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?
Great question. I'm sorry you have had a bad experience with life insurance salesman.
I'm going to have a contrarian opinion to other professionals on this board. I believe you should be well informed.
The first response is that at 27, I'm sure you are figuring out that we are all in sales. Selling ourselves to our employers to keep our jobs, starting a small business, influencing our spouses to let us watch what we want on TV, or even selling life insurance. So just because someone is in sales, does not mean they cannot be a great resources for you. Sales also include the high and mighty, "I'm not a salesman", fee-only financial service providers. To say otherwise is to not be honest. The fact is, as a capitalistic society, we are all competing for your dollar so please don't let the self-proclaimed non salesman distort reality for you. Otherwise, who would buy their fee-only service if they did not try to sell you the benefits of their services? And just for the record, I have experience doing all types of financial services to include fee-only. It is not a good value proposition for the consumer in my opinion. To make a plan profitable planners have to charge thousands of dollars per case or charge hundreds per hour to give you a binder of spreadsheets that most likely will be meaningless in 2 years because your situation has changed. And guess what? You will have to spend more to update your plan or pay a retainer. Now let me ask you, is that the best use of your capital? I mean, someone has to pay the CFP fees so why not you?
The next response is that I am proud to be a 4th generation life insurance professional. My family lineage has helped thousands upon thousands of people at their time of need during some of the darkest hours of their lives (death of a loved one). So I have a tremendous appreciation and respect for what life insurance can mean for a family and I am not embarrassed or ashamed of what I do professionally.
The next thing is that I agree with some of the posters that whole life is not for every person. It is really for individuals that are financially and professionally established that have an adequate income. At 27 years old, it may be premature for you to buy a whole life policy and it might be better for you to buy a longer-term policy with a feature to convert to whole life in the future. I prefer to recommend it when clients are in their 30s and 40s, generally speaking.
Now, to get back to your specific question, here are some (but not all) reasons why whole life insurance can be a great purchase for you:
1. Non-correlated asset class
Whole life insurance has two components that are not correlated with the market: a fixed interest rate and the timing of your death. Is that fair? Regardless of what the markets are doing at any one point in time, you are contractually guaranteed a fixed rate of return and your family will have permanent access to capital when you die. Which last time I checked we all die, right? So yes, you can theoretically earn more in the market however, you are subjecting yourself to unknown market risks and also risking your own insurability in the future with just a term product solution. So although it is not a sexy investment product, there are benefits to owning it as an asset class.
2. Risk Management
If you were to become permanently or temporarily disabled, will your employer fund your 401(k)? Roth IRA? IRA? Chances are they will not be funded. In the case of whole life insurance, there are features available that will make the insurance company responsible for paying your premiums while you are on disability. Whole life is also (depending on the state in which you live) protected from creditors and lawsuits if you are found liable for something you did professionally or personally (ie auto accident).
3. Tax treatment
Most posters have already mentioned that the tax treatment of cash value life insurance is favorable in this country including a tax deferral on cash value and an income tax free benefit to your beneficiaries.
4. Contract Backed By Financially Strong Institutions
Life insurance companies are some of the strongest financial institutions in the world. Many have high ratings from Moody's and Standard and Poor and I recommend buying from a highly rated and conservatively managed company.
5. Unknown time of death
You mentioned that you plan on not needing the insurance when you are older. Many posters have also mentioned this. I hate to ask you, but do you know the hour of your death? Any reasonable person will say that they do not. So therefore, if you do not know when you are going to die, then how do you know that your surviving family members will not need the money when you die? Having the protection in place for your family and loved ones to help with expenses and maintaining their standard of living when you die is not a poor financial choice as others on this board would lead you to believe. After all, life insurance is for the living not the dead.
Finally, Whole life insurance comes in many different shapes and sizes, including limited pay policies designed for cash value or policies designed for longer protection and not for cash accumulation. It depends on the strategy you are looking for. To make sure you are selecting the right policies, ask more questions and give it a fair chance and comparison to include non rate of return factors like risk management and liability protection.
Whole life insurance can be a very powerful element of your portfolio for a number of reasons, but advisors can also make a lot of money by selling them and mismanaged whole life policies can wreak havoc on your financial plan. As such, I would not buy whole life if you suspect it is merely transactional and the product is not being touted as part of a diversified plan.
Whole life policies offer numerous benefits throughout your life and beyond. Death benefits are generally passed on tax-free, so the taxable equivalent rate of return on legacy value is often substantial. Because whole life policies have guaranteed cash value growth, the cash value account can be utilized like the bond portion of your portfolio, allowing your to invest more aggressively outside of the policy. Perhaps the most attractive aspect is the fact that growth in the cash account can be realized completely tax-free. Anything up to your cost basis is distributed completely tax free, and cash distributions beyond that can be structured as a loan, which is also untaxed. You can potentially take a loan on the cash value while still receiving dividends, allowing you to generate multiple returns on your dollar if you have the opportunity to invest that capital elsewhere in the future. This feature is attractive to business owners and investment property buyers.
By having whole life along side an investment portfolio, you will have the option to choose the most beneficial source of capital for things like real estate purchases, home improvement, college tuition or retirement. This is often thought of as a "tortoise and hare" approach, and it will keep you from disinvesting a the bottom of a stock market cycle (the worst time to disinvest) due to capital needs. In retirement, having a permanent death benefit that will be passed on to your spouse allows you to spend your assets more liberally because you will not need to preserve income-producing assets. This is especially attractive in the early years of retirement, which are the most active. Having a permanent death benefit also allows you to maximize your pension election, if that is relevant in your career. Without a competent and reliable advisor walking you through these features and staying in contact to help you throughout your various life stages, it might be very difficult for you to realize and execute on these opportunities, however.
Whole life certainly has disadvantages, though, especially if it is mismanaged. Opening a policy is a commitment. Contributions are higher than for corresponding term policies, and you will lose liquidity in the first years of the policy (though this impact can be reduced by utilizing paid-up additions from the start). As you pay for the mortality and expenses of the policy early on, your premium contributions will not result in corresponding increases to cash value. Your cash value will only equal your gross contributions several years into the policy, depending how it is structured, so you should understand that if it is being pitched as an investment. Historically, the growth rate on these policies has not matched that of the market, though they are considered valuable because they "never have a bad day."
Regarding the fees, I also urge you to consider the fees that you are charged in 401(k) and Roth IRA accounts. I am surprised by how much my clients underestimate the impact of these fees, which can be numerous and well-hidden. People also frequently fail to realize the magnitude of their embedded tax liability in their 401(k) and other qualified accounts, which can be disastrous down the line. It is rare that you see a genuine apples-to-apples comparison of net returns across different product categories.
Like any other product, there are trade-offs that you must consider. However, whole life absolutely has a place in the portfolios of many investors.
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.
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.
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.
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.
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®