual funds,but managing my own by picking my own stocks. So far it has worked well (so far) since 2009.
The list of fund managers (hedge funds) I could think of as follows:
1. Warren Buffett
2. Ray Dalio
3. David Swensen
I agree with you that these managers are a rare commodity. Yes they did have some setbacks. And their fees are outrageous around 2%/20%.
@Jim, I don’t suggest shorting or using options (or other derivatives). Yes for average investors, mutual funds or ETFs are more appropriate than my suggestions, because they don’t have the right emotion of a successful investor like Charlie Munger or Warren Buffet said. You are entitled to your opinion about the investing strategy, but the history has shown that a spectacular success (meaning big returns) in investing has been accomplished by the Pros through a concentrated approach. Again, this strategy isn’t for typical retail investors. Briefly, GUL isn’t sustainable in the long-run and it’s cheap for a reason. Insurance companies know it will break (stop) in the future. GUL is an infinite term insurance. Term isn’t offered beyond 75 just because most of us are not insurable for the price of the term product (price is too high; a violation of insurance principles).
Warren Buffett doesn’t run a hedge fund. Nor does buying his cooking cost 2 and 20. You just have to buy Berkshire Hathaway stock. In fact, Buffett has an ongoing bet with a bunch of hedge fund managers that the S&P 500 will outperform them (and he’s winning decisively.) His Berkshire Hathaway stock is up 73.9% including dividends over the last 5 years. 500 index fund is up 102.6%, not including dividends.
David Swenson also does not run a hedge fund. He manages Yale’s portfolio which had a 12.5% 2013 return while the S&P 500 was up 32.39%. You can’t invest in Yale’s Portfolio, sorry.
Ray Dalio is also a huge believer in passive investing for his beta with Bridgewater Associates. Bridgewater manages money for institutional investors. You can’t pay 2 and 20 and get his services either.
I’m really surprised that you are not familiar with the data on passive investing vs active investing. I’d suggest a perusal of some of the classic books by Bogle, Swedroe, Ferri, and Bernstein.
Are you suggesting that insurance companies aren’t going to keep their GUL contracts? Or are you simply saying they’re not going to offer them. I don’t see any reason they can’t both keep them and offer them. Since there is no growth to the death benefit and no cash value, it seems priced about right to me.
Jim, I wasn’t specific enough in my earlier post. Let’s define what is hedge fund. Here is from investopedia. By the way, thank you for a little education about finance/investing from a Med Doc, and I am supposed to be a finance/accounting guy feels humble and appreciative.
“A hedge fund is basically a fancy name for an investment partnership. It’s the marriage of a fund manager, which can often be known as the general partner, and the investors in the hedge fund, sometimes known as the limited partners.”
I wasn’t talking about how their legal entities were formed either partnership, C Corporation, S Corporation or etc. My response to Beau, I meant these fund managers use investing strategies (actively managed not passive/index managed, because their fees are high) to outperform market up/downs by actively managing their funds.
Sorry telling you a little history about Warren. Warren started his company as a hedge/active fund investment company. Yes, I am mindful of his on going winning bet with a small actively managed fund shop. As I said on my earlier post, only a few of really good fund managers/companies out there, and there are expensive because they deliver, not always but so far they are winning against the index, and the rest of them are just “wanna be fund managers”.
Second, I know you are a huge proponent of index investing, and that is one of many strategies. That is ok. Here you are comparing Warren’s performance with SPX index (S&P 500). I notice that I must say this is your style in supporting your positions by picking and choosing partial facts. You have to be fair, neutral and impartial in presenting your views and factual data. I don’t expect you to be a journalist because this blog isn’t a form of journalism to reflex unbiased viewpoints. So, if you only took Warren’s performance for the last five years, it’s fair. Go check Birkshire’s annual reports. Its overall performance has beat S&P index.
In brief, the other two guys have employed actively managed fund strategies. I didn’t mean their employers. Anyhow, Ray Dalio actively manages his funds (hedge funds). Here is I got from his website. http://www.bwater.com
“Bridgewater ranked as the largest and best-performing hedge fund manager in the world and in both 2012 and 2013 Bridgewater was recognized for having earned its clients more than any other hedge fund in the history of the industry.”
Yes, most hedge funds aren’t accessible to retail investors, because most of them don’t meet the regulatory asset threshold.
