Whole Life Insurance Is a Terrible Investment For Most Millennials

Several months ago, I wrote a post on this blog that was… shall we say, somewhat critical of using whole life insurance as an investment.  To be clear, that’s not to say that I think life insurance itself is bad.  Life insurance is important if you have a spouse or children who depend on your income, or if have a mortgage.

But, there’s a big difference between getting life insurance because you actually need insurance versus getting a whole life insurance policy as an investment.  If you have an insurance need, you absolutely have to get a term life insurance policy to cover that need.  I emphasized this in my original post, and I’ll touch on it again below. If you are considering whole life insurance as an investment vehicle – or worse, if a life insurance salesman is trying to convince you that you need one – well, to borrow a phrase from my last article, you should run like hell.

Turns out, saying this didn’t win me a ton of fans in the insurance sales business.  I heard from a few people who make their living from selling these whole life insurance policies, who had a lot of arguments against what I said in my last post.  I even spoke to two of them on the phone to hear their point of view.

The points they made in favor of investing in whole life insurance (I’ll detail them all, with my responses, below) sound good at the surface, but their arguments flat out don’t hold up for almost all millennial investors.  In fact, I’ll go so far as to say that while there are some specific cases where whole life insurance could make theoretical sense for a handful of people out there, these cases are so few and far between that 95% of my readers shouldn’t even consider it.  If someone tries to sell you a whole life policy, and you aren’t a member of the 1% or trying to set up your estate for your heirs to inherit, you should run like hell.  Quickly.

Simply put, if you have an insurance need, you should buy term insurance.  It’s significantly cheaper, so you can invest the difference between the whole life premium and the term life premium.  With the right investment strategy, you should come out light years ahead of where you’d be with a whole life policy, as we’ll see below.

And if you don’t need insurance, just invest the money until you get married, have a child, or get a mortgage.  No need to buy a whole life insurance policy if you don’t need the insurance piece to begin with.

There’s a lot of information here, but it’s important.  I hope you use this post as a reference in the future as needed.

The Sales Gimmicks Life Insurance Salesmen Use are Just That- Gimmicks

A good salesman wouldn’t get very far without some good stories to convince (or worse, to scare) you into buying a whole life insurance policy. When I discussed my previous article with two sales reps from reputable life insurance companies, I heard several common reasons that they use to convince people to invest with them.  Let’s walk through them one by one – consider this your one stop shop for turning away a whole life insurance salesman.

Reason 1: Withdrawals from Life Insurance Investments are Tax Free

I start with this one because, frankly, it’s the best argument out there in favor of investing in life insurance.  It’s true- when you invest in life insurance, the policy builds up a “cash value” from which you can withdraw on a tax-free basis.  This “cash value” is the investment component of a whole life insurance policy.

Is it the only tax free investment out there?  Absolutely not.  In fact, there are several other options out there if you’re looking for a way to have tax free income in the future:

  • Roth IRAs are by far the most common type of tax-free accounts. There are annual contribution limits ($5,500 per year for millennials) and income limits (you have limited eligibility to contribute to a Roth IRA if your income exceeds $118,000 for individuals and $186,000 for couples in 2017).  But, if you are eligible to contribute to a Roth, this is my recommended tax-free-growth investment of choice.
  • Municipal bonds are investment vehicles that allow you to lend money to cities or towns, in exchange for interest payments. Those interest payments are tax free at the federal, state, and local level.  These aren’t particularly good long term growth investments (although we’ll compare their performance to whole life policies in a little bit). But if tax free income is what you’re after, a series of good, investment-grade municipal bonds will do the trick.
  • There are several other investment options that aren’t completely tax free, but are significantly tax-advantaged compared to more traditional mutual funds. Specifically, these include:
    • US Government bonds (taxable by the federal government, but not state and local governments)
    • Dividends– Investing in high-dividend, blue chip stocks that pay dividends isn’t tax free, but stock dividends are taxed at much lower rates than your standard income tax for most investors.  (As a side note, a “dividend” is like an interest payment that some companies pay to investors who own their stocks).

Yes, investing in whole life insurance gives you some tax advantages down the road.  But, so do other investments – and these alternatives don’t have the disadvantages of whole life that we’ll address at the end of this post.

Oh yeah, and did the life insurance salesman you were talking to about one of these policies mention that even though the withdrawals are tax free, you’ll be charged interest when you draw down the cash value of your life insurance policy?

I didn’t think so.

