There are circumstances where whole life insurance is a scam.
I’ll tell you what they are.
I get nervous what I see Whole Life Insurance pitched as a good investment.
One of the most questionable sales tactics I’ve seen is saying the returns are superior to traditional retirement account investing.
They suggest foregoing, or even liquidating traditional retirement accounts to quickly fund whole life insurance policies.
I’ve even seen this outrageous advice given in (questionable) military real estate groups.
When whole life is sold under these conditions, it’s a scam.
It is dangerous and wrong.
You will lose out on millions over a lifetime.
Today I’ll discuss what whole life insurance salesmen aren’t going to tell you about this complicated and expensive investment.
While there is a small need for something like whole life for high net worth individuals with unique circumstances (I’ll talk about this at the end), to say this is an appropriate investment for the average joe or typical military member or veteran is flat out irresponsible.
The strongest advocates of whole life insurance, which as far as I can tell are only the people who sell it, claim it is a better investment than the stock market or retirement accounts.
This is flat out wrong. I’ll explain the math below.
The people that are pitching this crap have no training in finances or investing.
They are, unfortunately, trained in sales and marketing.
Their commissions are among the highest in the industry.
Term Life Insurance Defined
If you want to understand what whole life insurance is, you need to first know what the much more common and useful term life insurance is.
This is probably what you are already familiar with, and for most people, this is insurance that is worth having.
A term life policy is where you pay a reasonable monthly premium for a set amount of years, say 20 or 30 years, and if you die during that time, you get a big payout.
In my case, I paid about $40 a month and had a policy for $1,000,000.
That price was good until about age 50, then the policy ends.
Term life insurance is affordable because most people don’t die young.
Most policies are never paid out.
And then the insurance industry thought up Whole Life Insurance.
Something way more complicated and unusually expensive that has limited usefulness to the average person…
There are probably much better places to put your money before it should end up in whole life insurance.
Whole Life Insurance Defined
Here are supposed benefits of whole life insurance:
- Guaranteed death benefit that gets paid even if you die of old age
- Cash value to borrow against to fund investments or emergencies
- Level premium payments that never increase
- Guaranteed and assumed rate of return that lets the cash value of your policy grow
- Tax advantaged growth supposedly much like retirement accounts
This sounds great, right!
Well, these benefits are confusing, and if the wrong salesman is presenting them, misleading.
Let’s break each one of these benefits down.
Guaranteed Death Benefit
Whole life insurance does have a guaranteed death benefit and term life insurance does not.
If it’s a million dollar policy, you will get that million if you continue to pay your premiums.
Sounds like a good deal right? It’s not!
Look how much you pay for this policy!
These are quotes from a website called policygenius.com that sells whole life insurance.
As you can see, a million dollar policy will cost you $827 a month.
That’s like another mortgage payment!
Seem high? It is.
10 to 20 times higher than an equivalent term life insurance policy.
You can get a $1,000,000 term life insurance policy for less than $50 bucks a month.
I’ll help you with the math.
Whole life is 16 times the cost in this particular case!
Why so much more?
Because the term policy is only for the first 30 years or so. You likely won’t die during that period and won’t get a payout.
Here’s the trick. They are charging you so much freaking money because you are going to get the benefit amount when you die.
Even if you die from old age!
While that might seem appealing, it’s expensive and, for most people that understand investments, totally unnecessary!
Index fund investing vs. whole life
Let me explain exactly what I mean.
Let’s do a quick compound interest exercise that whole life insurance salesmen do not want you to understand.
Instead of buying this whole life insurance policy for $827 a month, let’s invest that money in an index fund for the long term.
This happens to be how I’ve been investing the last 25 years!
If you invest $827 a month for 50 years in index funds and it grows at a 7% average per year, you will have $4.5 million.
If you buy a whole life insurance policy for $827 a month, after 50 years you only get $1M.
Where did the other $3.5M go?
To your insurance company and your salesman.
They thank you!
Whole life policies only grow at about 4%, and you still pay that fat commission.
Borrowing Against Cash Value
This is where the whole life insurance salesmen really try to lure in the real estate investors.
Something unique to whole life insurance policies is they have a cash value that you can borrow against.
The cash value in your policy is growing with your premium payments as well as by the guaranteed and assumed rate of return.
For many years, the cash value of your policy is less than the sum of your premiums because of the high commissions that need to come from somewhere.
Commissions are known to be 50-100% of one year’s premiums
Eventually, the policy starts making money, and you can borrow against that cash value for any reason you would like.
You are supposed to be impressed by this ability to borrow against your own policy.
They sometimes call this infinite banking or banking on yourself or being the bank.
They try to make you feel like doing this means you are outsmarting the evil banking system.
Beware of evil banks! (unsplash.com)
That’s actually a pretty stupid thing to think.
Here’s what I would offer.
What if you had just invested the money yourself, making millions more than what your policy pays, and when you need money, just take it out of your account.
You’re not even borrowing at this point. It’s your money!
You’ll make at least 7% in the market and millions more over a lifetime as I’ve already explained using index fund investing.
This can be done in normal brokerage accounts or retirement accounts. In both cases, you still beat the pants off a whole life policy!
Why borrow money from yourself through an expensive, overcomplicated policy with unimpressive growth and high commissions for seedy salesmen (no offense) and unimpressive growth.
No, this ability to borrow from your own policy does not impress me.
It appalls me. The returns are abysmal for such a long-term investment.
High commissions? 4 to 5% growth maybe?
Just so you can borrow against it?
If you need to borrow money for something, just go to a bank.
