All Life Insurance Tips

Whole life vs. term--can you prove higher return with whole life?

Someone posted a question about whole life vs. term and someone claimed they could prove whole life had equal or better return than buying term and investing the difference in the stock market but the question was closed before the answer was completed. Here's another chance for the whole-life apologists. My contention is that high fees and commissions on whole life will overwhelm any investment advantage. I also want to see this demonstrated for middle-class people, not multi-millionaires who get huge benefits from tax shelters. Assumptions: 20% marginal income tax rate (15% federal, 5% state) Buying insurance at age 30 and stopping/cashing out at 65 Stock market return is 10% per year and profits are taxed each year at long-term capital gains tax rate. Difference in premiums invested at start of each year. Reasonable amount of insurance coverage--$100,000, or $250,000 or so, not several million. Any advertisements or links to scams will be reported for abuse. Like I expected, the whole-life apologists are attacking my assumptions. First, that I shouldn't end the policy at 65. I'm assuming my kids are grown then, and surviving spouse will have Social Security (maybe), a home, and other assets to survive on. If it's more beneficial to convert the policy to an annuity at 65 and save taxes on my (presumably reduced) income, I will consider that possibility, just give me some facts. Someone said dividends are taxed at a higher rate than long-term capital gains, but I think that's wrong. Regardless, the rates on either are pretty low and I don't see that as a major factor. Someone else said term insurance would be a loser if my health failed before 65. If that's the case then I'll admit I'm comparing apples and oranges. Is there term insurance that doesn't expire as long as you pay the premiums, or does term insurance mean you'll lose coverage at the first sign that you're odds of collecting are higher than average?

