May 31, 2016

The Swiss Army Knife of the Financial World

It has been said that Whole Life Insurance is the Swiss Army Knife of the Financial World.  Where else can you have one financial product that solves so many financial issues and provides insurance?   Builds Cash Value, Pays for your Child’s College, Saves for Your Retirement, and Insures your Life.   Wow –  All in one!  I have seen all of these as claimed reasons to purchase a Whole Life Policy.  But can one product really deliver on so many promises?  Or is Whole Life Insurance a bad deal?

I Wonder:

But wait… how can a Life Insurance policy be a better retirement account than a Roth IRA?  Don’t Roth IRAs earn income – tax free for retirement?   How can you beat that?   Can a Whole Life Insurance policy be a better college savings plan than a 529 account?  Doesn’t a 529 account earn income tax free for qualified educational expenses?  Certainly its at least a great life insurance deal? Wait, why is it 12 times more expensive than a term life plan?

Some Common Reasons cited to Purchase Whole Life Insurance:

Builds up cash for College Savings.

Save for Retirement.

Builds Cash Value for emergency use.

Permanent Insurance, not just for a set term.

Savings within a secure contract.

Bequeathing money to loved ones.

However – Between all of those claims and reality lay the fine print,  guaranteed values, and a little bit of liberty.

The Realities of Whole Life Insurance:

Permanent vs a Term Period:

I would ask the salesmen of whole life policy, why does someone need life insurance when they are retired?  Why would they need any life insurance when their kids have moved out of the house?   How can they afford life insurance if these retirees live on a fixed income?  Remember the term “whole” means your “whole natural life.”  This means you will more than likely have to pay the yearly premium until you die.  The answer is that if clients choose, the by far less expensive option of term life insurance, saved the difference, and invested into an extremely safe account, they would indeed come out far ahead.   If a client of mine does this with a 20 year term policy, likely they will not need life insurance after saving for that same 20 year period.   Is it guaranteed that they will come out ahead?  Of course not.  But it is not guaranteed that they would be able to be able pay for the whole life policy for that period either.

26% of whole life policies end in just the first three years

Saving for Retirement:

Of all the claims of the benefits of whole life, this one seems the most absurd to me.   I am not a financial adviser, but the simple facts of retirement accounts are quiet straightforward.  A Roth IRA grows as a tax free account.  Place the maximum amount into it and wait to slowly withdraw it at your retirement.  The other option is to put the money into a whole life insurance plan and … take a loan out?  to pay for your retirement?

A 401K is another type of popular retirement account.  Different, but almost as good as a Roth IRA.   Set aside savings from your employer and hold off paying income taxes on it until you retire and withdraw.  Add to it the fact that some generous employers match some of that money.   Are life insurance plans matching your contributions?   Are the monies that you contribute to whole life insurance plans allowed to be tax differed if taken out at retirement?  Will you potentially lose your entire account if you do not make a contribution in any given year?  No, No, No.

The College Play:

Save for college by setting aside money in a whole life policy.  But wait, in order to pay for that plan, you have to pull money out of the account or take a loan out.  Both of these methods are laden with fees that are disclosed only in the fine print.   One of the other options is the much heralded 529 plans.  529 plans are simple in concept.  Set aside money and it grows tax free, with one real caveat.  The money must be used for qualified higher education expenses for a relative of yours.

One of the other pitches of why you should save money for college in a Cash Value Life policy is that the “savings” build up and will count little against you when requesting financial aid.   As with all the claims of cash value plans, this one has a bit of truth to it.   However, why would you trust a life insurance salesmen to the complicated world of financial aid?  Do your own homework on this one, before succumbing.   As with everything collegial, it is rarely simple.  According to the Wall Street Journal “Parents using life insurance to help save for college may be taking on more risk than they realize.”   If you are indeed looking to ‘hide’ money for financial aid purposes, consider consulting a lawyer or CPA.

If you want to do some more research yourself, consider learning how financial aid calculations are done and attempt a theoretical example yourself.  According to CBS,  “money set aside for college does not represent some sort of money time bomb. These assets usually don’t hurt a family’s chances for financial aid.”    According to Kiplingers, “know that income, not assets, is by far the biggest factor in financial aid.”