Reason 2: Whole Life Insurance Investments are a Good Way to Diversify

I get it, this sounds appealing at the surface.  “I’m putting most of my money into stock and bond mutual funds, and I know I shouldn’t put all of my eggs into one basket, so why not put a portion of my investments into a life insurance policy?”

Nope.  This one doesn’t work at all, for two reasons:

  1. If you put 20% of your portfolio into a life insurance policy, that means you are entrusting a single company with 20% of your assets. What if the life insurance company who runs the policy goes bankrupt in 10 years?  What happens then?   It might be a different type of investment vehicle, but you shouldn’t let a large percent of your portfolio ride on the successes of any one company.
  2. The way whole life insurance policies work is that you give your money to the insurance company, they invest the money for you, and direct a portion of it to build your cash value in the policy (the “investment” component), a portion to cover the policy’s death benefit (the “insurance” component), and a portion to cover their operating expenses.  How are they investing your money?  In the same stock and bond mutual funds that the rest of your investments are in.  If all of your money is invested in the same stuff, it doesn’t matter that the life insurance agency is the middle man.  Adding the middle man doesn’t really diversify you.  And remember, you’re losing a portion to cover their business expenses.

Next.

Reason 3: Everybody Needs Insurance

No, no they don’t.  I addressed this one in my last article.

If you have a family member (spouse, child, etc.) who depends on you for income, you need life insurance.

If you have a large debt that needs to be paid off (like a mortgage) even if you were to pass away, you need life insurance to cover that debt.

If you don’t have any financial obligations that would need to be covered if you were to die, you don’t need life insurance.  Period.  That might change in the future, but you don’t need it now.

But even if you do need life insurance, a term life insurance policy will do just fine for almost everyone.  In a term insurance policy, you specify how long you want the coverage to last.

Which is a good thing.  And, in fact, the entire point.  Most people don’t need life insurance in their 80s and 90s.

Once you’re retired, most people don’t need life insurance.  If your mortgage is paid off, your kids are grown and supporting themselves, and you’re living off of your retirement assets and managing them well, there’s no need for you to have insurance.  So, why pay for a whole life insurance policy that will be many multiples more expensive than a term insurance policy, if you won’t need the insurance coverage when you’re most likely to die?  It’s just a waste.

Reason #4: Whole Life Insurance Is a Good Investment for Some People

Sure.  Maybe.

But not for your typical millennial.

Whole life insurance policies can be a good way to transfer money to your heirs.  If you don’t have heirs (or a ton of money to leave them), like most people who read this blog, this doesn’t apply to you (yet).

And, as we’ll discuss in a bit, two of the three big downsides to investing in whole life insurance are that the premiums are very expensive, and you’re essentially locked into paying them for life.  You might be able to afford to pay these insurance premiums now, but what happens if you lose your job?  Or when you have children?

Simply put, there’s too much uncertainty about how the future will play out for millennials to invest in something like whole life insurance.

Reason #5: Life Insurance Salesmen Tout the Investment Benefits of Whole Life Insurance, but You’re Better Off Investing Elsewhere

The last common thread I heard when debating whole life insurance with these salesmen is that life insurance is a good part of an investment portfolio is that it’s “safe” or “guaranteed”.  We need to do a deeper dive into this one.

Yes, there are some guarantees associated with the buildup of cash value in a whole life insurance policy.  But, are they really better than the alternatives?  Let’s take a look:

Whole Life Investment Performance is Hard to Verify

In most cases, the performance of the underlying investments in your life insurance policy don’t match the stated rates of return that the company projects.  In fact, I’m not sure I’ve ever seen a whole life policy who’s actual investment return matches the projections the salesman showed you when (s)he tried to sell you the policy.  Finding the actual returns usually involves submitting an official request to the insurance carrier.

I spent more time than I’d like to admit trying to go through data to find a good data set to show actual performance of a sample whole life insurance policy.  Turns out, this isn’t data that the big companies like to advertise.  I could only find one set of data that looked reasonably accurate based on my experience in the industry, for a hypothetical 35 year old taking out a $100,000 whole life insurance policy:

A few things to notice here:

  • The average annual return for the policy from age 35 – 83 was about 5.5%. Not great, but not terrible for a conservative investment, right?
  • But, notice that the breakeven point (the point where your cash value is the same as the amount you pay in every year) doesn’t occur until about year ten! That means, this investment is guaranteed to lose money for you for the first ten years you have it!
  • The good returns don’t kick in until after the person who holds the policy is expected to die!
  • The premiums are expensive! On that note…
Investing in Whole Life vs. Buying Term Insurance and Investing the Difference

It’s time to get down to business.  I’ve made theoretical arguments about why investing in life insurance is a bad idea.  Let’s see some numbers to back it up.

