Myths of Whole Life Insurance Part 7 | The White Coat Investor

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Myths of Whole Life Insurance Part 7 | The White Coat Investor


I started this series of posts way back in December 2013. They continue to be among the most popular posts on the site. If you’ve never read one of them, I suggest you start at the beginning and work your way back to today’s post to have a complete understanding of how whole life insurance works, how it is sold, and why you most likely don’t want to buy it.

Disability Insurance

Each item in the list discusses an argument used to sell whole life insurance and my thoughts on why it is misleading or outright false.

Lots of people think I hate whole life insurance. I actually don’t. I hate the way it is sold and those who sell it inappropriately. If you really understand how it works and still want it, then feel free to buy as much as you like. It really doesn’t affect me one way or the other. But I’m sick of running into readers and listeners who DID NOT understand how it worked when they bought it, and once they do understand it, DO NOT want it.

Unfortunately, the vast majority of policies sold are sold inappropriately and the vast majority of those selling it are salesmen masquerading as financial advisors. Over 80% of whole life policies are surrendered prior to death and polls of actual real life doctors on this site and our Facebook group show that the vast majority of those who have purchased whole life policies regret their purchase. If this is all news to you, then go read Everything You Need to Know About Whole Life Insurance before continuing on with today’s post.

WCI FB Group WL Purchasers

While most WCI FB group members have never purchased whole life insurance, of those who have, 76% regret it.

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The numbers are similar but slightly lower in the ongoing post on this site (which unlike the FB group permits voting to be done by those who sell these policies.)

In part 6, we left off with # 29. So let’s move on to # 30.

9 More Reasons Why Buying Whole Life Insurance is a Bad Idea

# 30 After Maxing Out a 401(k) and Roth IRA, Isn’t Whole Life Insurance the Only Tax-sheltered Option Left?

This is the wrong question to be asking, but the answer to it is still no. Just because it is the only option presented to you by an insurance agent, doesn’t mean it is the only option. Other options for retirement savings include defined benefit/cash balance plans, an individual 401(k) for self-employment income, a spousal Roth IRA, your spouse’s employer-provided accounts, and Health Savings Accounts (HSAs). In some ways doing Roth conversions and paying off debt is also tax-sheltered. But most importantly, there is no limit on investing in a non-qualified mutual fund account (where long-term gains and qualified dividends are somewhat sheltered from taxes) or in real estate (where income is sheltered by depreciation and capital gains can be deferred indefinitely by exchanging.)

Obviously investing in whole life insurance compares better to investing in a taxable account than to a retirement account (where there is no comparison from a tax, investing, or in most states an asset protection standpoint). But the real problem with this argument is that it is focused entirely on the idea that any tax-advantaged investment is always better than any fully taxable investment. That simply isn’t true. It also mixes up the idea of an investment and an account, two things that financially naive doctors sometimes have a hard time telling apart. (Think of the accounts as different types of luggage and the investments as different types of clothing.) The real question to ask yourself when you hear this argument is “Where should I invest after maxing out my available retirement accounts?” The answer is a taxable, non-qualified account. Now you’re left with the question of what long-term investment to invest in–tax-efficient mutual funds, real estate, or whole life insurance? It’s pretty hard to really compare the merits of those three investments and end up choosing whole life insurance given its limitations and terrible returns previously discussed.

# 31 The Estate Tax Exemption Could Go Down

The idea behind this argument is a rebuttal to the argument discussed in Myth # 8. In summary, that argument is that you need whole life to avoid estate taxes, which is silly given the vast majority of doctors won’t owe any federal estate taxes. The next step is for the agent to argue “Well, the estate tax exemption might be decreased.” Well, I suppose that’s true. Congress can change any law they want any time they want. But buying insurance or investing based on what could happen seems foolhardy. I mean, it is probably just as likely that the estate tax is eliminated as the exemption reduced. It seems to me the best way to plan for the future is to project current law forward, since most laws aren’t going to be significantly changed. If they are, you can make changes at that point. At any rate, it isn’t like whole life insurance is some magic panacea to eliminate estate taxes. The only reason whole life insurance reduces your estate taxes is by making sure you have less money due to its low returns! The thing that reduces the size of your estate is the irrevocable trust you put the insurance into, and you don’t even have to put insurance into it if you don’t want to.