A Secure Contract:

By putting money into cash value life insurance policies, you are in essence handing it over to a corporation.   This company in turns hands you a contract or a commitment with the rules stipulated in it.   The idea is that this money is safeguarded from lawsuits and is safer than with money that sits in a bank.  Sometimes this concept is called Creditor Protection. I professionally cannot either argue for or against this.  I am not a bankruptcy attorney.    Personally if you are thinking of using a Whole Life Insurance policy for this purpose, certainly I would speak with an estate planning or bankruptcy attorney about this.   The laws and legal rulings on this are different from one jurisdiction to another.  Bankruptcy laws can be completely different from one state to another.  One state may protect to cash value in a life insurance policy vs another state which may have no protection what so ever.   Do your own research.

As I have stated, I will just leave the creditor protection theory to itself.  I will however suggest to you to consider the final return of your money that you may see.  Couldn’t you produce a better return of your money by investing in low cost ETFs?   So the question becomes, are you more concerned about a lawsuit or not having enough money at retirement?  Keep in mind that we are talking about a lawsuit that would not be covered by your umbrella insurance or potentially your business insurance.  Although possible, what is the likelihood of this?

Short Term Savings in a Whole Life policy?

If I were to recommend saving money with a Whole Life policy, it would not be for the short term.  After looking it over for years, I can only calculate that it has significant savings purposes only after about 25+ years or more.   Why?   Check out the guaranteed values of any whole life plan.  What  you are likely to see is that the first 2 or 3 years build up almost no savings.   How can you put money into a cash value life insurance plan that has no cash value?  Simply put, the life insurance company immediately deducts marketing and sales costs, from the first dollar that goes in.   When I say sales costs, I mean insurance agent commissions.

So, where is the better place to store your short term / emergency savings?  How about a bank!   Shop around for reputable online bank that pays a high rate of return on bankrate.com.   Check to make sure that the bank is FDIC insured.   By saving your emergency cash in a bank you can tap into it, likely without having to pay any fees.  Certainly you wont have a take a loan out from your own money.

Money for Loved Ones:

Isn’t leaving money for your heirs the main reason for all of life insurance?  Yes it most certainly is.  However there is a major difference between a term policy and a whole life policy.  While a term life insurance policy only pays out for a limited amount of years a whole life policy is guantanteed of paying out, assuming you can afford the endlessly high premiums.  This is in my opinion the best argument for a whole life policy.

The Liberty of it All:

As with any financial product the numbers that you use in the computation are paramount. And those numbers that you use will sway the outcome one way or perhaps another.   If an insurance agent is attempting to convince you of the benefit of an extremely complicated insurance product, they should be able to demonstrate this using guaranteed values.  If not with guaranteed values than with reasonably low assumed values.   They should be able to explain to you the tax benefits and the tax costs.   In selling you a term life policy, I can explain to you in black and white the EXACT cost, each year, for the full term of the life insurance policy.   I can point you to a dollar amount that will EXACTLY list the death benefit.

Of Special Note here in regards to the so called Assumed Values that Life insurance companies may try to show you.   Be certain to inquire about these values during a prolonged low interest rate period, such as the one we are now in.

Don’t Believe Me?

I don’t blame you.  After all I am a commissioned insurance agent.  I do seek to sell the competing product: Term Life Insurance.    Why am I blasting a product that many people in my own industry push?   Because it is an antiquated relic.  I’m sure it was a good product in the 1960s.  But now with the in innovation of 401Ks, 529s, keoghs, Roth IRAs, UTMA accounts… I just don’t see it.   That is I don’t see if for 99% of Americans.  What was once a fast race car, now just seems like a clunky old broken down vehicle.

If you are still unconvinced, do your own research.  Google: “Clark Howard Whole Life Insurance”  “Suze Orman Whole Life Insurance” or “Dave Ramsey Whole Life Insurance.”   Pick another national financial expert and google them.   In an era of political disagreement, you will not find all that much disagreement between the so called big three financial gurus with respect to their opinions on whole life insurance.  Read what all three have to say.

Know that according to the Wall Street Journal, Cancellation rates are “45% in the first 10 years.”  And  “26% of whole-life policies” end in the first three years.

One thing to keep in mind when doing your own research, is that I have just scratched the surface here with whole life insurance.  There are two other categories of life insurance that I have not even begun to explain:  Universal and Variable Life Insurance.   If you think the fine print is confusing for a whole life policy, wait till you peruse a universal policy.

