Fixing Bad Advice - Permanent, Cash Value Insurance
Aka "Just because it is too confusing for twitter gooroos doesn't make it bad"
Insurance is confusing. I get it. This isn’t smooth-brain stuff here. Lot’s of personal finance is just yelling “keep buying low-fee ETFs” or “Make a budget and spend less”. The lack of deep discussion on matters is a tad frustrating at times, but
(1) We get that repeating small soundbites works in the attention-shortened world of today and
(2) You can be unimpressive and still a gooroo when you say [redactedly] obvious things like “spend less than you make”
We sigh, but move on. There are people out there who do actually need a daily twitter reminder to “spend less than you make”….honestly, based on follower count, there are 10s of thousands of people that need someone to tell them that over and over.
[Want a deeper dive into permanent insurance? Check it here]
But then the gooroo starts getting a bit smug and talking expertly about actual complicated and nuanced things. Things like life insurance. And discouraging someone from being open to a powerful tool in their arsenal can actually harm your audience.
Give harmless and inane advice…fine…but give actively poor advice and we take issue.
What are some of the silly arguments against permanent life insurance:
It is a ‘scam’
‘No wealthy person uses it’
‘Choose term & invest the difference’
The fees are high
We will walk through each of these points.
“Permanent Insurance Is a Scam”
Terrible take.
Every single time I have seen this argument made, it generally comes down to the author saying:
I don’t understand how life insurance works
I don’t like the fees so I am going to say its a scam
I see the word commission and dismiss it
Its confusing so I’d rather just say “buy ETFs & budget for the 85th time”
Just internet search “IUL is a scam” or “Whole Life is a scam” etc. The arguments are all similar. And if you know insurance, all the arguments sound like “look at how much I don’t understand life insurance”.
First, there are insurance products made for accumulation and insurance products designed for the death benefit. If you select the right product, with the right features, and right charges for your purpose, the products work as advertised.
Second, fees are high on permanent insurance for a reason. You are guaranteed a death benefit if you keep paying your premium, and you have all sorts of flexibility while passing risks to the insurance company. It is only a ‘scam’ if you end up purchasing the wrong product or using the product you own wrong.
Example of “Scam” Insurance not being a scam
‘Tism Note - A perfect example of insurance being hard is in this bullet at the end of one the top ranking “IUL is a scam” articles from a blog by a self-proclaimed $4 millionaire (we still refuse to pass any traffic to these terrible gooroos)
First, he is literally saying “I am putting too much premiums into the product then getting angry about it”. (UL is flexible premium, you get to choose how much to put in and all the charges get deducted from your cash value. He only gets to that point by putting in too much premiums)
Second, if you are buying an insurance product for accumulation like he is indicating, you go with death benefit (DB) option B. With DB option B, your death benefit increases with your account. So a $300k account value would increase your death benefit to $400k. Your account value wouldn’t wind up > DB. He is misusing and misunderstanding a product. That doesn’t make it bad.
Third, you can use your cash value to pay premiums in any universal life (UL), which is one of the key selling points of UL over whole life, the flexible premiums. All the charges you pay come out of your account value. You contribute premiums into the account. If his account value was getting close to his DB, you can stop paying premiums. This is literally a feature of UL, not a bug. But he is ‘overfunding’ the account. That means he likely solved for the wrong goal when setting the premium…You misusing and misunderstanding a product doesn’t make it bad.
Fourth, nearly all UL allow for free partial withdrawals or taking out loans. He can likely take out loans and withdrawals to access the extra cash value. Yes you need to pay back loans if you die, but your free partial withdrawal just accesses your cash.
Fifth, your advisor can run unlimited illustrations to show you how you are progressing to avoid you screwing it up.
Honestly, insurance is confusing. But the mistakes he made above are things covered in insurance illustrations 101. I don’t care if he is a ‘$4 millionaire’ or blogger, he doesn’t know week 1 stuff on UL. And if the advisors he talked to genuinely set up the illustration that wrong, it is a poor look on that firm OR there is some feature in the product he didn’t mention/didn’t understand…The only positive of the post, is it highlights the point that a good advisor makes all the difference.]
“But Millionaires Don’t Buy Insurance”
No millionaire buys life insurance….At least that is what some online gooroo said. He even showed a screencap of his bank account and it was over $1 million.
Yea, this is terribly wrong as well.
We had a role in an insurance company where one of the responsibilities was to review all the large cases brought in for high-net worth individuals. These were $10s of million dollar face amounts and multi-million dollar premiums.
Typcially they were part of a package setting up trusts for family members to pass wealth down. Also, commonly seen was customers max funding UL policies to drive down the charges while using life insurance to fund retirement (LIRPs).
So yes, lots of rich people are using permanent insurance for tax efficient strategies of accessing or passing on wealth.
[‘Tism Note - cost of insurance (COI) are charges charged to your UL policy that are supposed to cover the cost of mortality to the insurer. As your chance of dying goes up every year as you get older, your COIs increase as well. COIs are multiplied by your net amount at risk (NAR) which is the difference between your death benefit and account value.
If you maximum fund your policy (drive up your account value) you decrease your NAR and lower one of the major expenses you pay on your policy over time.
Insurance companies will design products to lower the cost of this strategy to the customer.]
“No One Got Wealthy Buying Permanent Insurance”
No one should be claiming that your permanent insurance is a path to wealth for you.
Insurance is there to pass some risk to the insurance company, for a price you pay. Insurance is to protect against the unexpected…it is like buying a hedge. Yes, sometimes it works out profitably, but most of the time it is a cost to you. Life insurance can certainly leave a portion of your wealth to your heirs. But you can’t pass all your mortality and investment risk to the insurance company and expect them to take it for a loss.