I’m coming at this analysis from the perspective that if you’re considering investing in whole life insurance, you a) like the idea of investing conservatively, or b) like the idea of tax free investments.  So, the investment models I outline below aren’t my typical recommendations – instead, they are made with these specific goals in mind.

Simply put, can we come up with an investment portfolio with these qualities that is projected to beat the performance in the table above while also buying term insurance to make sure you’re fully insured?

Let’s take a look at two cases:

Case 1: Buy Term and Invest the Rest in Municipal Bonds

We’ve already discussed that municipal bonds are tax free, and, like “guaranteed” life insurance investments, are also appealing to risk-averse investors.  How does a municipal bond portfolio compare to a whole life insurance investment?

Take a look at the table below.  Here, we’re comparing the value of the same whole life policy we saw before with a comparable 20 year term life policy.  Notice the premium for the term life policy is about 10% of the whole life premium.  We’re taking the difference between the premiums and investing them into a municipal bond portfolio.  Since the historical average return on a good municipal bond is about 5% (rates are lower than that right now, but they’re rising), we’re assuming that the portfolio will pay 5% interest a year, tax free. Let’s take a look at how the portfolios would compare, if the investments perform as they have in the past (which, of course, is not a guarantee):

Twenty years later, the whole life policy is still underperforming a tax free municipal bond portfolio.  All while getting the insurance coverage you need.

Case 2: Buy Term and Invest in Dividend Paying Stocks

Municipal bonds are all well and good, but what if you’re a relatively conservative investor, still concerned about taxes, who wants to dabble in the stock market?

Let’s run the numbers one more time, this time against a portfolio of ten of the most boring stocks I can think of.  First, a disclaimer:  I like investing in individual stocks, but only as a complement to a more well-diversified portfolio.  You shouldn’t put 100% of your investments into the kind of portfolio I’m about to show below.  But, if you’re thinking about putting 20% of your portfolio into a life insurance policy as an investment, something like this might be an alternative worth considering for a small portion of your money.

What counts as a boring stock?  Specifically, I’m thinking of massive companies with a long track record of success that generate reliable dividend payments to investors every year.  In this analysis, we’re looking at big companies across many industries: Chevron, Aqua America, John Deere, Wells Fargo, Pepsi, AT&T, McDonalds, Johnson & Johnson, Disney, and Proctor and Gamble.  Pretty boring companies, right?  (Ok, maybe Wells Fargo has been less boring of late.  But you get my drift).

The average annual return for these stocks, combined, over the past 20 years?

8.96%

Again, past performance does not equal future returns.  But given that the 8.96% takes some good years (the late 1990s and the past five years) and some bad years (the early 2000s and of course the market crash in 2008-2009), it’s not the worst point of comparison against how this particular whole life insurance policy performed.

So, what does this comparison look like?

Now, keep in mind that this portfolio is taxable.  So, taxes will reduce these numbers a bit.

But, hopefully I’ve made my point.  There are better long term ways to invest than either of the options I presented here.  But starting from the perspective that a) you need to have insurance, and b) we want to invest in either tax free and relatively safe ways (municipal bonds) or in relatively secure companies (my “boring stocks”), whole life insurance just doesn’t hold up.

Whole life insurance is a bad investment.  Period.

A Bonus Three Reasons to Hate Whole Life Insurance

In my conversations with life insurance salesmen, there are three key points that they didn’t bring up as reasons to invest in their policies, even though they are critically important.  See if you can figure out why they might not have emphasized these characteristics to me…

Whole Life Policies are Complex

If you’ve made it this far, you’ve seen a lot of information on whole life insurance policies and are possibly (or even likely) overwhelmed with the details of these policies.  How does cash value build up in a life insurance policy?  Wait- what exactly is cash value in the first place?

There’s a lot to these policies.  It’s way more complex to invest in life insurance than it is to invest in just about anything else.  And, in my opinion, complexity doesn’t give you any value here.  It actually does the opposite.

In the spirit of Newton and Archimedes, I’d like to call this Nelson’s First Principle of Personal Finance:

“The more complex the investment, the worse it is for the average investor”

And whole life insurance policies are certainly on the “complex” end of the spectrum.

