WCI #2: Everything You Need to Know about Whole Life Insurance

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011.

Here's your host, Dr. Jim Dahli. Welcome to podcast number two here at the White Coat Investor.

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We're trying to have a lot of fun with this new podcast. It's a little weird if you've never done this. All I'm doing is sitting in my dining room with a microphone in front of me and my computer in front of me and trying to come up with something interesting for you to listen to. Very interesting task if you've never done it before. I'm sure as we go along through these that I'll become a little bit more polished and we'll get better at editing them, but I hope it consists of very high yield information for you. There's a few reasons that we're doing this podcast. One is to try to get this valuable information out to a new audience. What I discovered when I wrote my book a few years ago is there's an entire segment of people who are willing to read books who aren't willing to read blogs. And so we were able to get the message to a lot more people by getting into a book and selling it on Amazon. Also, we're looking to have a little bit of fun here and this is kind of a fun format to do a few things that we're not able to do on blogs and not able to do when I go out to speaking engagements and that sort of thing. But mostly I want to reinforce the ideas that are on the website, in the book, in the monthly newsletter, which is free by the way, if you haven't signed up for it. In fact, everything on the website's free and also a chance to do a lot more of the question and answer type format that we get. We get lots and lots and lots of questions. I can't write a blog post about every one of them, but hopefully I can answer a few more questions using this format. Please send us feedback so that we can improve this podcast. I expect each podcast will be better than the last. And a lot of that comes from you guys telling us what we're doing wrong. We also, even if you think we're doing a few things wrong, would appreciate you giving us a great rating so that we can help spread this message to others. Before we get too far into this, I'd like to put forth a disclaimer. Just for those of you who aren't aware, this is pretty prominently displayed everywhere else, whether it's a speaking engagement or whether it's a book or whether it's on the website. But I am not a financial advisor. I'm not an attorney, I am not an insurance agent. And you should be aware of that. Consider this conversation a discussion with somebody in the doctor's lounge that knows a little bit more about the subject than you do. If you lose hundreds of thousands of dollars by acting on something that you learned on this podcast, that's not my problem. So be sure to check anything you learn with the source you consider reputable, whether it's a financial professional or whether it's going to the direct source documents such as on IRS.gov or elsewhere. All right, today's subject that I thought would be appropriate to hit is whole life insurance. And I've got this reputation with whole life insurance on the Internet that I am one of its biggest bashers. The truth of the matter is, I don't hate whole life insurance. What I hate is the way it is sold. This is one of those products that is sold, not bought. Nobody goes out looking for a product like this going, boy, I wish I could find an insurance product that would give me insurance for my entire life that I could borrow against. And that gave me really low returns and paid high commissions to the person selling it to me. Nobody asked for that. And so it takes basically an army of commission salesmen to sell this product across the country. What is whole life insurance? Whole life insurance is basically a combination of a lifelong life insurance product that pays a death benefit when you die. No matter when that might be, whether that is in, you know, when you're 40 or whether that's when you're 90, it's going to pay. And the other aspect of it is basically a low returning investment account. And they meld these two products together, which allows you to do a number of creative things with it. But the problem is it becomes a very expensive product that keeps you from being able to put your money to better uses. Whole life insurance is sold in a number of different ways. And in fact, it's really pretty impressive how good the salesmen who are pushing this product are. Part of the reason why they work so hard to sell it is because the commissions on it are so darn high. A typical commission for a whole life insurance policy is 50 to 110% of the first year's premium. So if you're buying a policy that you're putting $25,000 a year into, that guy might be getting paid $25,000 to sell it to you. Now you know why he's giving you such a hard sell. But they'll do, they'll kind of do the sales in a lot of different ways. For example, they may talk about how nice it is to own your death benefit rather than renting it with term life insurance, because if you die after your term runs out, well, it's gone and you didn't get anything. It was just wasted money. Well, that's obviously a bunch of bunk. You want your life insurance to expire unused unless you really want to die young. That's not necessarily a bad thing. And just like when sometimes it's better to rent your house than to own it, sometimes it's better to rent your life insurance than to own it. A lot of insurance agents will push it as an extra