Is Whole Life Insurance a Good Investment?

Most Americans have some form of life insurance. Knowing that ones loved ones will be take care of should sudden tragedy strike, or natural death occur, gives peace of mind to individuals.

Others want to know they have money saved should they need it for an emergency in later years, regardless of the payout to beneficiaries. Many people get confused when trying to decide what type of life insurance to purchase.

But is whole life insurance really a good investment?

First, what is it…

Whole Life Insurance

Whole life insurance is a permanent life insurance policy. It lasts throughout the policy holders life or until the policy holder decides to end or cash in the policy. As long a premiums are paid, whole life insurance continues. Payments are made monthly and the rate always stays the same.

Benefits

With whole life insurance, policy holders can just leave the policy alone, keeping it active and collecting interest until they pass away. Upon the policy holders death, whomever was named as the beneficiary of the policy, will collect the pay out benefits.

However, there are other options and benefits to having a whole life insurance policy. Policy holders of whole life insurance, can cash in parts or all of the value of their policy at any time. Because whole life policies earn interest, policy holders often cash in on the interest alone. Thus they essentially leave the original value of the policy the same, only collecting the interest payments to help supplement their income or help pay expenses.

Policy holders can also choose to cash in all or part of their policy if they wish. Should an individual face a financial emergency or just want to go on a fun vacation, they may take out some of the money from their policy. The policy would remain active but would just have a lower pay out value. If one chooses to cash out the whole value of the policy, the policy would be closed and there would be no benefit payout upon death.


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Another benefit is that policy holders can borrow from their whole life insurance policy. They can use the money that they take from the policy as they wish, temporarily reducing the pay out amount. However, once they pay the money back, the benefit amount would return to what it was before the money was borrowed.

Drawbacks

Because whole life insurance policies are meant to be paid on for a long period of time, they do not typically benefit the elderly. The premiums would be very high on a whole life policy for someone of retirement age and this is where a term policy might be better.

Another drawback to a whole life policy is that if one chooses to withdraw money from the policy, they reduce the payout amount to the beneficiary. One may borrow money from the policy, with the intention of paying it back, but never get the chance, thus leaving the beneficiary with less of a pay out.

Mary Beth Storjohann, CFP from WorkableWealth.com has this to offer,

For clients I work with (which tend to be late 20’s to early 40’s young parents and families), term insurance is generally the road I recommend from a cash flow and complexity perspective. 

Whole life policies come with a greater level of complexity, higher commissions, and are generally much more expensive than a basic term policy for the same face value of coverage. 

A big part of the discussion is educating and discussing what clients view the insurance proceeds as protection for – mortgage pay down, college funding, income replacement, etc. Term can cover many of those issues at a much lower cost. 

With cash flow a big part of the financial planning pie for young families, the focus is typically on having a funded emergency fund, debt paid down and taking advantage of employer sponsored and personal retirement savings options first. Term policies fit in nicely to add protection to these scenarios.  

My Experience With Whole Life Insurance

First, let me say that I have never owned whole life insurance.  I’m more the firm believer that term life insurance makes more sense for me and my family.  Hence, why I have 3 individual term life policies on myself.

How I have experienced whole life insurance is through my clients.   I have several clients that took out a whole life insurance policy many years ago (ranging from 5 years to 20 years).  They were sold on the idea of having some life insurance with an underlying investment attached to it.   Heck, it’s a good story for anyone to consider.

What has actually happened is this:   They have paid on this policy for an extended period of time and while the life insurance is there, the investment portion is not.   At least it’s not as much as the illustrations that were run by the insurance agent that sold them the policy.

The funny thing is that most of these clients continue to pay on their policies even though they really don’t need the insurance.   If this is you, I strongly encourage to review your whole life insurance policy and see if it still makes sense in your overall financial plan.

Have you purchased a whole life insurance policy?  What has been your experience?


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Comments | 10 Responses

  1. Joe says

    My wife and I both have whole life policies that we started about 5 yrs ago. We’re 30 now. These plans have stayed true, so far, to our goal of having the base life insurance amount available to our beneficiaries and also increasing the cash value. This gives us an additional option in retirement planning that will allow us to take a “loan” if needed, or leave the whole policy to our heirs. For us, these plans offer peace of mind and allow greater options in the future!

    • says

      @Joe. Peace of mind is a definite factor in purchasing life insurance. If your current policy does that, then mission accomplished. The only thing I would have you consider is the life insurance portion on the whole life policy substantial enough? When I look at my current situation, I have $2.25m of term life insurance that costs me around $2k per year in premiums. That is the amount that I figure that my wife and 3 kids would need if something were to happen to me. If I were to get a whole life policy for that same amount, the premiums would be outrageous. It would not economically possible for me to afford it. Food for thought and thanks for the comment!

