Life Insurance Is Not an Investment

If you are like most doctors, you have most likely encountered the salesman trying to guarantee you a better retirement with variable life insurance products as great investments. You may have even been told that, for you, this is a better solution than even a 401(K) or IRA because of the tax advantages or that you can take loans against it.  I wish you could see my eyes roll as I type this…

The reality is, life insurance does have a purpose.  The general rule of thumb when answering the question of “do I need life insurance?” is to satisfy the following needs:

• Replacement of future income/savings for my spouse/family
• Paying off current debt (mortgage, school loans, credit card, etc…)
• If you have children, covering the cost of their college
• If you have specific charitable intent
• If you have specific legacy goals.

Most often, these can all be covered through the use of very cost-effective term policies. A term policy is purely LIFE INSURANCE.  There is an obvious omission from the above comprehensive list of needs for life insurance: Investments.

Insurance is one of the most expensive products to invest in. When that salesman was showing you the best case scenario with huge cash values, what was most likely left out was the worst case scenario that included all the fees. And they probably also forgot to tell you about the huge commissions they would get if you agreed to “invest.”

Because of this, I thought it would be helpful to peel back the layers of costs that are associated with life policies and how they impact the retirement you thought you were “guaranteed.”

1. Cost of Insurance (COI) for death benefit Claims
2. Fixed Administration Expense (FAE)
3. Premium Loads
4. Cash-Value-Based “Wrap Fees”

So, while many whole life policies guarantee a 2% return, that return is easily eroded if the market doesn’t significantly outperform the embedded costs of the policy year-over-year.  The other unfortunate part of the sales process is the annualized return that is shown. I have seen these as high as 10% annualized returns shown, which does show incredible cash values by the time you are ready to retire. Unfortunately, this is gross return, and grossly misleading. What is not considered is diversification of the investments in the cash value of the policy (they will show the most aggressive), and also the realistic volatility in the market. Often, the fees above can be as much as 5% or more annually. And, most of the fees are paid early in the policy (to pay commissions, etc…), which aggressively deteriorates the 8th wonder of the world called compound interest.  

So how can you know if you were sold a policy you don’t need?

• Were you told there is a great tax benefit to owning a whole life policy?
• Were you told a whole life policy is a great way to guarantee a great investment return?
• Were you told you could “bank on yourself” and borrow against the cash value?
• Were you told this is a great way to pay for college for your kids?
• Were you told whole life policies provide the best way to pass assets to your heirs tax-free?
• Were you told whole life is better than term because term expires without paying anything?
• Were you told whole life investments are “safe, liquid, tax-advantaged, creditor-proof, or competitive return”?

The good news if you were sold one of these policies early in your career is that you probably have accumulated some cash value.  The better news is often you can roll that cash value into an appropriate policy that will provide a completely paid up premium and increase your death benefit. This does a few things. First, it will free up cash flow to actually make appropriate investments that complement your financial plan. Next, it will most likely double the amount of death benefit you have. Lastly, you will reduce your costs substantially.

Or, in some cases, you may actually be approaching some significant milestones in your net worth that warrant some complex estate planning. This is actually an area where whole life policies can make sense, but would ultimately have to be converted to maximize your benefit.

First, you will be converting the whole life policy to a Survivor Indexed Universal Life (SIUL) policy, then placing that policy in an ILIT (Irrevocable Life Insurance Trust). The reason for the conversion is an SIUL will be based off the value of the index vs the dividends paid from the whole life policy. Next, you benefit because the death benefit that is paid to the ILIT will be free from inclusion of the gross estate of the insured, and if drafted properly, the death benefits can ultimately be used to provide the required liquidity to pay estate taxes, as well as other debts and expenses. This strategy does actually provide significant tax benefits if you expect to be in a taxable estate upon passing. But this also does require some advanced estate and financial planning that the typical insurance agent is not qualified to provide.  

In closing, remember that investments are investments and insurance is insurance.  Keeping them separate is generally the most cost-effective way to both grow and protect your net worth. Always remember: your financial plan should focus less on your “portfolio and returns” and more on your financial structure and outcomes.