So this argument isn’t wrong perse…but it is fundamentally misses the point of the product. A better way to think of it is “no one ever died and their beneficiaries regretted them buying insurance…oh and by the way, I got some fairly decent returns on the cash in the meantime”.
Honestly, if you are angry at the lack of cash value in your life insurance contract, blame the regulators. The Deficit Reduction Act (DEFRA) of 1984 & Technical And Miscellaneous Revenue Act of 1988 (TAMRA) limited the income taxation benefits of cash value life insurance.
Before these 2 acts, you could slam as much premium into as little of a death benefit as possible. Imagine a $1,000 face amount and you are putting $100,000 a year into the account and reaping all the tax benefits while paying essentially no fees on the product. Congress put an end to that 40 years ago, because the government didn’t like all these people avoiding taxes with the ‘loophole’.
In short, there are over 20 million millionaires in America all making their own personal finance decisions. And many of them are indeed using permanent life insurance.
“Buy Term & Invest The Difference”
Saying that you should buy term & invest the difference instead of buying permanent life insurance is like saying you should buy a coloring book & invest the difference instead of a library of books.
It is genuinely that big of a plot miss.
Yes term is great. But term is the coloring book of the insurance word. It has 2 uses (and most gooroos don’t even know enough to mention a conversion rider). So when they say buy term, they are talking about a product with 1 use, pay a death benefit if you die before the term is up.
What happens if you don’t die but get sick & uninsurable?
When was the last time you heard one of these ‘buy term & invest the difference’ folks explain the post-level term period? Or how much more expensive the policy is if you get underwritten as an unhealthy person later in life when you are older?
[‘Tism note - Generally, after your term period you can elect to keep paying for 1-year term policies. So you get a 20-year term product and pay $100 a year each year for 20 yrs.
After the 20 years is up, you can opt into the post-level term period. (ie-after the level payments). This is buying 1-year term policies and the price of these 1-year term policies gets crazy expensive in a hurry, like 100% increases a year.]
We broke down the basic types of insurance in a previous post and here is a graphic from that post.
Look at the amount of different product types under permanent insurance. Permanent insurance has so many more use cases. Even this exhibit is grossly simplified. Each of GUL, VUL, and IUL has a protection, hybrid, and accumulation product subtype for the different goals. Then you can get even more granular as different products are designed around:
Different payment patterns (ie lump-sum payments like 401k rollovers vs flat constant payments)
Tax-efficient access of your account
Early cash value growth
Maximum funding vs minimum funding the account value
Changing death benefit options to minimize charges you pay, etc etc.
There is likely a permanent insurance product out there for almost any niche use case you can think of.
[‘Tism Note - if you have a no-lapse guarantee / shadow account it is likely a protection product. If you have high surrender charges it is a product made to buy & hold while low surrender charges and high free partial withdrawals mean its better for early access of your account. High cost of insurance (COI) means its a product made for maximum funding & putting in a big lump sum whereas high sales loads are for doing a longer level pay design. ]
In our post later this week, we will breakdown the math to show a WL vs term products to give the full view of the story.
So are you better off buying term & investing the difference? Kind of. in the base case if historical stock market performance holds up.
You will likely see a better portfolio value investing in stock market. But you aren’t investing in insurance. You are buying a flexible product…
Sample Whole Life Illustration
We can do another post on all the details of an illustration, but that is outside the scope of this post. We just want to show how looking at the account value of a term product doesn’t tell the whole story.
Couple takeaways:
You are paying $3,512 a year for this $250k death benefit whole life product
This illustration is doing the standard WL setup with purchasing paid-up additions and growing the dividend and death benefit.
In year 30, you have paid $105,360 in premiums ($3,512 for 30 years)
You are earning $4,331 (green box) in dividends which is ~4.10% dividend rate (4,331/105,360)
You have $174,396 (Purple box) in cash value in your account, which is ~3.08% annualized return on your contributions
Your growth in cash value every year is more than your premium, for example $10,559 (red box)
Your death benefit is higher - from $250k to $385,269, a ~1.5% annual growth
Your death benefit is always ~$250,000 more than the premiums you paid, and you get cash value growth that is 3% net all your fees.
You are getting paid a 3% return on your money for 30 years and keeping a $250k death benefit.
If you are a 35 year old who took a 30 year term policy with $250k face you paid $350 a year instead of $3,512. In 30 years you paid $10,500 total on the term. If you invested the $3,150 difference each year for 30 years at 8% return you would $385,000.
Back of the envelope, you are $210,000 better off ($385k - $175k WL Cash value above)….but wait….you can access your cash value in the insurance product tax-advatanged through a loan. The money you invested in term is pre-tax. That $385k is more like $315k after-tax….so you are really $140k better off….
But remember, WL still has a net $250k death benefit, your term expired.
Did you want a new term policy at age 65? That is $6,000 a year to get a 20-year term for $250k face amount. You are now payin $2,500 more premium a year for term than your old whole life. (You want to buy a permanent product at 65? A $250k face amout is likely over $10,000 annual premium).
And you took 30 years of investment risk.
Conclusion: Permanent Life Insurance
We have no skin in the game if you buy a permanent policy or not. We continue to hold the majority of our life insurance in term (WITH conversion riders).
However, the misguided hate thrown at permanent life insurance is crazy. We will dig further into the maths in the post later this week to show more details around permanent insurance vs term.
In the meantime, just realize that there are very very few people who understand insurance and a general ‘personal finance gooroo’ is not oneof those people.