      • Joe says

        Jeff, I agree one cannot afford a 2.25m whole life policy! I didn’t mention that we also have term insurance to supplement our whole life ins. That combination takes care of all future care should one of us not be around.
        Thanks
        Joe

  2. Ruben says

    As an advisor that uses WL as part of my planning, it is important to say that not all WL policies are created equal and a handful of companies do it right. You cannot compare lower tier companies to higher tier companies and make a blanket statement saying that this product doesnt work and doesnt perfomr as illustrated.

    Also, proper planning would be a blend of WL & Term with the majority of the DB being in an affordable term product as WL is more expensive and serves an additional purpose.

  3. Randy Whittle says

    I have to echo what Ruben said on 7-21-11. Further, I think there’s a very important point to note: Oftentimes, even those in the financial business (or insurance agents themselves) do not know or understand the difference between Universal Life vs. Whole Life, often lumping the two together and calling both “Whole Life”. Nothing could be further from the truth (nor more unfair to traditional Participating Whole Life).

    Your comment about seeing policies that “did not perform” as well as the illustrations suggested make me wonder if you are confusing UL vs. WL, and if the illustrations & policies you looked at were in fact UL’s. I could go off on a rant about all the damage Universal Life policies have done both to the buyers that owned it as well as the industry that spawned it, but I’ll refrain here–suffice it to say, it lacks the guarantees that engender trust in a life insurance company, and that has made all the difference. It is not uncommon to see UL’s collapse under their own weight, ceasing to exist (along with the expected cash values they were supposed to accumulate) by the insured’s age 70.

    My experience with clients with *actual* Whole Life policies (and there have been many that thought they had WL, but in fact had UL’s instead) has been overwhelmingly positive. Earthshaking? No. But definitely positive and certainly respectable in its returns. In general, Whole Life has been treated like the red-headed stepchild of the financial world. Thankfully, there have been a handful of excellent articles that have treated it fairly and truthfully, particularly after the so-called “correction” of 2008 in the stock market.

    In fact, when you account for the tax-free growth benefits of the cash values and the “not having to pay for the term insurance” aspect (granted, term often needs to be used in a supplementary fashion), the long-term net after-tax, after term-premiums result on the cash-value is equivalent to between 7 – 9% returns, and a fair bit more on the death benefit (which, of course, on term insurance is equal to zero). I can show the details to you via webinar using calculators & etc. if you wish. But what it comes down to is if you had, say, $12,000/yr to invest, and $2,000 went to term, then the remaining $10,000 invested would, after taxes and market fluctuations, have to achieve a 7 to 9% return to be equal to what the $12,000/yr into Whole Life premiums would produce in cash value naturally. How confident are you that you’ll get a consistent, non-volatile return in the market that is 7 to 9%? Before you jump in like Dave Ramsey and say “10-12% is the norm”, it isn’t–there is a difference between “average” and “actual” returns, but alas that is beyond the scope of my commentary here (for more details, please see a video I did on this, along with support documents, hosted at http://www.screencast.com/t/fJ9CwUcQbQg2 In reality, actual market returns over the last 20 years–which includes the boom-boom 90’s as well as the dismal 2000’s has been less than 4%, despite that the overall “average” return was over 10%).

    Further, the living uses of WL are usually overlooked–even by those who sell the stuff. The smart owners I’ve known have used their WL as “pools of capital” from which they launch greater investments in businesses and real estate–then produce streams of cash flow that they store (tax-free) back in their Whole Life again for the next project. Frankly, “real” investing involves these kinds of decisions for the use of capital, and there is no better–read, safer, tax-efficient, liquid/available–place to park that capital to be poised and ready for such investment opportunities when they arise. Perhaps only once every several years, but you better be ready to seize those opportunities when they arise. The cash value component in Whole Life insurance is an ideal parking place for working capital in-between those opportunities.

    Throw in the tax-free nature of the cash value–by that, I mean it never even shows up in your tax return when you tap it–and consider the taxation on Social Security benefits and the likelihood of future (higher) tax rates in general (hello–your 401k getting taxed at 50% when you withdraw?), and you may begin to see the tremendous (albeit, unappreciated) position a good, solid Whole Life policy holds in the arena of financial products.

