By Dr. James M. Dahle, WCI Founder
Whole life insurance is frequently inappropriately sold to doctors and high-income professions. These are the top questions about whole life insurance I get by email, by blog post comment, on the WCI Forum, and in daily life.
Should I Buy Whole Life Insurance?
Probably not. For most cases Doctors should buy term life insurance. Whole life insurance does four things:
- Provides a death benefit in case you die while someone else depends on your income, but it is a very expensive way to provide that protection.
- Provides a death benefit when you die even if no one else depends on your income, such as in your 70s or 80s. This is unnecessary insurance.
- Accumulates a cash value that you can borrow against. While there are a number of uses for this cash value, it is generally inferior to other options that can accomplish the same purpose.
- Whole Life Insurance has some unique business and estate planning uses you are unlikely to need.
Still not convinced? Well, at least ask yourself these questions about whole life insurance (and go through the flow chart) before committing to buy.
My Insurance Agent Thinks You're Wrong About Whole Life Insurance. Why Is That?
Insurance agents receive their training primarily from their insurance company, and that training is mostly in sales, not financial planning or investment management. They have no fiduciary duty to you and receive huge commissions if they successfully convince you to purchase a policy. A typical commission for a cash value life insurance policy ranges from 50% to 110% of the first year's premium. So if you buy a policy with a $4,000 monthly premium, the agent was paid something like $25-50K to sell it to you. In short, you cannot trust the recommendation of an insurance agent about whether or not you should purchase a whole life policy.
Why Is Whole Life Insurance a Bad Idea Most of the Time?
Whole life insurance advocates (usually insurance agents) often describe “ideal” policies that pay lower commissions and have slightly higher returns than other policies. However, my readers and I seem to run into “non-ideal” policies about 99% of the time like these crummy, inappropriately sold ones that seem designed to maximize the agent's commission. There are generally four main reasons why whole life insurance is a bad idea:
#1 You Have Better Uses for Your Money
So many of the docs I run into who own whole life insurance owe on credit cards, student loans, or a mortgage. They might not even know about retirement accounts available to them such as a Backdoor Roth IRA or a Stealth IRA. They probably aren't maxing out their 401(k) and perhaps haven't even established an individual 401(k) for their moonlighting gig. Sometimes they aren't even getting their employer match on their retirement plan! Their children's college plans are also probably woefully underfunded. In short, they have something else with a better return and better tax benefits available to them. As my income rises through the tax brackets, I keep thinking I'm going to run into a situation where cash value life insurance makes sense for me. But even with a 7-figure income, I still seem to keep finding better uses for my money! What are the odds that a doctor with an average doctor income doesn't have a better use? Pretty low, unfortunately.
#2 Whole Life Insurance Has Low Returns
If you buy a whole life policy today while you are in your 30s, and hold it until you die, over a period of 50 years you should expect guaranteed returns of 2% per year and projected returns in the 4%-5% range on the cash value. Your actual return is likely to be somewhere between the guaranteed and the projected returns. Remember, the dividend rate is NOT the return on your investment. If I'm going to tie my money up for 5+ decades, I expect a better return than 3-4%.
#3 Negative Returns
The poor returns on whole life are heavily front-loaded. Most policies won't even break even for 10-15 years and due to surrender fees, you may not even get anything you paid back on a policy you surrender after just 3-4 years.
#4 Life Changes, but Whole Life Insurance Doesn't
Purchasing a whole life policy is a life-long decision, like marriage. This is not something you decide on in 20 minutes with an agent masquerading as a financial advisor. You should at least put as much time and effort into purchasing it as you did when you purchased your house. Although you can purchase a “10-pay policy“, it is much more common to commit to heavy premiums for 30+ years. Unfortunately, life changes, and what seemed like a good idea when you committed to it, no longer seems so. Unfortunately, this usually means that the policy ends up performing even worse than the original illustration.
#5 Life Insurance Lapse Rates Are High
Not convinced? Would the fact that nearly 80% of people who purchase a whole life policy (meant to be held for your entire life) surrender it prior to death bother you? It's true.
It takes 5-15 years for a typical whole life policy just to break even to where your surrender value equals your premiums paid (not counting the time value of money or inflation.) If you count inflation, some policies never break even while most take decades to do so. This brings to mind an important question:
How many people are still holding their policies after 5, 10, 15, or 20 years?
Luckily, this data is tracked by the Society of Actuaries and is demonstrated in the chart below.
