By Dr. Jim Dahle, WCI Founder
Cash value life insurance—such as whole life insurance, universal life insurance, and variable life insurance—are products designed to be sold, not bought. They are inappropriate for the vast majority of people on this planet, including physicians.
Among physicians that actually purchase the product, three-fourths of them regret their decision. Even among the general population, more than 80% of whole life insurance policies, a product designed to be held until death, are surrendered prior to death.
The vast majority of whole life insurance policies should never have been purchased. The fact that they were should be an embarrassing stain on an industry that is presumably trying to make families more financially secure. It's even worse when it is done by a mutual insurance company. In what other industry is a company actively trying to hose its owners?
Why do so many doctors regret purchasing whole life insurance? There are a number of reasons, and usually it's a combination of a few of them. In today's post, I'll list them all.
Remember as you go down the list, I don't have a problem with YOU buying whole life insurance or even with the product itself, really. If you really understand how it works and you want it, then buy as much as you like. My problem is with the way the product is sold, especially by those who sell it inappropriately while masquerading as unbiased financial advisors.
Top 10 Reasons to Regret the Purchase of Whole Life Insurance
#1 Bad Advice
The regret of purchasing a whole life insurance policy is often wrapped up together with the realization that you have been getting bad financial advice. Once you become financially literate, this isn't terribly surprising. I mean, you went to someone with an obvious financial conflict of interest expecting unbiased advice. You don't go to a used car salesman and expect unbiased advice when you ask whether you should drive to work or ride the train. Likewise, you shouldn't go to an insurance agent and expect the right answer if you ask whether you should max out your retirement accounts or buy whole life insurance.
More information here:
#2 Better Use for Your Money
Most doctors, especially young doctors, have a far better use for their money than whole life insurance. After a decade or more of deferred gratification before they reach an attending physician salary, the cash flow needs of a graduating resident typically exceed the cash available. There are student loans to pay back; house down payments to save up; disability, term life, and malpractice insurance premiums to pay; retirement accounts to max out, Roth conversions to do, emergency funds to save up, and 529s to fund. These docs don't have a prayer of starting a non-qualified investing account for at least a few more years.
Yet I keep running into doctors who owe $300,000 in 6%+ student loans who just bought a whole life insurance policy. What kind of a jerk sells such a thing to a young doc? There are only two answers to that question—incompetence or connivance, your choice.
#3 Life Changed
Here's another common issue. Life changes, and it changes far more frequently than we think it will. If you buy a whole life policy and, a couple years later, decide you want to work part-time or take a sabbatical or something else happens to your income, you can spend less money and save less money for retirement.
But you know what you can't cut back on? That whole life insurance premium. You've just picked up a massive fixed expense. Or perhaps life changed in other ways and you no longer have the need for insurance that you thought you did. Or maybe you changed employers and now have four times the amount of tax-protected space in retirement accounts. Either way, a life-long commitment to a whole life insurance policy doesn't work out well when life changes.
Buying a whole life policy is like getting married—it's either until death do you part, or it's going to cost you a lot of money to get out. How much money? Well, it's often similar to the cost of changing jobs or changing houses—tens of thousands of dollars.
#4 Unnecessary Insurance
As a doc becomes financially literate, they realize that insurance is, on average, a bad deal. This is a mathematical certainty. The insurance company collects premiums and must use that money to cover its expenses, pay its policyholders for any bad things that happened to them, and hopefully turn a profit. The average payout must necessarily be less than the average premium. Since insurance is a bad deal, you don't want to buy any more insurance than you need to cover financial catastrophes. Whole life insurance is, by design, supposed to pay out any time you die no matter when that may occur during your life. That includes time periods before you have an insurance need and after you have an insurance need. Dying at 85 is not a financial catastrophe; it's an expected event. You don't need to insure against it.
These days people are being suckered into buying whole life insurance just to get a long-term care rider on the policy. This is a classic example of buying unnecessary insurance. You've now bought a whole life policy you don't need just to get long-term care coverage. If long-term care policies weren't so terrible, this wouldn't even be a consideration.
More information here:
#5 Asset Protection
A large amount of the cash value in a whole life insurance policy is protected from your creditors in many states. If you don't live in one of those states (or moved from one of those states) but bought a whole life policy primarily for the asset protection benefits, you're highly likely to regret your decision. The following states have weak (I'm defining that as less than $250,000) or no creditor protection for whole life insurance cash value: California, Colorado, Connecticut, Maine, Minnesota, Nebraska, New Hampshire, North Dakota, South Dakota, Washington, West Virginia, and Wisconsin.
#6 Tax Advantages Oversold
A frequent method of selling whole life insurance is to claim there are massive tax advantages to buying it.
“Tax-free retirement income!”
“Tax-free to your heirs!”
It isn't that the agents are lying, but they ARE misleading you by what they're not pointing out. Consider the tax benefits of whole life insurance:
- Tax-protected growth: The dividends/interest aren't taxed as you go along. Technically, this is because they represent an overpayment of the premiums, but in essence, this is exactly what you would get in most investments and types of investment accounts. You get this in an annuity, a 401(k), a Roth IRA, a defined benefit plan, and even your home. In fact, even a stock that doesn't pay dividends will give you this.
- You can borrow against it tax-free, but not interest-free: Again, this is no different from your 401(k), your house, your car, or even a collection of mutual funds in a non-qualified account. Of course, borrowing money is tax-free; it isn't income.