retirement account. Some even, even call it just as good as a Roth ira. Well, it obviously isn't. There are some tax advantages associated with a whole life insurance policy. The main one is the fact that the cash that the death benefit is tax free. But compared to what you get in a typical tax deferred or tax free retirement account, it just pales in comparison. It's a far inferior tax benefit when it comes to retirement accounts. Some agents push it as a college savings account, which I think is pretty idiotic, to be honest. I mean, it often takes 10 to 15 years just to break even on the cash value on a whole life insurance policy. And most people who are saving for College only have 10 or 15 years to save anyway, 18 at the most. And so you're just not seeing any kind of a high quality return that you're looking for on that college savings money. You're far better off using a 529 plan or even an education savings account to save for college. Some agents push it as an asset protection benefit, and that's true in many states. Obviously you should look up your own state's law because some states don't give it any significant asset protection. But in most states, the cash value of your whole life insurance policy is protected from your creditors. Of course, you got to keep in mind that the likelihood of you being sued for more than your, for more than your policy limits is pretty low. I mean, I think I calculated it out for an emergency doc is about 1 out of 10,000. And so the likelihood of you actually needing that asset protection is very low. But if it's worth it to you to have some money that's protected from your creditors, that's not a terribly unreasonable use of a whole life insurance policy. Just realize what you're getting up to, give, giving up to get that. It cannot. It is also often pushed as something that's really necessary for estate planning. And they just kind of leave it out there as vague statement that it's good for estate planning. But when you actually look into how it should be used for estate planning, the way they're selling it to you doesn't make any sense. For example, most people aren't going to have an estate tax problem unless you are going to have more than five and a half million dollars in your estate when you die, or double that if you're married. And bear in mind those numbers under current law are indexed to inflation. You simply don't have an estate tax problem to worry about unless you're in one of the few states that still has their own estate tax with a lower limit than the federal limit. But the way people use life insurance in estate planning is they put it inside an irrevocable life insurance trust. They basically give the money away from their so it's not in their estate when they die, and then they can buy life insurance inside the trust. And that's a reasonable thing to do if you have an estate tax problem. But the problem is you buying a policy when you're 30 that isn't inside an irrevocable trust doesn't do anything for that whole. Life insurance is often sold to people who either already fear or are taught to fear stock market volatility. And so they're told this is a safe asset. It doesn't go down in value. You don't have to deal with the ups and downs of the stock market. Well, the problem with that is you don't get the benefits of the stock market either. You end up with terribly low investment return on the cash value portion of the policy. In addition, they talk about it not going down in value. Well, what about that first year you put $25,000 into the policy and all of a sudden it's worth 10 if you actually want your money back. I mean, that's a terrible loss that's way worse than what you see in a bad bear market. And so this idea that never goes down in value is just false. Some people use whole life insurance as a way to do what they call banking on yourself or infinite banking. This is basically overfunding a policy early on, trying to get it to the break even stage in just five or six or seven years, and then borrowing against it to buy anything that you happen to need. For example, borrowing against it instead of borrowing from a car loan, or borrowing against it to pay for schooling, or to borrow against it to buy a second home or whatever. The truth of the matter is, you're often able to borrow at much better terms from a bank than you are from your own life insurance policy. But if this is something you really wanted to do and you really understand how it works, and you buy a policy that's actually designed to do this, it's not a terribly unreasonable thing to do as long as you're maxing out your other available tax advantaged accounts. The real problem with the way whole life insurance is sold is it's sold to people who have much better uses for their money. For example, I keep running into docs who have been sold a whole life insurance policy and they still have student loans at 6.8%. Well, their whole life insurance policy isn't going to have a better return than that. They'd be better off paying off their student loans, and many times they'd be better off paying off their mortgage. These docs oftentimes don't even know what a backdoor Roth IRA is. They might not even be maxing out their 401k because they're spending all this money on a stupid whole life policy that's given them a 2% return. It just doesn't make any sense. It's also sometimes sold to people who would honestly rather spend their money on something fun like an expensive vacation or a wakeboat or whatever that might be. And the truth