Whole life insurance is, by definition, not an investment
By Jeffrey Reeves, Financial Author, Speaker and Guide, YouBeTheBank.com, Oct. 27, 2008
A whole life insurance policy bears some of the characteristics of an investment, but, at its core, it's a life insurance contract and not an investment. However, because a whole life insurance policy is a contract, it makes some promises that no investment can claim, such as:
-- A whole life insurance policy provides specific, predictable and guaranteed annual increases in its cash-value account
-- A whole life insurance policy lets you grow your wealth tax free year after year -- no sliding backward, no worries about stock market crashes or real estate market bubbles -- just peace of mind about your money
-- A whole life insurance policy can fund an inflation-protected income that you do not have to work for and you can't outlive
-- A whole life insurance policy offers protection from creditors and legal claims (check with your local attorney as laws vary among states)
-- You can use the money in your whole life insurance policy when one of life's surprisingly unsurprising surprises throws you off track
-- Your whole life insurance policy serves you without compromise while you are alive and allows you to pay forward (tax free and to anyone you choose) your legacy of wealth and wisdom
-- You have unqualified access to the cash value in a whole life policy (no approval needed). The government, your employer, or any other outsiders have nothing to say about how you use the money in your whole life insurance policy
-- Oh yes, did I mention that:
-- The growth of cash values in a whole life insurance policy are tax-free
-- The income you derive from a whole life insurance policy may be tax-free
-- If properly managed, the death benefits paid to beneficiaries are tax-free?
In addition, a whole life insurance policy from a mutual insurance company may also pay dividends. A dividend paid to a participating whole life insurance contract by an insurance company is considered a return of unused premium and, when properly managed, becomes part of the basic policy once it has been paid. That means the growth of cash values attributed to dividends is also tax free.
When you take into account these and many other benefits that can be derived from owning a whole life insurance policy, it might look better than much of what we call investments today.
Why? When an advisor (or your neighbor or the guy at the gym) refers to a "good" investment, they usually speak primarily about the rate of return. However, to paraphrase Benjamin Graham, the dean of Wall Street and Warren Buffet's mentor, an investment has two essential qualities: safety of principal and a reasonable rate of return.
A whole life insurance policy provides both, so, in that sense, you might consider it an investment. However, since a whole life insurance policy serves so many other purposes both by contract and de facto, it falls outside the definition of an investment and remains a whole life insurance policy.
However, much of what is presented to the public today as an investment is really a speculation. The issue of safety of principal is in question on everything from high-profile stocks (e.g., Enron, MCI, GM, AIG, Lehman Brothers, etc.) to mutual funds, ETFs and so on.
What usually makes these speculations seem attractive -- and what the sellers of them focus your attention on -- is the promised rate of return based on averages of past performance, even though they disclaim that past performance is in any way predictive of future performance.
Ask any well-informed investment economist for a prediction of future returns and you'll discover that 4 percent to 6 percent net of taxes, commissions and fees in a good market is reasonable for the typical mutual fund, 401(k) and ETF-type of investing. Facing a bear market, as we are today, you can and should expect less.
A whole life insurance contract guarantees its returns and offers the possibility of tax-free dividends as well. Over the long-term, a whole life insurance policy comes in about in the middle of the 4 percent to 6 percent range based on its past performance, which is predictive but not guaranteed. From that perspective, whole life insurance might be thought of as a "good" investment, at least according to Benjamin Graham's definition.
Having said all that, whole life insurance policies are still not investments. They do offer, however, options and benefits that are simply not available in any other financial product -- and that is perhaps what recommends them most as an essential part of every American's financial foundation. In fact, one financial writer recently called whole life insurance the Swiss Army Knife of financial products.
Perhaps it's time for America to re-awaken the principles and values that made us great in the first place and to elevate savings and legacy to a place of respect. If we do that, we will all be seeking out agents and advisors who can sell us one or more whole life insurance policies.