    As for “how much”, or the question of “its too expensive”? I’ve found that premium funded at somewhere in the range of 10% to 15% of your annual gross income will almost always cover your full human life value (usually between 10-20x your income) in WL insurance, which is all you could ever get from any insurance company(ies) anyway. Is that “too” much to be saving? I’d argue that 15% of your gross income is the minimum amount you should strive to save, and that anything less puts you at significant risk of eating dog food in retirement. Too much? Only if you think its trapped there without you being able to gain access to it–which is really truly of your 401k, but certainly not for life insurance.

    But when you realize the flexible, accessible, safe, tax-efficient, and leveraged nature of a Whole Life policy, it starts to look a whole lot more attractive than financial press gives it credit for. You do have to look past the seemingly obvious to uncover the actual truth.

    Final thought: I have owned WL for between 5 and 7 years (one smaller policy purchased farther back, supplemented with term, and later converted to a larger policy). I have found that once you get past those initial couple of years, especially if it is “over-funded” (more $ into the policy beyond the basic premium), my policies have have performed admirably, regularly earning nearly 5%–tax-free (after-tax equivalent of about 8%) in a world where most people cannot manage to get more than 0.5% from the bank. During that time I’ve used the policies as working capital for a business investment, a real estate project, and working capital in my own business. My life insurance has been an indispensable financial tool for securing and building my wealth, and the same has been true for many of the clients I have worked with.

    In golf, the club isn’t as important as knowing how to swing it (I guarantee Tiger Woods would beat you with a 30-year old set of half-bent clubs from a pawn shop). And although you may use different clubs throughout the game, there’s only one you will use on *every* hole. Whole Life insurance is like that putter. Other clubs might hit the ball farther, but you can always count on that putter to make that final shot count.

    Randy Whittle

  4. Michael Harr @ TodayForward says

    Whole life is a stinker for the overwhelming majority of consumers. It is a permanent insurance policy which would indicate that if you’re buying it, you should have a permanent insurable interest – e.g. business succession, estate tax offset, etc. Since most consumers don’t have permanent insurance needs, term life insurance remains the best option due to its affordable nature.

    @Randy Whittle – That’s a rousing argument that you’ve put together (sarcasm), but the numbers don’t add up.

    Show me how any whole life insurance policy beats a Roth IRA that has no cost of insurance, tax-free growth, and the ability to withdraw contributions without penalty, surrender charges, or taxes. Show me how a whole life insurance policy beats an employer sponsored plan with a match. Show me how the mortality costs associated with a permanent insurance policy combined with all the benefits you mentioned beat tax deferred growth in a Traditional IRA, 401k, 457, 403b, SIMPLE IRA, or SEP IRA over a lifetime. Can you show me?

    The fact is you can’t.

    In your argument, you state, “In reality, actual market returns over the last 20 years–which includes the boom-boom 90′s as well as the dismal 2000′s has been less than 4%, despite that the overall “average” return was over 10%).” This is a twisted little bit of logic as a Whole Life policy covers…get this…a person’s whole life. Unless you’re at a 20-year life expectancy, how does using a selected 20-year period make any sense in justifying your argument for whole life? Another issue with this statement is the 4% number. I’d love to see how you get to 4% from a 10% average annual return. The fact is that any investor could throw money into a balanced portfolio and beat the devil out of a whole life policy.

    If you understand whole life insurance, it’s not difficult to understand why this is true. So here it is for those less acquainted with whole life:

    1. The insurance company and an individual sign a contract that is a whole life policy.
    2. The individual pays premiums to the insurance company
    3. The premiums received by the insurance company are used to pay any expenses (commissions, admin, etc.) and the remainder is put into the company’s general investment account.
    4. The general investment account is invested by very smart (seriously, very smart) investment managers at the insurance company.
    5. Since the general account is measured by regulators to ensure that the insurer is solvent and will be able to meet future claims, the investment managers are required to invest in a highly diversified portfolio that is commonly around 50% to 65% stocks and the remainder in fixed income securities and cash equivalents.
    6. This balanced portfolio grows tax-free since the insurance company is merely holding these funds until the insured dies or the policy is canceled.
    7. Based on the investment returns, premiums collected, mortality experience, etc., the insurance company sets the interest rate for the whole life policy and makes the difference in returns.
    8. If people live longer than expected (this has been the case for decades now), the insurance company makes more money from the invested premiums as the money is invested longer. In addition, the company makes more money because the mortality experience is better than expected.
    9. When you die, you get the death benefit. When you live, you get the cash value. Both are less than what your dollars invested could have been had you done so on your own using a tax-favored investment account such as a Roth IRA, 401k, 403b, etc. assuming you reach your life expectancy.