Public Comments

1. If you are measuring straight return on investment, then buying term and WISELY investing the difference gives a better deal. However, if you are buying term insurance at 30 years old, in order to have insurance at 65, you will either have to convert the term to whole life when the tern is up, (presumably 50 years old as there is little available for a longer term), or buy a new term policy. If you convert, you may be able to get insurance without a new physical, but your age will work against you and the price will be sharply higher than the first term. If you buy a new term insurance, you will have to face a physical exam, and possible health problems may force you to pay extreme premiums, or you may not be able to get insurance at all. Insurance is not meant to be primarily an investment vhicle, it is for paying your final expenses and passing on financial security to your loved ones. Buy whole life and forget about it - you will never see the money. And you are covered until you are 100 yrs. old if you are so lucky. Find a good investment counselor, open a Roth IRA and pay a percentage of your income into it BEFORE anything else. You will reap the benifits in your old age.
2. First, your assumption of stock market returns being taxed at long-term cap gains rates is incorrect. Many stocks pay dividends. Those dividends will be taxed at current income tax rates. Whole life policies also have much more steady and predictable returns than the stock market. Second, cashing out the policy at age 65 is not the most preferred route for accessing the cash value in a permanent insurance policy. It is possible to take the cash out in smaller amounts tax-free. Since most people live to their 80s, this is more reasonable. Third, the issue arises as to most people's need (especially the middle class) for life insurance coverage past age 65 to help pay for final expenses, medical expenses, any debts that remain, taking care of survivors etc. Term insurance won't do that. In my experience, it is rare for a middle class person to save adequately for the expenses later in life.
3. I sold insurance for many years. Many guys that sell WL will try to say that it is the best. Unfortunately, they have just been brainwashed over the years and are just sponges repeating old stories. A great WL plan may get 6% return over a 30+ year period. Buying term and investing the difference is truly the best thing you can do if you are disciplined to save regularly. Now... if you want to compare term to Variable, then there may be some tax plays if you consider that the return is exactly the same. The problem is that almost all life policies have such steep expenses that they can never keep pace with good low cost investments.
4. I teach a class which has this topic as a component. In fact, students have to do this analysis. First, I hate to do this, but I need to attack your assumptions but for different reasons. I also need to point out something. Your tax rate is reasonable, but the average tax rate in the United States is 23%. Given the size of the Federal debt and Federal obligations a 33% long term rate is a more reasonable estimate. You can buy 30 year term insurance at about 30% of the price of the equivalent permanent insurance. Variable life permits complete equity investment so rates of return become an combination of three issues, fees, taxation and insurance structure. True whole life is really buying declining term and investing the difference. Whole life costs about 1/6th the nominal cost of term insurance over a long life. This creates two conundrums for you for comparison purposes. The first is that you need to have ordinary disability insurance for variable life and an investment plan to be equal. The reason is that by age 65 you need to presume a 50% chance of disability and of that group 50% will be disabled for 3 or more years. If you are no longer producing income, you cannot contribute to the stock market. A variable life policy will contribute for you through its premium waiver provision. So first you need to take 2% out of your monthly contribution to equal them out OR you need to calculate the insurance without waiver of premium. My group is all middle class with a handful of exceptions. Also, I require more realistic rates. I am a professional investor and teach on the side. Globally, I am among the highest performing investors on a purely statistical basis on any rolling period of 1 year or greater for a decade. The 10% rate historical stock market rate can be attributed to circumstances which are no longer present. I get four sets of permanent and term quotes each year. I don't use 30, I use 22 and 45 since one is after graduation and one is waiting. I don't have data on 30 year olds. It works out that the best policies are probably better and the worst should be avoided at all possible costs. But insurance is never an investment. One other note, insurance is taxed only after premium recovery. It is quite possible that an owner in whole life would never live long enough to be taxed. I would agree that the very best investors holding a declining term policy, presuming that they have mechanisms in place to manage taxation over the 35 years, would do better than the permanent policy, but there is a hitch in that. On average, a whole life variable policy will do average minus fees. The trick is that 80% of private investors underperform the market substantially. Variable life policies and 401(k) plans share the same pitfall, they are managed by people who shouldn't manage their own portfolios. There is a wonderful set of psychological studies that shows that something on the order of 80% of us believe we are above average drivers. I can show that I am a statistically better investor than any of the indices on a consistant stable basis in both increasing and declining markets. Be very careful on your assumptions on your return. I suspect that the S&P 500, bought today, will return in the 7.5% range (gross before taxes) over the next 20 years. Be carefull because internal rates of return have a strong impact on the spreadsheet analysis.
5. Whole life: A client of mine owned it since 1978. It is now 2006 and there's only 20,000 in the cash value. The client is now 58 years old and going to retire soon. Do you think $20,000 is enough for retirement? That won't even last for 1 year. So the average rate of return is less than 2%. Remember: To access cash value, you have to borrow it (this is stated in every cash value policy). If you wish to take it all out, you will have to surrender the policy with possible surrender charges (depends on how long you had it). I believe that you don't need life insurance during the retirement years because you have no or very little financial obligations. With term, premiums are lower than whole life because it doesn't have cash value. So, client should invest the difference in mutual funds. In the past 25 years, mutual funds has perform an average rate of 14%. However, investors rate of return is only 2.9%. Why? Stock market crashes, people tend to pull out. And when the stock market rebounds, people start putting money back in. If they were to just leave their money where it is no matter how the market performs, they could of earn an average rate of 14%. (this is what one of the Legg Mason portfolio managers said and show a graphic illustration). My client has also invested in mutual funds back in 1993. She made a small deposit of $5000. She now has over $40,000 in it. So here's comparison base on what my client had: Whole life: Took over 25 years to accumulate $20,000 (i roll it over to variable annuities using 1035 exchange) Mutual funds: Took just over 10 years to accumulate $40,000. Which one do you think is better? Point proven, cash value policies suck and that's why financial experts say you should always keep investments separate from life insurance. This is only done by buying term and investing the difference. When its time to renew your term, you do not need a proof of insurability and you may elect to lower your coverage amount. In case you die, your beneficiary will get death benefit from term and your assets. Compare to cash value policies, your beneficiary will only get one of the above. (by the way, after showing my client the truth, she now owns Term and putting away more money toward her retirement).
6. Whole life insurance should not be used as an investment tool. Unless the policyholder is paying above the target premium, the policy will not appreciate at a level proposed by the salesperson. Here's why: There is a point where the IRS considers this policy an investment, called a Modified Endowment Contract. The only way a person can get around this classification is to raise the death benefit of the policy, therebye increasing the annual premium, wiping out any substantial gains through interest or, if it is an equity indexed fund, through increased value of the stock market. Whole life does provide one benefit: If there is cash value in the policy, it can be borrowed against, and when repaid, the interest being repaid is payable to the owner of the policy (typically the insured). Generally speaking, life insurance is not a good mechanism for investment. The MEC limit of a whole life policy provides a limit on the return you can realize as an investment. Term policies only pay when you die. This is to protect your family or possibly a business in which you are a key figure from financial hardship. Index tracking stocks are a much better bet, as they avoid specific risk and do not carry the loads of mutual funds. Here's a stat you may find interesting: Insurance companies only pay about 7% of all life insurance policies that are taken out. This means your insurance will probably expire before you do. Good Luck!!