Top five reasons not to buy term and invest the difference
By Adam Stohlman, LUTCF, Founder/Principal, LUTCF, Stohlman Financial, Aug. 25, 2008
Somewhere in the declining interest rate environment of the 1990s, the "buy term and invest the difference" philosophy was appropriated by the financial world and has been pushed upon the public ever since as the credo of any smart investor. The reasons for this are two-fold, and very simple.
First, from the late 1970s through the 1980s, the life insurance industry sold countless universal life insurance policies -- which are basically term with a cash-value component that comprises part of the policy's death benefit amount all along -- allowing a policyholder to purchase less actual life insurance coverage within the policy as the policyholder ages and rates rise. This provides a level death benefit, depending upon the interest return on the cash value, without the higher cost of all the guarantees of whole life insurance. However, as interest rates dropped precipitously in the late '80s and into the '90s, these universal life plans, which had shown cash-value returns at 9 percent to 12 percent when originally sold, began to return only 5 percent to 6 percent -- meaning that much more premium was required to maintain the policies in force with the death benefits originally chosen.
Consequently, consumers who do not like thinking about life insurance anyway -- and often steadfastly refuse to let a life agent back in their door after their initial purchase -- were shocked to receive notices by the early- and mid-1990s stating that their policies, which were originally projected not only to stay in force but also thrive, were either in serious jeopardy or outright cancellation. This left an extremely bitter taste in the mouths of many insureds at the time and still does for some to this very day. Meanwhile, as the securities markets generally boomed during this period, the grass looked much greener on the other side of the financial fence.
Second, it was and remains in the financial and investment firms' best interests to take advantage of this considerable consumer disgruntlement and to push the "buy term and invest the difference" philosophy, which has today become a financial gospel on an unsuspecting public. The reason that Wall Street and many Main Street financial advisors and brokerage firms advocate the "buy term and invest the difference" philosophy is to gain maximum control of their clients' every insurance and investment dollar to earn maximum commissions for themselves year after year and increase assets under management, investment returns and profits for their shareholders. All of this at the expense, quite literally, of what may be in their clients' actual best interests.
What do I mean by that last statement? Simply this: the adage, "buy term and invest the difference" does not work, never has worked... and never will work. And, it is most certainly not in the vast majority of clients' best interests. Here are the top five reasons (among others) why this strategy is outdated:
1. People don't understand their savings
Countless term plans are sold to people every day under the premise that they can take the "savings" from the difference in premium versus permanent life and -- nine times out of 10 -- invest it in a security, such as a stock, mutual fund, etc. However, once the term life policy is secured, what do people really do with that supposed savings? They spend it on car payments, boat payments, house payments, or even pizza and beer -- things that increase their standard of living or level of enjoyment now -- rather than investing it in the markets for later. Their spirits may initially have been willing -- when the stockbrokers or financial advisors were at their sides, filling their heads with visions of future fortune -- but their flesh later became very, very weak. This is the first place "buy term and invest the difference" fails -- and miserably, at that. In the end, the consumer is left not only without any life insurance, but also without any investments.
2. Investments can lose value or disappear by death
Among the many myths surrounding the "buy term and invest the difference" mantra is that somehow, as if by magic, one's investments will certainly grow and will certainly be there, ready and waiting -- and at their peak -- by the time funds are needed for immediate cash or long-term income. This is not always true, however, and far too often the reverse is actually the case. Disciplined financial investing over a long enough period of time generally does result in a profit, if investments are chosen wisely and provide a return higher than inflation or monetary devaluation, but there are no guarantees whatsoever and, even worse, there is a risk of total loss. Enron and other companies that did not live up to their pension plan promises or that got by on questionable accounting practices only to go bankrupt overnight are prime examples. This is one perilous possible outcome of the "buy term and invest the difference" gambit that has greeted too many at retirement -- and one that investors are rarely, if ever, properly warned about.