    So, how did the insurance company do? Very well.

    How did the insured do? If he or she died earlier than expected, great! Major return on investment (yippee! oh, you’re dead). If he or she died on time or later than expected, the returns are pathetic compared to other alternatives.

    Here’s the deal: It is IMPOSSIBLE for any permanent life insurance policy to outperform tax-favored investment vehicles when invested in a similar fashion. The mortality, selling, general, and administrative expenses are far greater than in a tax-favored account. Over an individual’s lifetime, it is NOT POSSIBLE to outperform tax-favored investment accounts with any type of permanent life insurance contract because of these cost structures.

    Also, Randy Whittle, I thought that the insurance regulators were against selling permanent life insurance (UL/VUL/WL) as an investment vehicle? Did something change?

    I know this has been quite the rant, but I vomit in my mouth just a little bit each time I see someone peddling this brand of garbage.

    Here’s a quick tidbit on term from our blog: http://livingtodayforward.com/blog/2011/03/16/why-term-life-insurance-is-so-popular Click the link at the bottom of the post to see where term doesn’t fit and why. You’ll notice that the reasons have nothing to do with comparing investment returns. It has everything to do with an individual’s insurance need and/or their ability to save and invest consistently over time. Whole life is insurance; it is NOT an investment.

  5. Randy Whittle says

    I agree that Whole Life (WL) is not a good “Investment” because by definition, an Investment puts your capital at risk. Clearly WL does *not* do that.

    Rather, I think it is safe to say WL is a Savings vehicle. The only question is what do you get with that savings vehicle, as compared to your other alternatives? And for all investment/savings vehicles, what are the costs, both in terms of actual costs, rates of return, and risk associated? Keep in mind not every person *wants* to ride the volatile roller-coaster. They could do very well for 2 or 3 decades of their lifetime, only to lose the game in the final quarter of play. Perhaps they consider the stakes of having (or not having) money in retirement to be too high to gamble it unnecessarily (after all, life offers no do-overs when it comes to their money!). So is it fair to at least be honest about what they can expect to receive (and/or what they are giving up) if there are interested in evaluating that choice of risk-reward?

    I never suggested that WL would beat everything else at all times. It does not do that. As you eloquently attempted to describe, it likely cannot. So what is the *real* truth? Both the truth of what stock market investments do, and also the truth of what a properly-structured WL policy does? True, it may not be for everyone, just as the stock market may not be for everyone. I’m going to freely admit that if you have trouble saving more than a couple hundred dollars per month, then maybe a Roth rather than WL might be better for you. But even then…the choice of a Roth would likely be coupled with the cost of a term insurance policy, and what additional costs does that introduce into the equation?

    Here’s what we do know about the stock market: (1) Its volatile (making “averages” meaningless–you have to do a year-by-year “actual” calculation to get *real* returns), (2) Its risky (especially in the last decade), (3) Returns can be very good or very bad (60’s & 70’s stunk, 80’s & 90’s were excellent, 2000’s were awful), (4) There are taxes to consider (except for Roth–and if you go to Qualified Money, there are other liquidity and capacity issues to consider, as well as future taxes on non-Roths), (5) Fees and expenses on the account, and (6) Externalities to consider (such as the cost of term insurance).

    If the choice is between being able to reliably expect to get (and keep) a 12% return in the stock market vs. a 2% return in your life insurance, its fairly obvious what most anyone would choose. But what if the 12% return expectation isn’t actually correct—or worse, it does not actually get anywhere near that level? And what if life insurance yields much better than the meager 2% assumption? What if these two choices were in actuality much closer together in what they yield? Would the risk of one justify choosing it over the other if the difference between them was small?

    You see, its not incumbent upon me to show WL “beating” the market in any way–I wouldn’t try to. What I *will* do, however, is show the market, in reality, doesn’t get anywhere near the 12% that media pundits like to spout off about. And I will likewise show that WL, properly structured, does much better than you previously thought. And when some people see these two converge closer in performance, they might decide whatever difference there is between them does not justify the additional risk necessary to get that difference. They might prefer a safe return with guarantees over a risky gamble if that difference is small enough.

    So with that in mind, I’m not going to try to show WL “beating” anything. But I will gladly show the truth behind each. You repeatedly state “the numbers don’t add up”, yet you fail to cite any evidence or do any calculations. I will do so for you here.