As to GUL, I have some doubt about no-lapse guaranteed insurance products other than whole life insurance that has been around more than 100 years old. UL insurance products have been around since 1980s. Read this article if you are interested why.
http://www.peterkatt.com/articles/AAII_jul2003.html
Are there people who have used active management to beat passive management in the past? Yes. Can you identify them a priori? The data suggests you cannot. If you want to try, it’s a free country. I prefer to invest in a way that the evidence, limited as it is, suggests is likely to be most effective.
I wouldn’t include Buffet in discussions like these. He has major leverage on any of his “stock picking” deals based on BRK, and it puts him in a different category when comparing to other fund managers.
Nate, yes you are correct. I meant his early privately held investment partnership where he started with Charlie to actively manage people’s money.
Also not accessible. The question isn’t “What about Warren Buffett?” The question is “Where are all the other Warren Buffetts?” Statistically, there ought to be more even if just from simple dumb luck.
Any friend that sells you a whole life policy is no friend of yours but a leech feeding off your supposed friendship.
You might need to do a post on not getting investment advice from insurance agents for equities. I didn’t think it was possible to get worse advice then the typical buy permanent insurance but it appears that isn’t true.
I was a rep with a large broker dealer for 17 years. Left to set up my own firm a few years ago and gave up my insurance licenses to do flat fee only financial planning. I never sold any permanent life even though it was offered and promoted as a way to enhance your relationship with clients, add value, but more importantly generate fantastic commissions. The logic that is used with clients boils down to sales tactics and ploys to convince people to do something. But many of the agents are true believers. They have bought into the product completely – it defines them and is now a part of their DNA. No amount of data or logic will change their thinking. When I read their follow-up comments it is as if they do not even read your postings. I appreciate your work Jim. However, you will never get back the time you spend following up on these comments.
It’s not the agents I’m serving by replying to them. Docs and other professionals need to understand that there are counter arguments to each of the sales ploys used.
Keep up the good fight
I mostly sell term life insurance but do think there is a time and place for Whole/UL, I just haven’t had a client in the past 2 years that I felt it was right for. Most of my clients are doctors.
Permanent life insurance is for less than 2% of the country. I don’t know why people can think that paying more taxes during your highest earning years so that you pay less in retirement (your 0 earning years) is a benefit.
I saw that the WCI mentions the relative meager returns of cash value life insurance but I didn’t see that he acknowledged the cost of the insurance on those returns as well. In addition, what you save in tax deferral in a life insurance contract you end up paying in insurance. Those people not only pay more for insurance but when they take a loan on their policy then end up paying interest too!
The biggest problem with permanent life insurance is that the agent probably sets the contract up to have more “cash value” go towards insurance than cash value build up. The bigger the face value of the contract relative to the premium paid, the worst for the client.
Also, the insurance agents that make the most money prey on fear, fear of the stock market (risk tolerance), fear of taxes going up, etc… There is a new thought process on risk tolerance. I for one do a risk tolerance questionnaire because I am obligated to but I feel goals are much more important than risk tolerance. If a prospect is too afraid to invest properly to reach their goals then they will not be an investment client of mine. I say this because the CPA above mentioned “risk tolerance” a few times. Investment decisions should be less about risk tolerance than they are about reaching goals and reconciling differences between the two.
I can see where life insurance can be used in some states for asset protection and large estate plans but most americans with estate’s less than 15-20 million and incomes less than $750k probably should never even consider a whole life contact. I would estimate that this is about 2% of the US citizens.
JT,
Make sure your E&O insurance updated and don’t get sued if you have a FINRA issued license. Look!, the subjects/topics we are discussing here are too subjective and there isn’t a one solution.
[Belittling attacks deleted. Odd how these always come from people who sell permanent life insurance and never from high income professionals or financial professionals like lenders etc]
JT, let me share a little story about my client referred by a local attorney. In July 2008, a husband of a wealthy and retired widow passed away due to a heart attack. When I sit down with her in the Mid 2009, she expressed her grievances about a huge loss of stock and bond investments she sustained in that year and subsequent years because her husband was a huge proponent of these investment vehicles. He bragged so much to his daughters and grand children about his portfolios and told them that they will inherit so much according to this widow. She had her accounts with UBS then, confronted her deceased husband’s broker and told him “sell what remains and put them in CDs.” Until now she has had a CD account inside her inherited IRA account around $750k and $2mil in various time deposits with Chase you know rates now. She confessed that her husband lost around $7 to $8 mils in security markets and he was also a victim of Bernie Madoff and invested also in Worldcom. what a perfect storm right? Fortunately, she still has some liquid assets which she carefully preserves and plans to pass them to her daughters and two real-estate properties and a small interest in an oil & gas partnership (she keeps this one because of a family investment).