# 32 Whole Life Insurance Protects From Nursing Home Creditors

This one was particularly fun to debunk. Apparently, the idea here is to not pay for your own nursing home care somehow by purchasing whole life insurance instead of mutual funds. I’m not sure exactly how those envisioning this process think it will go. Maybe they think the nursing home doesn’t ask for money until after you die or something, which is, of course, completely silly. But I think what they’re referring to is the ability to spend down your assets to Medicaid levels, get Medicaid to pay for the nursing home, and still be able to leave a huge inheritance to your heirs because Medicaid somehow doesn’t look at the value of your whole life insurance.

The whole process of Medicaid planning is a little distasteful to me to be honest. The idea is to hide someone’s assets from the state so that the heirs can have them, foisting the cost of caring for the owner of those assets on to the public. But even assuming that you have no ethical problem with doing this, it’s unlikely to work very well. Medicaid is state law, so it varies by state, but in Utah, a person can have up to $2,000 in countable assets and still qualify for Medicaid. Above that level, no Medicaid until you spend down to that level. If there is a spouse, the spouse can keep 100% of assets up to $24,720 and 50% of assets up to $123,600. Above that, Medicaid won’t pay for the nursing home.  Non-countable assets in Utah include:

  • Your home if your spouse lives in it
  • The value of one vehicle (including a Tesla)
  • Funds set aside for a funeral
  • Household and personal items
  • Cash value of your life insurance policies IF the total face value of all policies is < $1500

So I guess if you want to hide money from Medicaid in Utah, then you could go buy a $1,000 whole life policy. Most states have similar policies regarding cash value life insurance. Even if there were a state with a higher limit than Utah, this seems silly for someone who should spend her entire retirement as a multimillionaire to be making plans to spend down to Medicaid levels for nursing home care. A far better plan to stiff your fellow Utah taxpayer (assuming you have a spouse who doesn’t need care) is to upgrade your house and your car.

# 33 WCI Doesn’t Understand the Opportunity Cost of Borrowing Against WLI and Investing Elsewhere

This statement has been made without explanation, but the idea isn’t that complicated (nor misunderstood by WCI.) You can borrow against the cash value in your whole life policy and use that money for whatever you want. You can spend it or you can invest it. Lots of whole life fans use fun phrases like “velocity of money” to describe buying a whole life policy, borrowing the money out, and investing it in something else. The really talented salesmen get you to invest it (along with any home equity they can get you to borrow out) in yet another insurance product.

Is there a cost to not maximally leveraging your life in this manner? Sure, anytime you can borrow at a lower rate and earn at a higher rate you’ll come out ahead. But leverage works both ways, and the risk is not insignificant. What is not often mentioned by those advocating doing this is the opportunity cost of plunking money into a low return life insurance policy and buying unneeded death benefit instead of a higher returning investment. For instance, consider two options. You can invest $10K a year into an investment that returns 10% per year or you can buy a whole life policy that won’t break even for ten years. After ten years, the first investment is worth $175K and the whole life policy only has a cash value of $100K. That’s a $75K opportunity cost that apparently the “insurance agent doesn’t understand.”

With a properly structured policy, you can break even in perhaps 5 years (maximizing the use of Paid-Up Additions), and using the combination of wash loans (interest rate to borrow against the policy = dividend rate of the policy) and a non-direct recognition policy, this idea becomes “not terrible.” You still have the opportunity cost of the first few years in the policy, but that is balanced out by a higher return on your cash in later years. I have discussed “Bank on Yourself” or “Infinite Banking” previously in detail if you are interested. It’s not an insane use of whole life insurance, but it isn’t for me. If you really understand how it works (it’s going to take working through a lot of hype to do so) and want to do it, go for it.