    For starters, the stock market: What can you really reasonably expect? Some say 10% or 12% “average” is reasonable over the “long run” (this is the position of the likes of many public financial personalities like Dave Ramsey and Suze Orman). I used the last 20 years in an earlier posting, and you suggested that wasn’t long enough. Okay, we can use 30…or 40 or more if you like. The problem for your argument is the longer I go, the worse it gets for the stock scenario–more volatility gets introduced and it tends to drag down overall actual returns. And just as you suggest that 20 years isn’t long enough (because most people’s life expectancy is longer than 20 years), by the same token you can’t reasonably use 100 years because that’s far too long for any person’s working career and retirement. Given that most retirees go into retirement wanting to get more conservative (typically shifting portfolios to mostly bonds or even bank CD’s), we can suggest a working career of somewhere in the 30-ish years should be reasonable to use. Because after that, most retirees shift into more conservative investments any way (which is already achieved inside of a mature WL policy at that point in time).

    You asked for my numbers. The video link I provided in my previous post was tweaked in a way that made it unusable. I apologize for that. Here is the proper link:

    http://www.screencast.com/t/875kZqloFI

    Here you will see how the net after tax, after fees, after volatility in the market *actual* (not “average”) rate of return over the last 20 years is under 4%. I assure you that if you stretch it to 30 years (add the 1980’s to that), it would not be appreciably better. You can take many different 30 year periods of time and not get a whole lot better. Maybe 5 or 6%, but certainly not 10 or 12%. That 10-12% is a myth that needs to be put to bed (as referenced in the Wall St. Journal and many other articles I provide links for below). Speaking of which, here’s a slew of verifiable articles from reputable sources that echo this same point. To whit:

    The BCT /Harvard Business Study that came out in 2005 that showed retail investors, with the help of their financial advisors, ended up getting only about 2.9% returns (and did 6.6% on their own without an advisor). This was ACTUAL results, and they are dramatically lower than the fairy tale figure of a 10 or 12% “average” often suggested to investors by the advisory community. More here:
    http://trendfollowing.com/whitepaper/The%20Study%20of%20the%20Decade.pdf
    And also here: http://www.people.hbs.edu/ptufano/bbenefits_Nov2004.pdf

    “The 0% Return despite what Ibbotson Charts Show”:
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Financial%20Transfers/media/002a25bf-a224-4610-a365-49cde4fa7baa/The%200-Perc%20Return%20Despite%20what%20Ibbotson%20charts%20show.pdf?downloadOnly=true

    “Avg. Ann’l Returns lead investors astray” (Forbes Apr-11):
    http://www.screencast.com/t/xvXIoUeWXK

    “Does Ramsey’s 12% Mutual Fund Exist?”
    http://www.screencast.com/t/VoDah1qFwpLr

    “Dow Stock Average and Actual” (Crestmont Research 2011)
    http://www.screencast.com/t/niY7sIid

    “Let’s Bury the Myth of Averages” (Forbes Feb-09)
    http://www.screencast.com/t/adRKt4z0x

    “Stocks will never reach their long-term average” (Crestmont Research 2010)
    http://www.screencast.com/t/67lKrVQBsC

    “Ten Stock Market Myths that just won’t die” (Wall St Jrnl, 2010)
    http://www.screencast.com/t/sn5mWSg9E

    “Why some investors may be fooling themselves” (WSJ)
    http://www.screencast.com/t/uRMeL5ri

    “The Impact of Losses” (Chart from Crestmont Research, 2009)
    http://www.screencast.com/t/OEEZmnHWT

    Articles about Fees & Trading Costs in Mutual Funds:

    “The 401k Fee Fiasco” (Forbes, Sep-09)
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Financial%20Transfers/media/002a25bf-a224-4610-a365-49cde4fa7baa/The%20401k%20Fee%20Fiasco%20(Forbes%20Sep-09).pdf?downloadOnly=true

    “Hidden Costs of Mutual Funds” (WSJ, Mar-10)
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Financial%20Transfers/media/002a25bf-a224-4610-a365-49cde4fa7baa/WSJ%20-%20Hidden%20Costs%20of%20Mutual%20Funds%20(3-1-10).pdf?downloadOnly=true

    ZAG Study on MF Trading Costs:
    http://thefloat.typepad.com/the_float/files/2004_zag_study_on_mutual_fund_trading_costs.pdf

    Next up: Qualified money (IRA’s, 401k’s): Drawbacks? First of all, you can’t touch it–period–for 20 or 30 (or 40) years until you turn 59 1/2. Oh, I suppose you can break it early if you’re willing to pay the taxes and penalties (if you’re allowed to at all–many 401k’s won’t let you), the figures can amount to well in the way of 40 to 45% in taxes & penalties. Just think: That IRA/401k has $100K in it…but realistically, only about $60K is really yours. That’s a real splash of water in your face!). Furthermore, some people simply like to have access to their money. You never know when a real investment or business opportunity may show itself. You either have access to your money when that happens, or you don’t. 401k’s do not lend themselves to taking advantage of such opportunities.