If we use an 11% lapse rate in year 1, 9% in year two, 7% in year three, 6% in year four, and 6% in year 5, that means that 1/3 of folks have surrendered their policies within just 5 years, long before breaking even. If we continue on to 10 years (using a 5% lapse rate for years 6-10) then we're down to an overall lapse rate of 50%. Using an annual 4% lapse rate for years 11-20, the overall lapse rate is 60% at year 15 and 70% at year 20. By year 30 (using a 3% lapse rate for years 21+), about the time of retirement for someone buying one of these upon residency graduation in their early 30s, 77% of those who purchased their policies no longer own them.
How Do Insurance Agents Convince So Many Doctors to Buy Whole Life Insurance Inappropriately?
Insurance agents need to feed their kids and send them to college, too. So they have developed some extremely well-honed sales skills to sell these high-commission products. Unfortunately, many of the techniques used to sell these policies rely on myths about them.
Debunking the Myths of Whole Life Insurance
Most of the time, the agents aren't even lying. They actually believe these myths, which makes them even more effective at selling.
- Whole life insurance is great for pre-retirement income replacement. No. It's too expensive.
- Whole life insurance is the best way to get a permanent death benefit. No, Guaranteed Universal Life is half the price.
- Whole life insurance provides a great investment return. Nope. Negative returns for the first decade, and only 2-5% if you hold it for 3+ decades.
- Insurance companies are great investors. No. They're buying the same stuff you can buy, but inserting an extra layer of fees.
- Whole life insurance is a great asset class. No. There are 10 reasons why it isn't a great asset class, not even as a “bond replacement”.
- Whole life insurance is a great way to save on taxes. No. Its tax benefits pale in comparison to retirement accounts. All loans are tax-free.
- Whole life insurance protects your money from creditors. True in some states, but not others. Retirement accounts generally provide better protection.
- You need whole life insurance for estate planning. No. Most doctors won't owe estate taxes or have estate liquidity needs.
- Whole life insurance is a great way to pay for college. No. 529s are better. You want higher returns and you want them in the first 18 years. Hiding assets in life insurance cash value isn't going to help since your kids aren't going to get much aid anyway.
- Whole life insurance is a luxury you want. No. A luxury you want is probably a Tesla, a second home, a boat, and maybe a kitchen upgrade. As purchases go, whole life insurance might be the least likely one to increase your happiness.
- Whole life insurance lets you spend down your retirement assets more efficiently. A Single Premium Immediate Annuity does this more effectively. Heck, even a reverse mortgage does this more effectively.
- Whole life insurance is a great way to buy expensive stuff. No. Cash works just fine for that, no whole life policy needed.
- Really rich people or businesses buy whole life insurance so you should, too. This is irrelevant. You are neither “really rich” nor a business. Buying whole life insurance doesn't turn you into either.
- You should buy whole life insurance when you're young. You probably don't need it at all and never will. It is no better an investment at 20 than at 50.
- Waiver of premium riders provide disability protection. Disability insurance does a better job.
- You should exchange your old policy for a new one. Probably not. The low returns are heavily front-loaded. An older policy usually performs better than a new one. But the agent gets a big commission if they can talk you into exchanging.
- Whole life is the only way to pass money to heirs tax-free. Not true. Almost all assets are passed tax-free thanks to the step-up in basis.
- With whole life, there is no way I can lose money. Nope. Not only will you lose money if you surrender in the first decade or so, but state insurance guaranty corps only back relatively small policies.
- Life insurance should not be rented. Wrong. Just like a home should be rented if you're only staying for 2-3 years, a life insurance policy should be “rented” (i.e. term) if you only need it for 2-3 decades.
- Banks own life insurance so you should, too. No. Just like you're not a very rich person or a business, you're not a bank, either.
- Corporate CEOs own life insurance so you should, too. No. Again, you're not a corporate CEO. You actually need a reasonable return on your money.
- Banks failed during the Great Depression but insurance companies didn't. Not true. 14% of companies did fail.
- After-tax, whole life insurance returns are better than bond returns. Misleading at best, but generally just false.
- Whole life keeps assets off the FAFSA. True. But irrelevant to most docs whose kids won't get any need-based aid either, and most need-based aid is just loans anyway.
- Term life expires without paying anything. True, but that's a feature, not a bug. Just like you don't want to use your auto, health, or disability insurance, you'd rather not use your term life insurance.
- Whole life insurance is the perfect investment because it is safe, liquid, tax-advantaged, creditor-proof, and offers a competitive return. Four partial truths and one big whopper there.
- Insurance agents are just people trying to feed their family. So are time-share salesmen. Doesn't mean you should buy what they're selling.