You’re Locked into Whole Life Policies

If you buy a whole life policies, you’re typically locked into paying these high premiums until you’re 100 years old.  If you miss a payment, your policy will lapse.  And, you could lose the “benefits” that made you buy the policy in the first place.

If you’re a young investor, this should scare you.  If you don’t know for sure where your life will be in 10 or 15 years (spoiler alert: you don’t), you shouldn’t mess with locking into a policy that (as we’ve seen) has poor returns for the first several years.

I’ve already shown how your investment returns could be greater by buying term and investing the difference.  And that analysis assumes that you don’t let your policy lapse.  If you do, the difference is all the more clear.

Life Insurance Salesmen Have Huge Incentives to Sell Whole Life Insurance (And Have No Incentives to Sell You Term Insurance)

I point blank asked a life insurance salesman how much more he gets paid to sell a whole life policy than a term life policy.  They didn’t even know, because their pay for selling term life insurance is so low that they’ve never bothered to sell one.

This is a HUGE problem.  Life insurance agents are paid way more to sell whole life policies than term life policies.  A “financial advisor” who works for a life insurance company has zero incentive to show you a portfolio of term life insurance and a municipal bond portfolio like the one I showed you before.  Zero.

There’s a reason that trust in the financial services industry typically polls somewhere around levels of the criminal justice system.  And selling bad life insurance policies to people under the age of 40 is, in no small part, a reason why.

This is a huge part of the reason I started my own firm, among many others.  I believe that the best financial advice you can receive is paid based on a level fee.  In other words, the fees you pay should not vary depending on what the advisor recommends to minimize conflicts of interest.  Life insurance salesmen don’t operate that way.

Conclusion

There’s a lot here.  But this stuff is important.

It can be very easy to be talked into investing in life insurance.  The facts and figures salesmen use make it seem appealing.

But unless you’re in the top 1%, you should get your insurance needs covered with a term policy.  There are better investment options elsewhere.

Thinking About “Investing” In Whole Life Insurance? Don’t!

Last month, I put out a request on social media for topic suggestions to write about on this blog.  The most common request I received, both via email and comments on my request, had to do with life insurance.

And for good reason.  Life insurance companies dominate the airwaves with ads, and sponsor sporting events across the country.  If you’ve ever been to a networking event or business mixer, odds are you bumped into multiple life insurance sales reps.  Insurance is a topic that seems to come up everywhere.  And it’s not something that most people were ever taught about in school.

There’s a lot of information out there about life insurance. A good chunk of it, in my opinion, is misleading, at best.  The good news is that if you do a little homework, this is a relatively straightforward issue for most people.

Unless you are in the top 1% of earners and are nearing retirement, run like hell if someone tries to sell you a whole or permanent life insurance policy.  For millennials, buy term insurance or don’t buy at all.

You Need Life Insurance If…

Let’s keep this simple.  If you just graduated college and aren’t married, you probably don’t need life insurance at all.

You need life insurance when you…

  • Get married
  • Have a child
  • Buy a house and take out a mortgage
  • Generally, you need life insurance when you have a financial obligation that would still need to be met if you were to pass away unexpectedly

In other words, you need life insurance when there is actually a need for you to, you know, have insurance.

This seems inherently obvious.  But, as we’ll get to in a bit, if you sit down to meet with a life insurance salesperson, they’ll likely primarily emphasize the investment benefits of a whole or permament life insurance policy, rather than the insurance itself.  I can’t say it enough, my advice to you when that happens: run like hell.

Types of Insurance

One more thing we need to run through before we talk about why I dislike most life insurance products.  And that is, the difference between the types of insurance itself.

Term Insurance

Term Insurance is insurance that is good for a set length of time, typically from 10 – 30 years.  If you pass away before the insurance expires, your family gets the specified amount of the policy.  If you pass away after the insurance expires, no benefit is paid out upon your death.  Think of it as “renting” life insurance for a set period of time.

In almost all cases, this is the type of insurance I recommend to people who need life insurance.  The reasons are numerous:

  • It’s much less expensive than other types of insurance policies
  • It’s temporary. Life insurance salespeople often argue that the temporary nature of term insurance is a reason not to get it. They couldn’t be more wrong.  Very few people need life insurance once they hit retirement.  Let’s walk through the reasons I specified as reasons to get insurance above:
    • You get married- you need insurance to replace your income if you were to pass away unexpectedly. Once you hit retirement, your income typically goes to zero anyway.  So, get a term insurance policy that lasts until retirement, and expires afterward.  Typically, there’s no need to pay for insurance beyond that point.
    • You have a child- you need insurance to cover the cost of raising your child and to pay for college. So, get a 20-25 year term insurance policy when your child is born to cover that amount.
    • You take out a mortgage- you need insurance to make sure the mortgage is taken care of if you were to die. So, get a term insurance policy that matches the life of the mortgage.
    • Generally, you need life insurance when you have any sort of financial obligation that would still need to be met if you were to pass away unexpectedly- get a term insurance policy that matches the length of the commitment.