    Then of course there are more fees on 401k’s (and IRA’s, and Mutual Funds in general). They include Plan Administration Fees, Individual Service Fees, Investment Fees, Transaction/Trading Fees, Marketing (12b-1) Fees, Turnover expenses, etc.

    And many more fees that are undisclosed, having a huge impact on your bottom line, as shown here on Bloomberg TV:

    http://www.youtube.com/watch?v=08UPQ3JaRek (Part 1/3)
    http://www.youtube.com/watch?v=94eDjL4ciVE&feature=related (Part 2/3)
    http://www.youtube.com/watch?v=x1NPUf2Q-sw&feature=related (Part 3/3)

    From 60 Minutes (Undisclosed fees in 401k’s):
    http://www.youtube.com/watch?v=K5WpOknON9Q

    From CBS News (also discusses risks in the market):
    http://www.youtube.com/watch?v=e7eszE3-tWs

    MoneyTalks News
    http://www.youtube.com/watch?v=qsBeau8FV-Q

    Typical 401k fees in the 3-4% range (see time 1:14):
    http://www.youtube.com/watch?v=W07w1tr4X2E&feature=related

    Yes, many people get a match on their 401k, and that’s not to be ignored. In general, I agree–contribute to your 401k to get the match, but anything over the match is inefficient, and should be saved elsewhere. This video link here shows the good, the bad, and the ugly of a 401k quite handily–and does so in very specific mathematic detail complete with pie charts in a live, easy to follow calculator:

    http://www.truthconcepts.com/support/tutorials/QualifiedPlan.wmv

    …as you can see from the video, the overall net result after taxes and fees on the 401k is a little over 5% return, and the value of the employer match constitutes a total of only 9% of the entire account. Nothing to really write home about. The key, if you’re going to really make best use of your 401k, is to contribute the absolute minimum into the account to get the full employer match (and direct the rest of your savings elsewhere). When you pursue this strategy, the amount of employer match becomes a higher percentage of the total and you really get maximum efficiency from your 401k. (Again, I’ll be happy to show this to you or any reader via webinar if you really want to see the truth of this for yourself.)

    As with any of the investment options available (401k, IRA, Roth, Mutual Funds, etc.) the question to continually ask yourself is “Given the full picture here…the taxes, fees, external factors, market risk, risk of future tax increases, or legal changes (not allowed to touch until you’re 70?) …is it still worth doing, given all the risks involved and the alternatives available to me?” Sometimes the answer is “Yes”, other times its “No”. But once everything is accounted for, its clearly not a given that such options are automatically superior.

    Regardless, there are plenty of reputable sources suggesting the 401k just plain doesn’t work for our nation’s retirement needs, and that the whole idea of the 401k should perhaps be jettisoned:

    CBS Moneywatch:
    http://www.youtube.com/watch?v=FNdBW9qXddk&feature=related

    The 401k Re-Think (Forbes, Sep-09)
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Demographics/media/5b5846e2-7cdd-4171-9f50-f5f2c95d4ca0/The%20401k%20Re-Think%20(Forbes%20Sep-09).pdf?downloadOnly=true

    The Tax Deferral Trap (Forbes, Sep-09):
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Demographics/media/5b5846e2-7cdd-4171-9f50-f5f2c95d4ca0/The%20Tax-Deferral%20Trap%20(Forbes,%20Sep-09).pdf?downloadOnly=true

    IRA Time Bomb (Forbes, Apr-09)
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Demographics/media/5b5846e2-7cdd-4171-9f50-f5f2c95d4ca0/Girouard_Forbes%20IRA%20Time%20Bomb%20(4-7-09).pdf?downloadOnly=true

    Riding the Tax Tiger (Kiplinger):
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Demographics/media/5b5846e2-7cdd-4171-9f50-f5f2c95d4ca0/Riding%20the%20Tax%20Tiger%20(Kiplinger2005).pdf?downloadOnly=true

    And of course there’s always the very real possibility of a government grab where they simply confiscate your 401k’s and IRA’s as countries like Argentina tried to do:
    http://content.screencast.com/users/ClarityWS/folders/Financial%20Caffeine%20Series%201–Demographics/media/5b5846e2-7cdd-4171-9f50-f5f2c95d4ca0/Argentina%20Makes%20Pension%20Grab%20(WSJ%2010-22-08).pdf?downloadOnly=true

    All this adds up to some very real concerns about the viability, if not the sensibility, of 401k’s and IRA’s. The risk of (higher) future taxation alone is enough to give one pause. Do you think taxes in the future are going to go up or down? Most people, given the current state of the economy and our gov’t fiscal condition, will say “Up”. If that’s true, does it make sense to get a tax break at 30% contributing today, only to withdraw at a tax rate of 40% or even 50% in another 5 or 10 or 20 years from now? For many, the answer is “No Thanks”.

