What are the benefits of investing in a whole life insurance policy?
I'm 27 years old and have had a few insurance salesman try to sell me whole life insurance. They call themselves financial advisors, but no matter what I tell them, they continue to tell me that whole life insurance is what I need. The way I look at it is, I'm not going to need insurance at a certain point in the future. Why would I pay high fees to tie together my insurance and investments when I could just invest in my 401(k) and Roth IRA and buy cheap term insurance? I feel like these salesman have no experience and know less about personal finance than I do. What are some good reasons to buy whole life insurance?
I'm impressed that you're able to get through their "financial advisor" shtick and see what they really are, salesmen. You're correct that combining insurance and investments is typically an inefficient way to address those two issues. There really isn't a good reason to buy Whole Life insurance from someone trying that hard to sell it to you. Now, that doesn't mean there aren't a few instances where Whole Life policies make sense, but the majority of these policies are improperly sold.
If you've maxed out all other sources of tax-deferred savings and have a lot of extra income to save away in a tax-deferred vehicle, then these policies can make sense. However, for them to make sense, you need to be in a high tax bracket, find a policy that isn't egregiously expensive, and dump a lot of money into the policy without it qualifying as a MEC. This allows you to get large tax-deferred growth and you can tap into the policy tax-free in retirement with loans, as long as the policy is designed correctly to not implode down the line. They can also make sense in certain business situations to provide some cash-out retirement money for business owners and protect the business in the event of an owner death. Whole Life Policies also play a role in some trust and estate planning.
However, I’m guessing that you’re not at the point where you need Whole Life insurance (most people never get to that point) and that these are just salesmen trying to sling their product. You're right to avoid them.
There are none. However, there is one good reason to sell it, very large commissions. Let's say your annual premiums would be $3,600 a year. The gross commission to the agency would be over $3,600. If you invested in a load mutual fund, the gross commission would be about $144.
Get the tax deduction and max out what you can put into your 401(k) before doing anything else. When you retire, you'll be self insured, meaning any dependents will be able to live off your investments, as you did before you die. I prefer the current tax deduction of the regular 401(k) investment. But it's not a bad idea to accumulate $20,000 - $50,000 in a Roth IRA or 401(k) before you retire. It will make tax planning easier.
You are spot on, insurance is not an investment, it is insurance! Many financial planners employ the moniker of "Buy term, invest the rest." I couldn't agree more. My dad always told me that houses are for people with kids and I feel the same way about life insurance.
So to answer your question, here is why people buy whole life insurance.
1) Wealth Transfer- This can provide a bridge for those looking to mitigate estate taxes, generally a husband and wife with a net worth well above $10M. What they do is contribute annual payments to an ILIT (Irrevocable life insurance trust) and this is excluded from their estate. In this case though, because of the size and complexity, there are often better options with higher returns such as Private placement life insurance that is then invested in things such as hedge funds.
2) Suckers- Yes this may be a little rough, but sometimes so is the truth. You could have received a great rate in the early 80s, maybe as high as 6-8%(Guaranteed), sounds great, but you could have also bought long term bonds with a much greater rate, or invested in the S&P 500 for a return orders of magnitude greater! The main reason insurance agents sell permanent life products is because of the commissions, which are usually equal to one year of premium payments, and if you pay upfront for the first year, they will get that commission in one lump sum.
3) Tax efficiency- Life insurance after all grows and pays out tax free (on your death), a Roth IRA enjoys the same benefits, but without you needing to die to reap them. Virtually every scenario outside of purchasing them in 2000 or 2008 would have been better served via the combination of term life and long-term investing. Even in those scenarios (2000/2008), the returns would have been below that of an investor investing monthly into the S&P 500 over a 10 to 15 year period.
I wish I could come up with some good reasons, but I really can't and have tested a great many scenarios. Make sure you like this response because I can promise you a great many insurance agents will not!
Please note that the information above is not a recommendation and is for informational purposes only.
Good question. Your concerns are why many of us become RIAs. There are certainly good insurance agents, but you are correct, many work environments give little incentives for those to gain the experience or knowledge to give "real" advice.
1) First ask yourself; do I have something to insure? At your age, it is often very basic insurance needs. If you have federal student loans, they are not the responsibility of your estate. When you have little to insure, you most often are better off "buying term and investing the difference." It is a common slogan.
2) Second, do you, or will you soon have the need for permanent insurance? You are more insurable now, but is that worth the cost and illiquidity of insurance? And the opportunity cost of investing the difference? It might be. Whole-life insurance is not bad, it is just oversold because of the large commissions and the environments created. The "salesmen" are often good people, but they are hired and trained to sell the product, no matter to whom or what purpose.
At your age, you can get a lot of cheap term insurance. You could even stagger the terms of a couple different policies if you were concerned about getting insured as you get older.
Make sure you explore all your options. Many of us work at www.napfa.org, work hourly, and can advise on insurance matters. We take the word "financial advisor" seriously and believe in the value of our profession.
Mark Struthers CFA, CFP®
Whole life insurance can be evaluated like any other financial product, compare the costs versus the benefits. The primary cost of this product is the mortality cost, what it takes to provide the death benefit. There are some other fees and expenses.
I suggest you set up a competition. Pick a number to use as a monthly contribution, let's say $500 per month. Go to one of the insurance guys and say, “let’s suppose I give you $500 per month. Design a product to maximize cash accumulation, Then, when I turn age 65, give me a guaranteed annual income stream for life.” If they use the product correctly, that cash will accumulate tax-deferred, and the income will be distributed tax-free. Such are the tax advantages of life insurance.
Then go to an investment person and set up the exact same model. Their costs would involve management fees, sales load, etc. Use the same monthly contribution, in the same timeframe, to your age 65. Tell them to also illustrate a guaranteed annual income stream for life, on an after-tax basis.
If the cost of insuring you with whole life insurance is lower than the costs of an investment product, including taxes, then it will put more money in your pocket. Plus, you will have a survivor benefit to use in case you get married, have kids, buy a house, start a business, etc.
If the cost of insuring you is a higher than the cost of an investment product, including taxes, then whole life insurance wouldn't put more money in your pocket. It would make sense then to buy an investment product. You would just have to worry about qualifying for life insurance later on, should you need it.