3. People still need significant life insurance at older ages and until death
Another myth is: "By the time you retire, you won't need life insurance anymore." Oh, really? Let's examine that assertion for a moment. The idea may be presented to the consumer that once the children are grown, the house is paid off and the client's investments have accumulated to the point that they have it made, life insurance is useless and unnecessary. But nothing could be further from the truth. Final expenses, including any unpaid medical -- which, today, could easily run into the thousands (or tens of thousands) of dollars -- probate and administrative costs, debts for which a spouse is still responsible as well as state or federal estate and/or inheritance taxes -- all of which will still be due and payable at time of death for each and every one of us. And on top of that, which strategy is truly wiser and truly makes more sense: to pay for all these things dollar for dollar out of the precious investments you have worked a lifetime to accumulate (without any guarantee they will still be there), or to pay for them with ten or fifteen cents on the dollar with guaranteed life insurance proceeds? You decide.
4. Insurability may be lost between terms
Consider this fact that "buy term and invest the difference" advocates virtually never share: Most term policies lapse or expire without ever paying a death benefit. Not so with permanent life insurance policies. This is one reason why term life insurance is so inexpensive. And since this is the case, many people who let their term coverage lapse or expire encounter numerous problems -- problems for many of which there are no remedies. The most basic of these is that, if a term policy lapses, the former policyholder must pay higher premiums at his or her current age and also prove insurability (translate: "qualify by health") all over again for new coverage. Not only can this be an inconvenience at later ages or larger face amounts -- where blood chemistry, paramedical exams and attending physician statements are involved -- but if the former policyholder's health situation has changed, a new policy may be highly rated, requiring much higher premiums (adversely affecting the original investment plan), or may even be declined altogether -- meaning new coverage cannot be obtained at all -- ever. This situation has left many a spouse and family in a tragic and terrible financial position. Contrast this scenario with the guaranteed, pennies-on-the-dollar death benefit (translate: "cash") permanent, in-force life insurance policy will provide spouse and family at death -- no matter when a policyholder dies.
5. Investments are subject to federal income tax, federal estate tax, probate costs and court delays; yet life insurance is not
Life insurance proceeds, unlike investments, are not subject to federal income tax, estate tax (except for face amounts being included in the total valuation of the estate), state or inheritance tax (in most states) or probate costs (which run 5 percent to 8 percent or more). This means that with life insurance, your heirs receive every single dollar you intended for them. What's more, they receive those dollars usually within about two weeks of your death -- no strings, will-contesters, attorneys, creditors or assorted others attached. No investment can do that. In fact, your estate may pay substantial federal and estate taxes (especially if your spouse predeceases you), plus state taxes and inheritance taxes on your investments, not to mention probate and other court or settlement costs. Further, investments may have to be liquidated in a hurry in order to pay those taxes -- and often at a great loss. Finally, after all the taxes are paid, and the probate process is completed, which can take several months, your heirs may at last receive whatever portion is left -- provided any contesters of your will, attorneys, or creditors have not gotten it first. The sad fact is that investments actually cost spouses and heirs significantly at death versus life insurance, which only pays them. Yet another rarely discussed but extremely detrimental consequence of following the "buy term and invest the difference" mantra. Now, in saying all this, do I believe that term life insurance has its place? Most definitely. Term coverage is ideal for short-term or limited needs, such as covering a mortgage, an auto or boat loan, or even the period of time during which you are saving and investing for your children's college education -- in case you don't live to see that through. It is also clearly necessary at times when there is too large a need and too small a budget to cover it with permanent insurance. For true long-term life needs until death, however, permanent life insurance coverage provides the best -- and by far most financially sound -- solution for almost every individual's lifelong and at-death needs. And, it can do so far more cost effectively and efficiently than any investment. Couple that with the fact that it is guaranteed to be there when you and your heirs need it while investments are not and permanent life insurance does far more than any investment vehicle sold by financial advisors or touted by television talk-show gurus.
As I stated at the outset, the "buy term and invest the difference" strategy simply does not work, never has worked and never will work. Now you have five of the top reasons why. It's well past time that consumers and investors were made aware of its many real dangers and devastating consequences. And it's also well past time that purported financial advisors and investment representatives took far more seriously both their responsibility and privilege to share the whole truth about life insurance and investments with their clients.