    Next up, yes it is true Roths are great. But they also have their limitations. For starters, you must have earned income to qualify, and the most you can put in is $5,000/yr (previously 3K, and 2K prior to that). If that’s the most you can muster, then perhaps it would be ideal for you. But also…access to and usage of the funds? You have to wait 5 years before you can touch it (a similar argument could be made against WL, but if structured properly, a large portion of the cash value there can be accessed in the first year) and when you do touch it prior to age 59 1/2, you’re limited to your own contributions (none of the growth). And once you pull that money out, you have no ability to put it back in (essentially depleting your retirement account with no way of building it back up).

    Now there is also the question of the cost of term insurance (I will presume by your writing that term insurance is a superior approach that some kind of life insurance is desired or necessary). In rough terms, any investing you do in whatever vehicles you choose, will also require a “carrying cost” on top of it–that is, the money going to pay for term insurance for those 20 or 30 years will thereby *not* be going to the investment account. So if, say, this person has $12,000/yr to invest and his term insurance costs $1,000 or $2,000, then he only has the remaining $10,000 or $11,000 to actually invest. That means that assuming the death benefit is similar (or identical), that $10,000/yr into an investment account has to compete with the cash values produced by a WL policy funded at $12,000/yr, and then when that 20 or 30 years is over with, you’ll also have to account for the lost value of the death benefit previously provided by the now-defunct term policy.

    This is difficult to explain in words, which is why I offered in my first post to do so via webinar with the host of this blog, and I will extend the same offer to you, assuming you are sincere in your desire to understand the full truth. So for this part, I will turn it over via a YouTube video produced by another party to save me the time and trouble of doing so myself. But he does a fine job so I’m happy to suggest viewing it:

    “The Truth Behind “Buy Term and Invest the Difference”:
    http://www.youtube.com/watch?v=Xtg6Ug8p3Zc

    (A similar video with similar, though not identical figures, can be found at:
    http://www.youtube.com/watch?v=DOR_6Cf5uhI )

    The software calculator(s) used are by “Truth Concepts” (www.TruthConcepts.com) and readily available to the general public–you are free to obtain them for a fee and scrutinize the calculations all you wish (as a matter of fact, you saw one of the modules in use when earlier I linked to a video about real results from a 401k). In the video example linked above, the person in the video uses the example of a 36 year old person over 30 years to retirement age 65. You can see exactly where the figures come from, and how they go into the software for calculation. You can also see that on its face, that maximum-funded WL policy yields a 5.3% return (4.69% in the other video link). When you account for the taxes at 30% one would have to pay each year (not on a Roth, of course), an outside account would have to achieve a consistent, year-by-year return of 7.58% (without any “down” years–and that figure is 6.7% in the other video link). He further shows the fees on such an account. I provided links above that address fees–and those fees are not a mere 1% or less as the popular myth goes, but more in the way of 2, 3, or even 4+%. But for purposes of this video, he uses only 1.5%. End result there? Your outside fund would have to get 9.21% before fees and taxes to be equal to what that WL policy does by default.

    But wait–there’s still more: You’d have to pay for Term Insurance too! Okay, so you’d have to suck away premiums for term insurance that would otherwise go into your investment. So if $1,000/yr has to go pay for that… Oops. Now your side investment has to pull off 10.33% (9.19% in the other video)–consistently, every year, without slipping, without a drop, without any hiccups–for 30 consecutive years to account for the losses to paying for term insurance, fees, and taxes, just to equal the cash value that would be in that WL policy in the same period of time. And we haven’t even discussed the loss of the death benefit when that term policy expires.