They are actually not as evil as you think!
Level Premium Payments
Whole life insurance salesmen, like the one pictured above, like to remind us that the premiums never go up.
This is actually true.
But here’s the problem.
In the example I just talked about, the whole life policy is more than sixteen times more expensive than a comparable term life policy.
Of course these premiums never go up, they are already sky high!
Surrendering your policy
Here’s another big issue with these premiums.
Let’s say you lose your job for six months.
You’ll need to come up with that $50 a month so you can keep your term life insurance policy for a million dollars.
No big deal.
What are you going to do about your $827 monthly obligation for whole life insurance.
That’s the size of a frickin’ house payment!
You won’t be able to pay it!
When you stop paying, you surrender the policy and get your cash value minus penalties.
This causes an already poor investment to get worse.
You don’t get the death benefit, you may get taxed on money you thought would be tax free, and you may have losses that you can’t deduct.
Surrendering whole life policies ends up happening to more than half the people that take out these absurd plans.
They realize it’s a raw f’ing deal.
Guaranteed and Assumed Rate of Return
Now let’s shift to the next overexaggerated benefit touted by whole life insurance salesmen.
Again, no offense to these salesmen.
They’ve gotta make a living!
These policies typically have a guaranteed rate of return on the cash value of the policy of at least 2%.
The returns should be higher than that, and usually are. They also give you an assumed rate of return that might be 4-5%.
The cash value of your policy will likely grow at some rate between these two numbers.
While that’s not a bad rate of return compared to a savings account, it’s a really crappy rate of return for decades of investing, or even a lifetime!
As I already covered earlier, if your investments grow at even 7% (and higher is likely), you stand to make far more money investing it yourself in the market.
In my earlier example, you make 4.5X more money investing it yourself over 50 years.
Tax-Free Loan Benefit
As stated before, you can borrow money against the cash value of your policy.
While you typically pay interest for this privilege, this is a tax-free loan.
The salesmen I’ve ran into like to emphasize this tax-free loan as an amazing benefit for real estate investors.
It really isn’t a benefit, as all loans are typically tax free.
To say that’s a benefit is a stretch.
When you borrow money, you still have to pay it back.
That is why it is not taxed!
Sorry, a tax-free loan is not a unique benefit to whole life insurance policies.
Tax-free death benefit
Advocates of whole life insurance policies , which are very few outside of the salemen, will talk up the tax benefits of the policy.
Let’s understand this.
They say that when the death benefit is paid, it is generally not taxed as income.
Well isn’t that something!
Actually, it isn’t something.
Almost any death benefit of any kind, including the 16 times cheaper term life insurance policies, are also tax-free payments.
Sorry whole life salesman, but this is not a unique tax benefit.
The cash value of your whole life policy is not taxed while it’s growing. This is a good thing and similar to how retirement accounts work.
One problem with this is, you don’t control this money.
Another is it’s growing a lot slower than it would be if you were invested in the stock market.
If you invest your money in either an IRA, 401k, TSP or other type of retirement account, it will likely grow much faster, be under your control, and you will also have tax-free or tax deferred growth.
Bottom line here, retirement accounts are superior investments to whole life insurance.
This isn’t an opinion.
It’s a fact.
If you are foregoing investing in retirement accounts to stuff money into your whole life insurance policy, and pay that fat commission, you’re a sucker.
God forbid they talk you into liquidating retirement accounts for this purpose.
I’m not making this up. There are shady salesmen out there doing exactly that.
I hope you understand the math behind this idea and how bad it is.
Whole life insurance salesmen are going to love you and buy a vacation home in the Bahamas off their commissions from you.
When is Whole Life Right for you?
One example when this investment can make sense is when you are responsible for a special needs adult who cannot earn money or take care of themselves.
If they are going to permanently live with you, unable to take care of themselves, and could use an infusion of tax-free cash when you die, then this isn’t the worst thing in the world.
I still think it’s better to invest the money yourself, and then just give them money as needed.
Another possible situation is you have already maxed all your retirement accounts, you have plenty of money in taxable accounts, significant real estate holdings, and you’ve still got lots of money you’d like to park somewhere.
I wish I had this problem!
Whole life will probably work out better than a savings account and should outpace inflation if you don’t mind paying a commission and being locked into life-long high payments.
Here are the characteristics of whole life policies laid out again.
- Guaranteed death benefit – Yes, but you don’t need a large death benefit in your twilight years.
- Level premium payments – Yes, they are level, but they are 10, even 20 times more expensive than a comparable term life policy that will fit most people’s needs.
- Guaranteed and assumed rate of return – These rates of return will beat savings accounts, and even keep up with inflation, but are nowhere near the returns you should be getting for long-term, even life-long investing.
- Cash value to borrow against – Sure, but I’d rather make much more investing it myself and have control of it.
- Tax advantaged growth – These advantages appear to be exaggerated. You’ll do better with traditional retirement accounts.
Whole Life insurance policies are pushed by salesmen as a great investment or tool for helping you achieve your financial goals.
Unfortunately, they often try to claim these are superior to standard retirement accounts and try to convince you to forego investing in TSPs, IRAs and 401ks in favor of these insurance policies.
In the most extreme cases where I call it a scam, they try to convince you to liquidate your retirement account holdings.
This is horrible advice. Choosing whole life over traditional retirement accounts will cost you millions over a lifetime.
It’s inappropriate for most people, especially the typical beginning or intermediate investor.
Outside of limited circumstances for higher earners with unique needs, this investment is not worth considering.
Don’t be a sucker.
Rich on Money