Read articles from the Wall Street Journal: Life Policies: The Whole Truth and Surprise Your Life Insurance Rates are Going Up.

Or Consumer Reports: Is Whole Life Insurance Right for You?

Read and understand how State Premium Taxes may  Change your Whole Life Insurance Value.

Better yet, try and find a whole life insurance policy and read it yourself.

My Advice on Purchasing Whole Life Insurance:

In the end, Whole life insurance is indeed a Swiss Army Knife.  MacGyver Beware!  But if a swiss army knife represents a tool to your finances than a house can represent your life.  When was the last time that you completed a home improvement project with just a swiss army knife?  Would you ever want to?  Yes, a swiss army knife can act as your screwdriver in a pinch.  It can also act as a wrench, maybe even a flashlight.  But how many of those things does it do well?  How many jobs does it do first rate.   Wouldn’t it be better to have a phillips screwdriver, a Lowe’s wrench, and a “Mag” brand flashlight?  All as separate tools?   Or would you rather fumble around with one small general tool?   In the financial world, wouldn’t a combination of a 529 plan, a 401K plan, a Roth IRA, Short Term Savings Account, and Term Life Insurance make a better plan?   Each with their specific purpose.  All using low cost fees.  Each from Vendors ranked as best in class.

45% of whole life policies are cancelled within ten years of inception

Remember my statement about the fine print and guaranteed values.  My advice: You should not even consider purchasing a whole life insurance policy unless you understand both of these in depth.   Is it possible for one product to produce all of these results, simultaneously?  Not really.  It may be possible for it to come to the rescue in an emergency, but not without charging really hefty fees.

My advice for those that really just want to purchase Whole Life insurance is to start by getting a competitive quote for both term and whole life insurance.  If they still wish to proceed, at least consider a policy comparison across five or more companies.  Next, think 55%.  Are you one of the 55% that will stay with the policy for ten years or more.  Lastly – Work with someone that specializes in independent whole life sales.   There are services out there that will do this for you.

Is Whole Life Insurance a Bad Deal for Everyone?

No Whole Life Insurance is not a bad deal for everyone.  They are just bad decisions for most.  There are a few examples of situations which I whole heartily endorse their use.  Here is one example.  Funding of a special needs trust.   Special needs as in you have a child that has a condition that will require care for the remainder of their life.  My heart goes out to these parents .  I can see no better use than in funding a special needs trust with a Whole Life Insurance policy.  Come hell or high water the money must be there when both parents pass.   Set up with a lawyer properly and Whole Life can fill a real need.

There are other, limited examples of where whole life insurance can be a smart decision.  As part of a financial plan for very wealthy individuals.  People that make lots of money and will make lots of money each and every year for decades.   These people may already have much of the money for future premiums sitting in bank accounts. People that can guarantee that they can afford the plan each year for the rest of their life.  Think the 1% here.

Clients that need a final expense policy or that cannot qualify for a Term Life plan, may be good candidates as well.

About Marindependent Insurance Services LLC:

Marindependent Insurance Services LLC is a licensed and bonded insurance brokerage and agency that is regulated by the California Department of Insurance.  License 0K10734.    Reading about insurance online is no substitute for meeting with a licensed agent in your state or jurisdiction.

About this Article:

As with most articles that I write, it began long ago as a note on a scrap of paper.   I would come back to it often after speaking with owners of ‘failed’ whole life policies.  Recently I was approached by a leader of a movement of life insurance agents that are dissatisfied with the sales state of the life insurance industry.   Although I have never met this person or “rebel leader” that he prefers to be called, I have known him from an online community.  It is my true belief that Whole Life Insurance is generally a miss-sold product.   You can read about the Life Insurance agent movement here.

Disclosures:

Please read our full disclosures.  Always speak with a licensed insurance agent in your jurisdiction whenever considering any type of insurance, life or otherwise.  Marindependent is a licensed insurance agency and we are not licensed to sell nor solicit financial products such as stocks, bonds, or variable life insurance.  We are not CPAs, Attorneys, or other.   Rules and Regulations are different in various States and Countries.  Tax treatments change as well.   Please read the fine print on all life insurance plans before you purchase, whole life, universal life, term life, or otherwise.