Think of it this way: you get health insurance to make sure that you are adequately protected in the event something bad were to happen to you.  Life insurance should work the same way.  Quite frankly, if the money is “wasted” in that you never actually have to “use” either your life or health insurance policy, that’s a good thing!

Permanent Insurance

Permanent Insurance, of which Whole Life Insurance is the most common type, does not expire.  These types of insurance policies (of which there are numerous variations that work slightly differently) will automatically pay a death benefit when you die, and they do not expire as long as you continue to pay the premiums.

When you hear people refer to “investing” in life insurance, this is the type of policy they are referring to.  The premiums you pay are invested by the insurance company, who in turn passes on a portion of the resulting gains to you in the form of a “cash value”.  This cash value is an amount of money you can either take out of the policy to pay for [insert financial need here], or kept in the policy and paid out as a life insurance benefit upon your death.

See the problem here?  Keep reading…

Why I Hate Permanent/Whole Life Insurance Policies

Let me count the ways…

  • They’re expensive. Premiums for whole life policies can be significantly higher than term insurance policies.  I’ve seen quotes for whole life insurance be 10x higher than quotes for 30 year term insurance for the same person.
  • They’re complicated. Go back and re-read the paragraphs I wrote summarizing permanent insurance policies above. “Cash value”.  “Death benefit”.  Quite frankly, it was really freaking hard for me to summarize permanent life insurance policies in just a couple paragraphs, and I still ended up using technical terms.  Not to mention I didn’t get into any of the details.  These policies are incredibly complex, and it can be very easy for salespeople to highlight the alleged benefits of the policies and gloss over the complicated details.
  • Life Insurance is an inefficient way to invest: If I were to ask you to come up with a good way for you to invest your money, your answer would probably be a variant of “put my money into the stock market” or “buy a few stocks or bonds”. What you probably wouldn’t come up is the following: “I think it would be a great idea to pay my money to an insurance company, have them invest the money I give them into the stock market, that investment will make money, then the insurance company will take the profits from the investment, keep a portion for themselves (since, after all, they’re in business to make money), and then give me the remaining share”.  Your gut is probably telling you that that last sentence is insane.  Your gut is right.
  • It’s hard to take money out of life insurance: If you were to ever need to access money you have invested in the stock market, almost all of the time you’re able to get your money into your checking account within 24 hours. Money that’s “invested” in a whole life policy is much less liquid- meaning that it’s much harder to take money out of the policy than it would be for other investments.
  • “Guaranteed” does not equal “Better”: Whole life insurance generally has a “guaranteed” investment return associated with the cash value of the policy. Very conservative investors tend to highlight this as the primary reason to invest in a life insurance policy.  The only issue?  These guaranteed returns are usually way below the historical average for investments in the market.  Again, investing in life insurance is just a terribly inefficient way to invest.
  • Hidden Fees and Commissions: Finally, there are a lot of hidden fees and charges baked into the premiums you pay for whole life insurance. And, they can be huge.  Frequently, the life insurance salesperson who tries to sell you whole life insurance gets paid 100% of your premium for the first year you buy the policy, and a good cut of the premium each year thereafter. No wonder these life insurance reps almost always recommend whole life insurance over term insurance!  Simply put, life insurance salespeople are paid an astronomical amount to push whole life policies, even when term life insurance may be more appropriate.  Just say no.
So, What to Do?

If you need life insurance, find a fee-only insurance agency or financial planner to discuss appropriate coverage amounts.  “Fee-only” generally means that the advisor isn’t paid by commission and charges a level fee regardless of what you buy.  This helps to put you and the advisor on the same side of the table and removes conflicts of interest, to allow you to get the best advice possible.

An advisor who charges a flat fee is able to analyze your situation and get paid the same amount regardless of what type of policy they recommend.

And whatever you do, look for low-fee, low-cost term insurance first when you are considering life insurance.  If you want to invest, invest in the stock and bond market.  Use your life insurance for just that- life insurance.  Your wallet will thank you!