# 34 Buy Whole Life Insurance For the LTC Rider

In recent years, insurance companies are adding on a Long Term Care rider to whole life insurance policies (and universal life policies and annuities) and agents are using the fear of expensive long term care to sell them. I find this appalling. Not only are you mixing insurance and investing, but you’re now combining two different types of insurance policies with investing. Given the track record of insurance companies with long term care, I think most of my readers should strive to get a place where they can self-insure the risk of long term care, but even if they cannot, I’d prefer a simpler long term care policy on its own than mixing it with an otherwise unnecessary and expensive insurance policy.

The benefit of buying this as a rider of a whole life policy is that the premiums of the policy are guaranteed–you don’t have the risk of the insurer upping the premiums like you do with a long term care policy or upping the cost of the underlying insurance like you do with a universal life policy. Those guarantees are worth something.

Remember we’re not talking about just an accelerated death benefit. This is just another way of self-insuring long-term care, but with a lower return on the investments used to pay for it. You’re really buying two policies combined into one. But there’s no free lunch here. You’re either paying more for the combined policy, or you’re getting less of something, usually death benefit. Most likely, you’re also paying for a life insurance policy you don’t need or wouldn’t otherwise buy. That death benefit isn’t free. The reason life insurance companies stopped selling long term care insurance and started selling these hybrid policies is that their actuaries were convinced they are more likely to make money that way. That profit has to come from you, there is no other possible source.

If you do decide you wish to purchase some sort of long term care insurance policy, it is entirely possible that a hybrid product is right for you, but just like health and disability insurance, the devil is in the details. Read the fine print and be sure you know what guarantees the insurance company is actually providing. Know about what is covered, what isn’t covered, and whether benefits are indexed to inflation or capped. Or better yet, live like a resident for 2-5 years out of residency so you’ll be rich enough to self-insure this risk and never have to make this decision.

# 35 We Don’t Say Put All Your Money Into Whole Life Insurance

This argument is simply bizarre, but used by agents once the prospective buyer has refused to buy the massive policy they were offered at first. A small commission is better than no commission, I guess. Of course, you shouldn’t put all your money into whole life insurance, that’s a straw man argument. Also, if buying a policy is a bad idea, you’re going to be better off if you buy a small one than a big one. But that’s hardly a reason to buy a policy in the first place. Like any asset class, if it isn’t a good idea to put a significant chunk of your portfolio into it, it probably isn’t a good idea to put any of your money into it.

how does whole life insurance work

Buying whole life as an investment is as dumb as the captain going down with the ship

# 36 Yes, We Have a Few Bad Eggs But Most of Us Are Ethical

This argument is used when I point out that literally hundreds or even thousands of my readers have been sold clearly inappropriate insurance policies. The problem is there are two options to explain this phenomenon. The first is that these agents are unethical. The second is that they’re incompetent. Given the statistic that 80% of policies are surrendered prior to death and 76% of the docs I’ve surveyed regret their purchase, this is hardly just a “Few Bad Eggs” doing this. It’s an industry-wide problem.

# 37 You Should Buy Insurance to Preserve Insurability

This one is used to sell insurance to people that don’t even have a need for insurance. The idea is to prey upon their fear of the combined risk of needing insurance AND not being able to purchase it. One example would be a 25-year-old single doc with no kids. No life insurance need here. “But what if you get diabetes before you get married and have kids? You should buy the policy now.” Uhhhh….no.

First, you may never have dependents.

Second, if you do need it, you’ll probably be able to buy it at that time at a reasonable price.

Third, if you do become less insurable, you will still likely have options for some insurance through an employer or other groups.