    Is it possible for the stock market to pull off that 10% return every year for over 30 years? Perhaps. How often has it happened? Well…actually its never happened. But hope springs eternal, right? How confident are you that its going to? If 100% confident…why would you do it, when you get a high degree of certainty that a WL produce the same net result without taking such risk? You see, WL doesn’t have to “beat” the stock market. It just has to get into the ballpark. Because what it *does* do is arrive there with a high degree of certainty while the stock market lacks that certainty. For some people, even if their WL yields 5%, they likewise understand that stocks would have to achieve around 10% to match all that their WL does as its standard operating procedure, and they’re just not willing to take the risk necessary to try to reach that (higher) return figure. Because in their effort to get 10 or 12% (or 15 or 20%), they also know they can easily end up losing a whole lot along the way, and they just don’t want to play that game. Or maybe they do play it, but they play both sides. You see, it doesn’t have to be an either/or decision. Many people do both.

    Even the financial press has started to accept that Life Insurance (though they usually do not distinguish between Whole Life vs. Universal Life) plays a role as a viable financial option:

    NBC News:
    http://www.youtube.com/watch?v=1sskwUTj4z8&NR=1

    “A Financial Bunker for Scary Times” (Forbes, Feb-09)
    http://www.forbes.com/2009/02/10/mutual-life-insurance-financial-adviser-network_0210_financial_planning.html

    “The Resurgence of Whole Life” (WSJ Special Section, Sep-09)
    http://www.screencast.com/t/YZOzQeSC

    “The Case for Investing in Life Insurance” (Medical Economics, Jun-09)
    http://www.screencast.com/t/RGk4q3h6

    “WL, Long Derided, Gets a New Lease” (WSJ, Feb-10)
    http://www.screencast.com/t/fct6961PgVAi

    “Fusty Insurance Lures Buyers Seeking Safety” (WSJ, Mar-09)
    http://www.screencast.com/t/V17zFOBg

    Should you choose to respond, please leave the rhetoric behind. First prove wrong the neutral academic studies with no ax to grind, and show the calculations incorrect before you go any further. I gave the numbers, and I showed in gory detail where those numbers came from and how they are calculated.

    The only people vilifying Whole Life as a “rip off” are either missing the full context of the picture, or are willfully ignorant.

    How unfortunate for them.

    Randy Whittle
    http://www.ClarityWealthSolutions.com

  6. ron says

    Great post Jeff.

    Although, the comments section is a wee bit heated, now. ;)

    Regarding the whole life as an “investment” idea, this is a loaded question. Not all insurances are created equal, nor are all whole life contracts. Among companies issuances will differ. Furthermore, even within the same company each policy will still be as unique as each purchaser. In contrast, every share of common stock in an issued class is the exact same regardless of the purchaser. Herein lies the crux, how can the insurance purchaser know whether or not he’s receiving a good, investment-grade contract if all he has is a product-biased salesperson to educate him?

    Well, let’s think of the whole life issue another way. Whole life, not variable nor universal nor any of its derivatives, as issued by a Subchapter L insurance company, i.e. mutual company, functions much like an investment in preferred stock. At times it functions like an equity, other times it performs more like a bond. The best description for this product it that it’s a stake in the actual issuing company in which the owner is admitted participation in insurance company profits via buying a policy. The participation in these profits allows policyholders to earn money off of insurance products as well as the company’s own investment portfolio alongside the insurance company, much like a common stock investment in Nike would allow shareholders to share in Nike’s profits from sales of trainers.

    However, to compare this instrument to a common stock equity would be as inaccurate as comparing a municipal bond with a high-yield bond. How much more skewed of comparison results from matching a whole life policy with a creature of the tax code, a la 401K, IRA, Roth IRA, or to an entire index, i.e. the S&P 500. Accordingly, comparing a whole life contract’s internal rate of return to a municipal bond yield would be a much stronger match, perhaps even more so since both instruments share similar tax advantages. However, the difference here is that as a muni bondholder your position would be that of a creditor, while as a whole life policyholder your position would be as a voting equity stakeholder. Therein lies the built-in hybrid equity/fixed income nature of the vehicle.

    After all is said and done, the performance of the whole life product will assume the returns, in dividends (or “return of premiums” per the IRC), in proportion the performance of the company underwriting the policy.

    Hope this all helps cut through the weeds.

  7. Katie P says

    Thanks for all of the info everyone. My husband just started a WL/Term combo and after the sales pitch to me for a policy on me I’m wondering if he’s not better off starting the conversion into a full life now rather than wait the two years. Any suggestions? As for me, I’m torn with what to do. Neither of us are six-figure salaried people, we have one baby, one on the way and are not real savy on investing. I have a 401-K (discretionary match-last year was nothing) and I have a larger chunk of money sitting in my 401-k from my old company that I left 5 years ago. It was performing really well so I left it alone. My husband, being a teacher, has a retirement plan through the school district, but then also puts a small amount of money into an annuity. Any suggestions for us with which way to go on our insurance or other investments?

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