- No 1099 income with whole life. That's right. Because there's no actual income, nobody sends you a 1099. Just like when you borrow against your home equity or your car title. You need some serious tax paranoia to buy into this argument.
- The White Coat Investor is just a doctor. When you run out of other arguments, just go ad hominem. I'm sure that will be effective.
- After maxing out a 401(k) and Roth IRA, isn’t whole life insurance the only tax-sheltered option left? No. It isn't. And that isn't the right question to be asking anyway.
- The estate tax exemption could go down. It could also be eliminated. Base your plan on current law and adjust as needed.
- Whole life insurance protects from nursing home creditors. Not really. Nor is this a feature white coat investors should need even if it were available.
- WCI doesn't understand the opportunity cost of NOT using whole life. Yes. He does. He still recommends against it for most.
- Buy whole life insurance for the long-term care rider. If mixing insurance and investing is a bad idea, why would mixing two types of insurance with investing be a good one? Do all you can to self-insure for this possible need.
- We don't say to put ALL your money into whole life insurance. If it isn’t a good idea to put a significant chunk of your portfolio into an asset class, it probably isn’t a good idea to put any of your money into whole life.
- Yes, we have a few bad eggs but most of us are ethical. If there were only a few, why do 3/4 of doctors who buy whole life insurance regret their decision? This is an industry-wide issue with selling this product inappropriately.
- You should buy insurance to preserve insurability. No, you shouldn't. You can't really do it, and even if you could, the multiplied risk (inability to buy life insurance x early death) is too low to insure against.
More information here:
When Is Whole Life Insurance a Good Idea?
Obviously, there are a few rare exceptions where a whole life insurance policy can make sense. Being a doctor isn't one of them. These generally include some specialized estate planning and business purposes, as well as asset protection for someone willing to give up higher investment returns in exchange for the asset protection.
Some financial advisors think there are some situations where very high-earning doctors can benefit from investing in a variable universal life (VUL) policy instead of a taxable account. The basic idea is that the insurance costs will be lower than the tax costs in the long run. Whole life insurance may be a good idea for you if all or most of the following are true:
- You’re in the highest tax bracket now
- You'll be in the highest tax bracket in retirement
- You’ve bought a GOOD VUL packed with good investments like DFA or Vanguard funds you would invest in anyway
- You’re committed to holding it your entire life
- You will have no trouble making the premiums (consult your crystal ball if necessary)
- This is money you plan to completely spend in retirement
- You cannot invest in an extremely tax-efficient manner in a taxable account, and
- Neither the government nor the insurance company changes the rules significantly over the next 6-7 decades
Insurance agents these days are heavily pushing indexed universal life (IUL) policies, probably because people have caught on to the fact that whole life insurance and VUL aren't usually a good idea and the additional complexity of these policies can be used to confuse the purchaser in new ways. Despite the additional complexity (good luck actually understanding what you're investing in here), you generally give up so much of the index return in exchange for the guarantees, these policies are likely to have the same low long-term returns as whole life insurance policies. Just say no.
What Do You Think About “Banking” Using Whole Life Insurance?
I think there are worse things you can do with your money than “Infinite Banking” or “Banking on Yourself“. However, the concept is dramatically oversold as some magic alternative banking system. If you're going to borrow to buy things like cars during your life anyway, then this works out okay. Make sure if you want to do this that you get a policy actually designed to do this well.
What Is the Best Way to Buy Life Insurance?
Your life insurance needs should usually be met with a 20-30 year level premium term life policy purchased from an independent agent. Here is a step-by-step guide showing you how to buy life insurance and how to figure out how much life insurance you need. Contact one of my recommended insurance agents to get a quote today.
Should I Buy Whole Life Insurance on My Children?
How Can I Know If I Should Cancel My Life Insurance Policy?
First, get an in-force illustration. Next, either hire an unbiased person to analyze it or analyze your life insurance policy yourself.
How Do I Cancel My Life Insurance Policy?
If you have decided you no longer want your policy, you may want to consider some options other than just surrendering it, especially if you have a significant difference between what you paid in premiums and its current value. Here is a guide to help you get rid of your whole life policy.
I hope this post provides a worthwhile, easily-shared resource for those wondering whether they should buy a new whole life policy or get rid of a policy they already have. As I always tell whole life advocates—if you understand how the policy works and are okay with the significant downsides, buy as much as you like. But typically, once a doctor or other high-income professional understands what they've bought, they regret the decision to buy.
What do you think? Why do you think whole life insurance is pitched to so many doctors? Why do so many of them buy it? Comment below!