My question to you. Would you tell this person “well you money is not generating enough income because what you do doesn’t match with the financial goal we like (by the way she wants to earn as much money as possible for her heirs). So I recommend that you should put your money in security investments again to recoup those losses.” Are you gonna fire this person as your client because her risk tolerance for security investments is very low? As an adviser, we all shall be flexible and listen to our clients’ need regardless how foolish it may sound.
Furthermore, JT I want to offer some tip for you. You do have a tax background (EA) and if you also offer insurance products, you should target a fiduciary market, working together with gatekeepers of your doctor clients by offering them more advance insurance products (yes permanent insurance and P&C insurance policies) such as Sec 79 insurance, RPT or captive insurances. Don’t talk to your doctor clients, because they don’t understand these and we are talking about serious premiums min $35k and up annually. Your doctor clients will check with their gatekeepers anyway,so work with them directly. You need to reach out to CPAs, attorneys, controllers, and pension TPA. These plans are controversial but if done right, they will benefit all parties.
[Belittling attacks deleted.]
Oh Jt,
when you are working with these gatekeepers, don’t treat them like your typical individual clients. They are very skeptical and that is ok because they just want to protect their clients.
When you design an insurance plan, make sure the target premium is reasonable, print an insurance cost/expense sheet, and be honest and cooperative with them. The tax and financial benefits are there for their clients, and that is a good thing. Cheers.
I disagree that more advanced insurance products are generally a good idea.
[Persistently repeated belittling comments deleted.]
Nansan,
My goals are not important ( I think this is why this blog was created), I want my clients to reach their goals. I also don’t invest clients in concentrated positions in one company’s stock and don’t tell prospects about unreal fake returns. I would not manage the investments of someone who is ultra conservative if their goals say they need to invest for growth to meet their goals.
I am open minded in solutions for clients, that’s why I say there are times when WL/VUL can work, just not nearly as often as many would like you to believe. The doctors I work with have student loans, living expenses and don’t make 600k in private practice, not sure where large commitments to WL work into their plan to reach their goals.
Your estimate is far too high. The 1% income-wise starts at ~ $350K I believe. >$750K is probably top 0.3% or so.
WCI, and the rest of the docs here. As I am sure you know, the conversation normally starts like this, “Have you heard about the benefits of a whole life insurance policy? No? Great, let me tell you about this fantastic addition to your portfolio” That is life insurance sales training 101.
Most people who sell this (a lot) probably have ChFC, CLU, and maybe LUTCF behind their name. Many people have all 3, they aren’t very hard to get, no college education or board exam required. When you see this combination of designations that means they probably got their start in the business at a NML, NY Life, Guardian, etc… I took those classes too but stopped taking them when I realized it was just a way to differentiate myself as a true life insurance sales professional, that is why I stopped taking those classes. Of course, CFPs sell this too but too much less extent than the other designations mentioned above.
Well I hope WCI and Garrett are able to get together for the seminar. It should be an interesting discussion! Please let us out of staters know if there is a way we can access that material if it comes to fruition!
Thanks!
Hi all, so quick disclaimer, I do broker life insurance but have not been doing it for long. When I started I spent about a couple months just learning everything I could, all day everyday designing and redesigning and calling the sales desk and comparing in portfolios.
I think I understand a lot of the concerns people have, but I think that if you plan kind of comprehensively and think a lot about risks then whole life becomes a lot more attractive. When you go with company’s like Mass Mutual and Penn Mutual that have high and maintained dividend rates, the returns are much closer to averaging 5-6% a year, if you design for maximize cash value. If you are maxing your Roth, getting the match in the 401k, then I feel like whole life is a pretty sensible part of your portfolio. The death benefit I don’t think of as death benefit, I think it’s primary advantage is for long term care because the companies I mentioned also allow you to access it for long term care benefits. I’m not sure of everyone’s familiarity with long term care options but I personally am extremely skeptical of the stability of traditional long term care and the lack of guarantees or proven track record as well as the recent selling off of policies to less stable insurers has kind of driven me away from suggesting them and really feeling that tapping into a life insurance death benefit is the best way to address that care if you don’t have the cash flow to handle it outright.