Fourth, even if you become uninsurable through anyone, the risks must be multiplied. For example, let’s say there’s a 5% risk of you becoming uninsurable before you have a real insurance need. And the risk of you dying before reaching financial independence is 5%. To get your true risk of a financial catastrophe, you must multiple those risks. 5% x 5% = 0.25%. That is a 1 in 400 chance. Life is risky. You can’t eliminate every possibility of something bad happening to you and even if you could, that wouldn’t be a wise use of your money. Wait to buy insurance until you have a need for that insurance.

This argument is often even extended to children. If you’re buying life insurance from the same company that sells you baby food, you’re probably doing something wrong. Now, if you could buy a lot of future insurability for that kid very, very cheaply, that might be something to consider. Unfortunately, you can’t really do that for several reasons:

First, you have to actually buy unneeded insurance. That newborn likely won’t have any need at all for life insurance for 25-30 years.

Second, you’re not pre-buying the policy that kid will need. You can’t buy the right to buy a 30-year level term policy at age 30. You have to buy a whole life insurance policy. Which means you’re also paying for insurance that will be unnecessary on the far end of life too, after the kid has become financially independent.

Third, you generally can’t buy enough insurance, or even enough future insurability, to actually meet any sort of realistic life insurance need. Most of these infant policies are only $10K or so. That’s basically a burial policy, and as sad as it would be to bury your kid, it’s not a financial risk my readers should need to insure against. (I’ve even heard the argument that you should buy the policy so you can take a few months off work because you’ll be too distraught to work, but that’s what an emergency fund is for.) Even if you find a policy that allows you to purchase future insurability for a larger policy, let’s say $500K, that’s not going to mean much in 30 years when the life insurance need actually shows up for the first time, much less in 50 years when the kid is actually reasonably likely to die. At 3% inflation, $500K today will only be worth $200K in 30 years and $109K in 50 years. Better than nothing, but you went to all this effort and expense to preserve insurability and your kid still ended up with inadequate life insurance coverage.

# 38 Whole Life Insurance is a Great Investment To Put In Your Defined Benefit/Cash Balance Plan

I had this one pitched to me by a doc turned financial advisor of all people. The argument was that you could buy whole life with pre-tax dollars and then if you wanted to pull the policy out of the defined benefit plan you could do so. He felt this was an “advanced technique” for “high net worth folks.” I was flabbergasted. It was such a stupid idea I couldn’t believe it. A defined benefit/cash balance plan already provides tax protected growth and asset protection, two reasons frequently cited to buy whole life insurance. You’re now paying twice for those benefits. To make matters worse, should you die while this policy is in the defined benefit plan, part of the death benefit becomes taxable, negating another usual advantage of life insurance- a completely tax-free death benefit. But the main reason why this is such a stupid idea is when it comes time to close the defined benefit plan, which is usually done every 5-10 years or so in order to roll it into an IRA. At that point, you have to do one of two things.

First, you can surrender the policy and move the cash surrender value into the IRA. But what is the investment return on the first 5-10 years of a whole life policy? You break even if you’re lucky. Not exactly a great investment for that time period, especially compared to a typical conservative mix of stocks and bonds.

Second, you can purchase the policy from the plan. Of course, you have to do that with AFTER-TAX dollars. So while you initially bought it with the pre-tax dollars in the plan, eventually you’re going to have to cough up after-tax dollars for the policy. And then what are you left with? A whole life policy you probably neither want nor need and perhaps even with associated premiums you have to make each year. Some deal!

There you go. Nine more reasons for buying whole life insurance debunked. Don’t worry; the agents who sell this stuff will come up with more. Just hang out in the comments section over the next year or two and you can watch. Whole life insurance is a product designed to be sold, not bought and the only way to win an argument with an agent trying to sell it to you is to stand up and walk away. As Upton Sinclair famously said, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Maybe it should be called Whole LIE Insurance.

What do you think? What other arguments have you heard for buying whole life insurance that haven’t yet been covered? Comment below!





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