- Tax-free death benefit: It's nice that your heirs don't have to pay taxes on the death benefit when you die. But this really isn't any different than almost anything else they inherit. If they get your house, your investment properties, or your mutual funds, they also get a step up in basis there for a tax-free inheritance.
- Partial surrender tax-free: This “first in, first out” tax treatment is a nice feature of whole life insurance. You can partially surrender the policy and take out some of the principal before taking out the interest. You can't necessarily do that with most investments or even an annuity. But again, it's no surprise this is tax-free. You've already paid tax on this money; it's your principal, not interest. It's not actually income.
But look at the tax benefits you don't get.
- No tax deduction for contributing: You get this with any tax-deferred retirement account or HSA. In some states, you get a state tax deduction or credit with a 529.
- No lower capital gains taxes: If you surrender a policy with a gain, you don't get to pay at the lower long-term capital gains rates even if you've held the policy for decades. You pay on those gains at your ordinary income tax rate.
- No tax-loss harvesting: If you surrender a policy with a loss, you're just out of luck. You can't even use that loss to offset investment gains, much less any of your earned income.
- No depreciation: If you buy a rental property or other real estate investment, you can depreciate it, shielding some or all of your income from taxes. Even if you sell the property before death, that depreciation will be recaptured at a lower rate. There is no similar tax benefit with whole life insurance.
- Interest is not deductible: Yes, you can borrow tax-free against your policy cash value. But those terms are often unfavorable to you, and the interest isn't deductible, like borrowing against your house or your investments.
When policyholders realize the tax benefits aren't nearly as good as the agent made them sound, they often regret their purchase.
#7 Negative Returns
This one happens way too frequently. This isn't a bug, it's a feature of a whole life insurance policy. For a period of years after purchase, the cash value of the policy will be less than the total of premiums paid. It must be so. The insurance company has expenses, particularly the large commission paid to the selling agent. Some of the premium also has to cover the cost of the death benefit.
It should not be a surprise to see that you're in the red for five, 10, or even 15 years after purchase. If you would have read the illustration you were given when you bought this, you would have seen that. But this is a major reason why people regret and even surrender a policy they've held for two, three, seven, or even 10-15 years.
“I'm still underwater! I thought this was a good investment!”
No, it's not a good investment, and you should have expected to be underwater for years after purchasing it.
#8 Low Returns
Even after the policy eventually breaks even (and all but the most terrible eventually will), many investors are disappointed to learn just how low the returns on your cash value are. The reason is usually that they mistook the dividend rate for the rate of return.
These are two very different numbers, and only in the very long term (3-6 decades) does the rate of return begin to approach the dividend rate of 5%-7%. In fact, the policy, for all its talk of “guarantees,” really only guarantees a return of about 2% per year, less than the average rate of inflation, on a policy held for the rest of your life.
Even the rosy projected returns (generally projected as high as the law allows them to be projected) typically average out to only around 5% on a policy held for your entire life. If this isn't what you were expecting when you bought the policy, you're likely to regret its purchase.
#9 Cost of Insurance Rises
This one is technically not about whole life insurance, where the premiums are guaranteed, but about its cousin universal life insurance.
Universal Life Insurance
In a universal life policy, the cost of insurance actually goes up each year just like it would with an annually renewable term life insurance policy. While the cost is quite low in the beginning, allowing a substantial amount of cash value to build up, the cost of the insurance eats up more and more of the premium as the years progress. Eventually, it eats up the entire premium and starts into the cash value.
If the investment performance of the policy was not as good as projected (and it usually isn't), the entire cash value can be used up to pay the premiums. Once the cash value is gone, the policyholder must start making larger and larger premium payments each year to keep the policy in force.
Rather than being a source of income in retirement, the policy has now become a huge expense! Often, the policyholder cannot afford to keep it in force and ends up surrendering the policy, technically with a fully taxable gain and no cash value to pay the tax bill on that gain.
Unlike a whole life insurance policy, many universal life policies really aren't designed to provide a large death benefit after a long life. The only way to even have the policy in force at the end of your life is to dramatically reduce the death benefit as you get older so you can afford to pay the premiums from the cash value or your other income.
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#10 Non-Qualified Investments Aren't That Bad
Finally, many docs get suckered into buying whole life insurance because they don't know where to invest more money for retirement after maxing out their 401(k). Aside from the fact that the agent is unlikely to suggest such places as a Backdoor Roth IRA, an HSA, an individual 401(k), or a defined benefit/cash balance plan, those who are not very financially literate don't realize that they can actually invest money outside of retirement plans and insurance policies.
If you invest tax-efficiently using total market index funds, municipal bonds (or funds), and equity real estate, a non-qualified account is an excellent place to invest for all kinds of purposes, including retirement. You benefit from the lower qualified dividend rates, the lower long-term capital gains tax rates, tax-gain harvesting, tax-loss harvesting, the ability to use appreciated shares for charitable giving (flushing the capital gains out of your account), and (with real estate) depreciation and exchanging. There's nothing to be afraid of here, especially since the tax benefits of whole life insurance aren't all that great anyway.
Whole life insurance is a product designed to be sold, not bought. Most who buy it regret their decision. Now you know why.
Have more questions about life insurance and what kind of policies would be the best for you? Hire a WCI-vetted professional to help you sort it out.
What do you think? Have you bought whole life insurance? Did you regret it? Why or why not? Comment below![This updated post was originally published in 2019.]