Another reason I like the policies is because of versatility by comparison to a 529 plan for example, if you have a 529 in equities, you don’t really decide when your kid is going to college, they generally just go at age 18, give or take a year, so if you are unlucky and that’s a year that the market crashes then you are taking distributions that are destroying everything you’ve built in it. If your kid doesnt end up going to college, or if your kid goes out of country, you can run into multiple areas where that 529 is not serving you. If you have something come up and need an early withdrawal because of an emergency then you get penalized and pay long term gains tax on the gains which in California is about 40% total tax (including the penalty). Im only mentioning 529s because they were talked about earlier.
I think I differ in philosophy from the author here mainly because I think you should plan a bit for differing risk environments such as tax increases, a lot of planners call that tax diversification I believe. I think the principle protection in a whole life policy and the dynamic utility are pretty valuable and I don’t want to take that for granted, and if something happens to you before all these plans come to fruition then your family still gets a death benefit. So anyway, it is not a solve all by any means and you should certainly be heavily invested in diversified equities and us treasuries and corporate bonds, and real estate, they have all proven to be extremely lucrative over time. But I have a hard time believing that whole life insurance is the great evil that people are making it out to be, it’s a conservative risk adverse asset that when structured properly and utilized properly can be advantageous for an individual. I know we mentioned Ray Dalio and David Swenson before and I think they both have said how defense is ten times as important as offense.
Sorry, I wanted to make a quick clarification because I don’t want to be taken for overselling or anything like that. The 5-6% rates I mentioned are only if you are in these policies for generally 12-15 years. The entire first decade does have low returns, no matter what carrier you go with or how you design it.
If someone is interested in seeing a sample illustration I could show one, and these illustrations are based off of dividend yields from low interest environments with rates that have been maintained through the 2008 crisis. Both these companies I’ve mentioned are known for very realistic illustrations of dividend yields. Of course, as in any investment, your growth is not guaranteed, just like the 10% actual average mentioned in this article.
Too late. If you’re pushing it as better than a 529 and great for LTC< you're already guilty of overselling. Here are the acceptable reasons for buying whole life: https://www.whitecoatinvestor.com/appropriate-uses-of-permanent-life-insurance/
But if you only sold it for those reasons, you’d make so little money selling it that you’d quit bothering and spend your time on something else.
I’m not sure anyone needs to see a “sample illustration,” as there seem to be plenty right here:
https://www.whitecoatinvestor.com/forums/topic/inappropriate-whole-life-policy-of-the-week/page/3/
But if you want to send me one, I’ll use it to demonstrate what I said above- that even in a well-designed policy you have negative returns for the first 5-15 years, that the guaranteed returns are 2% a year after decades and that the projected returns are ~5% after decades.
A few points:
1) You broker life insurance. “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” – Upton Sinclair. I mean, wouldn’t it be convenient if whole life WERE awesome? Then you could sell this high commission product and actually be doing the world a huge service.
2) 2 months of learning everything you could huh. Do you have any idea how this sounds to a physician?
3) The typical returns for a well-designed whole life policy bought today and held for multiple decades (until death) are 2% guaranteed and ~5% projected. Nobody sees those kinds of returns in the first decade, and a decade is a long time. Unfortunately, most whole life policies are not well-designed to maximize cash value. They are like these: https://www.whitecoatinvestor.com/forums/topic/inappropriate-whole-life-policy-of-the-week/ and are sold by people like you. Why are the agents not maximizing cash value in these policies? Because that minimizes their commission. See # 1 above
4) You don’t think of the death benefits as a death benefit huh. So you’re selling these to people who have no need for a permanent death benefit. That would make you part of the problem, not the solution. Mixing insurance and investing is a problem to start with. Mixing it in with another insurance problem further complicates matters and makes it easier to sell and harder for those who buy it to realize they’ve bought a pig in a poke. https://www.whitecoatinvestor.com/dont-mix-insurance-and-investing/
5) Using a WL policy when you should be using a 529 is downright idiotic. Financial malpractice. Your scare tactics to get people to use an inferior product to save for college are very revealing of your true motivation- sell people a product that pays you well and that they neither need, nor want once they understand how it really works. https://www.whitecoatinvestor.com/debunking-the-myths-of-whole-life-insurance-part-2/
6) “Dynamic utility”? “Principle protection?” Did your company teach you those? Here’s some principle protection for you- make whole life payments for a decade and still have less in cash value than you have paid in. How does that protect your principle? It doesn’t. You take an immediate huge haircut. And where are all those little hairs? They’re in your pocket. I’m not surprised that you “differ in philosophy” with the author, as the author is trying to protect his readers and their money from people like you. Do us all a favor and try to find something else to do with your life. I agree it’s not a “solve-all,” so please stop trying to make it such. It’s not a 529. It’s not a LTC policy. It’s not a retirement account. It is rarely useful and so should be sold rarely.
Thank you for taking the time to respond so thoroughly and on a Sunday morning. I also wanted to say I really appreciate this blog and all the articles here.
That is a good quote, and something to be mindful of. I do broker other services though with my Life and Health license, like disability insurance and even group health, so if you convince whole life insurance isn’t great, I’ll still make a living.
I’d like to continue the discussion with you because you seem very passionate about it and I’m genuinely interested in what you have to say, but I understand if you don’t want to respond back and forth. I came here having seen the title and always being interested to learn more, and I’ve read some of your articles before, but you seem almost mad at me for trying to come here and understand and give some of my reasoning. I am not a soulless bamboozler, and I’ve never really thought of myself as a salesman. I do what I do thinking that it is helpful to other people, as I’m sure you do, and if I find that it isn’t then I would refrain. Anyway, I just wanted to say that to hopefully change the tone of the conversation. My favorite quote is by William Penn, “I expect to pass through life but once, if therefore there be any good thing I can do for any fellow being, let me do so now, and not defer or neglect it, for I shall not pass this way again.”
I think I understand your comparison of 2 months of education to a physician’s rigorous training and preparation, but I don’t know if it is really a fair comparison. I wouldn’t compare the structuring of life insurance to the art of medicine. To be able to cure the human body of numerous ailments is incredible and deserving of the prestige those professionals receive. Learning how to work with life insurance is not nearly as in depth or complicated, its a numbers game, all it takes is running and manipulating numbers for maximum return. So while 2 months may not be a long time, I think it is ample to have an understanding of one particular product. I would think that you did not spend the same time studying life insurance as you did studying medicine and yet you consider yourself pretty knowledgeable on the subject.
You may be right, I think there are multiple co-workers of mine that do not build policies properly and that’s very sad. I think this gets more to philosophy. There are people that do not use guns the way they should be used (or i guess more for the purpose they should be used) but I still think the populace should be allowed to have guns. So what you say is absolutely correct. And you are also correct about the commissions, to structure a policy well on me I would put about $550 a year into the base premium and $2000 a year into the paid up addition. Base premium pays 55% to the agent/broker the first year and then residuals, paid up addition pays 3%. So properly built it only pays $302+$60=$367. But if someone built like you are saying, and a lot of people do, then it would be $2550 in base premium and pay, $1402, almost four times as much. I don’t design that way and maybe to you that doesn’t matter, but every-time I design a policy I make that choice to be ethical and always do what is best for the client, often people that I know. I’m not trying to throw a pity party, but I certainly feel that in a fair world I don’t deserve to be treated the same as the person who does structure for max commission.
My apologies, I guess I misrepresented my position. I understand your frustration with that statement about death benefit. I suppose that what I meant was the death benefit can be a protective death benefit while you are younger, which for many people is important and provides a sense of security, and as it grows it can still be dynamically utilized for long term care expenses. This is better in the long run in my opinion when you weigh that against paying for long term care insurance which is also very expensive and is often not used, it is the same as car insurance in function but not in cost and can be incredibly burdensome to an older couple. It sounds like maybe you think traditional long term care insurance is a good solution and still should be the solution considered for individuals, but I would passionately disagree with that point.
To emphasize the point that I don’t think everyone should have this product and I don’t suggest that, I met a woman who is a chef, but has a large history of sales, her husband does sales currently for a credit card processing firm. She has a distinct plan for her financial future if something were to happen to him. They are young and are not immediately concerned about long term care which could have numerous change before it is likely to affect them in 50 years. They aren’t contributing to an IRA at all. They have no kids, and they have probably a solid 20-30 years until retirement. So I felt no need to suggest this product to them. They have no health insurance and have been paying the penalty so I’ve been working with them to get health insurance. I think people who make commission can still work ethically in their clients best interests.
I think your response about 529 plans is a little uncalled for. I have been speaking to you pretty respectfully and I have met several people who had a terrible time with their 529 plans. If you put all into a 529 with a couple kids and one starts college in 1999 or 2000 or 2001 or 2002 or 2003, it would have been a really rough ride, and a lot of people were in that boat. Or if they started in 2006, 2007, 2008, 2009, 2010, it still would have been a very rough ride. I did read your section on 529 vs whole life. You often will lose state tax favorability if you withdraw for out of state tuition. I know that you’ve had bad experience with some policies but again, properly designed you get immediate return on your dollar in year 4 (meaning if you put in $2500 in total premium you are already seeing more than that as an increase in your cash vale), cash values break even with total premium in year 8, and then you can have an actual annual weighted return as high as 5-6% by year 12-15. If the market crashes when your kids go to school all the money is still there. If you can’t make it to that year and need money back because of emergency, its there without penalty. My wife and I don’t have kids yet but, we will most likely do both. I think college is a particular issue though where you are not maneuverable in time-frame, unlike retirement age where you have a little more fluidity. Of course you could delay your child’s college attendance but people are particularly loath to do that. I’m open to it if there is compelling information on why a 529 is very favorable, but so far I haven’t seen it. They are ok vehicles for growing money for a specific purpose, and I think its ok to use it, but I would be extremely wary of overfunding one or relying on one exclusively or even too heavily.
I feel like I’ve been pretty straightforward of the benefits here, I haven’t exaggerated anything or made anything untrue. A whole life insurance’s illustration by the way is far more reliable than any projection of stock market performance, insurance companies are not known for volatility, the US equities market is. Insurance companies are also not known for incredible growth, the US equities market is famous for it. Armed with that knowledge a person should be making the proper decisions about what they want to do with their money. I want to stress that point though because it does identify whole life as a specific tool, most people you speak to who are unhappy with their whole life policy is not because the projections they were told were wrong, its just because the projections had low growth and they see the market with 30% and 40% years. My wife and I have our Roths fully invested in securities, and there is no guarantee of performance, but we expect volatility, we also have some money invested in whole life, and there is no guarantee of performance, but we expect stability.
And to agree on a final point, you are correct that you will have less than you put in up until the 8th year at best in a whole life policy, I’ve never seen or structured one that could return the full investment before that. That should absolutely be a main factor in considering that vehicle. If you have no need of life insurance at the time that you purchase it, then that doesn’t make much sense, because that’s the only thing you’ll really be getting for, especially for the first 1-3 years.
Again, I want to say that I really thank you for your time and your feedback and I appreciate your perspective. I admire people who run blogs like this to educate people and provide a forum for discussion of multiple perspectives and hopefully intimate environments for people to further their own education. You seem to be very self-sacrificing with your time and knowledge and whether we agree on each perspective or not I think you’re doing a service for your community and find it very admirable. Thank you
I’m only mad at you if you’re selling whole life insurance inappropriately to physicians and I’m glad you have other products to offer.
Despite your politeness, I do think your opinion of whole life is entirely too positive, particularly as a college savings vehicle.
I’d like to hear more about these people who invested in a 529 prior to the 2000-2002 bear market. Good luck finding them.
At any rate, I really don’t have time to argue (again) with an agent who writes comments as long as my post about the merits of whole life. Suffice to say I find your arguments severely flawed. For instance, you fault 529s for the performance of the investment inside of them. If you don’t like owning stocks in a 529, then buy bonds. Voila! No more worry about stock market performance affecting your kid’s college money. Another example, this crazy argument you’re using about how your account goes up by more than your premiums by year four. While the fact is probably true, it conveniently ignores the fact that you’re still underwater and your opportunity cost on those last 3 premiums. If you calculate out the return on those 3 premiums, it’s still terrible, even if positive in year four. Calculate it out. See what it is. Does that sound attractive as an investment? Of course not.
I agree it doesn’t make sense to buy permanent life insurance if you don’t have a need for a permanent death benefit.