of the matter is, if people have got enough money saved for retirement and their other financial goals, they don't need to be saving more for it. And to encourage them to do so should be financial malpractice. They ought to use that money for things that will make them happier. Now, now, I think it's worthwhile examining for a minute what returns you can expect out of a whole life insurance policy. Now, if you bought one back in the 80s when interest rates were really high, you may have done okay. Over the last 30 years, I've seen some where people made about 7% a year that bought them back in the 80s. But if you're buying a policy today, if you run the numbers out to your expected death, basically your life expectancy for 40 or 50 years, you will find that the company is guaranteeing you a return over that time period. If you stay invested the whole time of about 2% per year, they're projecting a return somewhere around 4 or 5 or 5.5%. And what I would expect out of the policy is probably somewhere in between those two numbers, maybe 3 or 4% a year if you hold on to it for your whole life. Now, if you bail out of the policy early, you're almost surely going to have a worse return. And that's part of the issue. You're literally committing to tie your money up for the next four, five, six decades. And I think you ought to be paid a little more than 3 or 4% if you're going to be asked to do that. I mean, that's not very much liquidity. Now, the benefit of the way people say you should use these as a retirement account is not to cash it out when you get to retirement, but to borrow against it. And this is the big benefit of it, right? That it's tax free. What they don't tell you is you can borrow against anything tax free. If you borrow against your house is tax free. If you borrow against your car, it's tax free. If you borrow against your mutual fund portfolio, it's tax free. Borrowing is always tax free. So that's not something special about whole life insurance. The only thing special about life insurance is that the death benefit is tax free. And so the way they say you're supposed to use this is you borrow against the policy and spend that money that you borrowed and they let you borrow up to a certain amount of it, not the entire death benefit. And then when you die, the death benefit is paid out. First it goes to pay off any loans you had, and then it goes to your heirs or whoever you your beneficiary is. And that is basically the way you're supposed to use this to keep it tax free. And while that is a nice benefit to get a tax free death benefit, it's dramatically oversold by those who sell these things. Now, a lot of people wonder if they should get rid of their whole life insurance policy. And the truth of the matter is that the decision to get rid of a policy is dramatically different from the decision to buy it in the first place. It's entirely possible that that a Policy that was a dumb idea for you to buy is now a good idea for you to keep. And the reason for that is that the poor return years are heavily front loaded in a whole life insurance policy, partly due to the cost of the insurance, but also due to that big heavy commission that the agent gets paid at the beginning. And so if you've been in a policy for 10 years or more, it's quite possible that it's worth holding onto because the return going forward might not be too bad, even though the overall return is pretty crummy. If you do decide that you want to get rid of the whole life policy, there are a couple of other things you can do with it that you might find attractive. For example, some people like to exchange it into a variable annuity, and the benefit of that is that you can preserve the basis for it. So if you are not yet back to even, but you have some cash value in the policy, you exchange it into a low cost variable annuity, such as those available at Jefferson national or Vanguard, and you invest it aggressively. And when the value gets back to the total of the premiums you paid for the life insurance policy, then you cash it out at no tax cost. Basically, you got yourself back to even and got your money back. And so the IRS won't charge you on any of those gains from the time you did the exchange until the time you surrender the variable annuities. And so that's a smart way to get rid of it. Another smart way is you can exchange into the variable annuity and then surrender the variable annuity and claim that loss on your taxes. Whole life insurance has a few cousins. Universal Life, Index Universal Life, Variable Universal Life. These are all pretty much variations on a theme. The goal with the index universal Life and the variable universal life is basically to get you a little higher return than you would expect out of whole life insurance. And that is entirely possible if it's the right person buying this. That means you've already maxed out all your other tax advantaged accounts and you're saving large amounts in a taxable investing account every year, and you're willing to hold on to the policy for your entire life, and you get a good policy, meaning one with good solid, low cost investments that you would invest in outside of the variable annuity or outside of the variable universal life policy, and that has low costs of insurance. So if you can find one of those policies, that's a reasonable thing to do. But it's hardly mandatory. This is totally optional for anybody if they want to do that. And again, it has to be for the right person. This is not for the pediatrician making $150,000 a year, having trouble maxing out his 401k who still has student loans. All right, let's move on to a few questions. This is one that came in on the forum. I believe this came. Oh, no, this one's on a different forum that I read it. This is a gentleman who says, I'm a beneficiary of my father's estate along with my brother. My father had his investments split between Vanguard and Merrill Lynch. At Merrill lynch, the broker had him holding an astonishing number of positions, including individual municipal bonds and dozens of dividend paying stocks. And he's trying to decide what to do with all these individual positions. He gives a few facts. There are 35 equities in the Merrill account worth about 68,000. All them are dividend paying and large cap companies such as Duke Energy or Coca Cola. The sales commission for each stock at fidelity is 795. The New York Municipal Bonds are paying a coupon of 5%, and that's about a third of the total. And he mentions, I'm not a resident of New York because these are New York Muni bonds. But he's trying to decide whether he should sell these assets, whether it's worth the time to research each stock to make a decision about keeping them, or whether he should worry about the 795 cost of selling them. Well, there's something really cool that happens when you inherit some individual securities as of the date of death. You get a step up in basis. That means it's like you bought all those stocks and bonds on the day that the person who gave them to you died. And so you can sell them right away without having to pay any long term capital gains tax. So the general rule, especially inheriting individual stocks like this that are very liquid and very easy to sell and very inexpensive to sell, is to just sell them all and move the money into your own portfolio. So that's what he ought to be doing with these 35 stocks. As far as the bonds, those municipal bonds may not be very liquid, particularly if they're going to mature soon. It may be worth just holding on to them for a few years. The problem is you take such a haircut when you sell some illiquid bonds that it may be worth holding onto them just to avoid taking that loss. Plus, there's not usually a terribly high long term capital gain associated with holding onto those bonds. So since these are relatively low Percentage of this guy's portfolio, it would be reasonable to hold the bonds for a few years until they mature. Now, if they're 30 year bonds, maybe I wouldn't hold them that long. But certainly holding onto them for a little bit, it would not be an unreasonable thing to do. But I'd sell those costs and I wouldn't think twice about the $8 apiece cost of it. There's a reason it's not wise to invest in individual securities and that's because of the lack of diversification. And that's certainly worth paying eight bucks a stock for to get out of this position. All right, next question. I got this comes from someone who says I just sold my med school house and after we deduct taxes and expenses, we have a profit about $40,000. That's great. I'm not sure I would have recommended they bought a house in med school, but I'm glad it's worked out well for them. For many people who bought a house in the last five years in this rising market, they've done quite well. All right, he now says we are PGY1. 3 years residency with possible fellowship for 3 more years. And we won't buy a house until we're done with training, which could be another two and a half or five and a half years. We are dinks, dual income, no kids, and our gross is around $120,000 a year. We're renting now and are planning to do so until we get out of residency. So what he's asking is we are $200,000 in debt. We have $150,000 at 5.5% and $50,000 at 6.8% and no other debts. What should we do with the money? Should be investing it, should be paying down our debts. Should we save it for a down payment for our next house? What should we do with it? Well, there are a lot of good things to do with it. And this is really one of the benefits of having a really good financial plan because it tells you when you come up with extra money what you should do with it. But in this case, the student loans seem like a no brainer to throw this money at. I mean, you can't beat a no risk 6.8% return. But before doing that, this doc needs to make sure that he's not going for public service loan forgiveness. You don't want to be paying off loans that someone else is going to forgive. And so I would hold off throwing it at the loans until you're sure you're not going for public service loan forgiveness, especially for somebody planning to train for six years. I mean, when you come out of that training period, if you just work at an academic center for four more years, all of your student loans could be forgiven. And that's pretty attractive thing to have ahead of you. But if you're sure he doesn't want to do academics, then sure it's reasonable to throw it at the loans and pay those down. But I would probably look a little more carefully into using it to live on while directing my earned income into retirement accounts. For example, if the residency program is offering a Roth 401K or if it's offering or of course you could use back to or a Roth IRA and a spousal Roth IRA to max out those investing accounts and get a start toward investing. That's certainly a very reasonable use of that money. I'm not sure I'd save it for a down payment. It doesn't sound like they're going to be buying a house for three to six more years. That's a long time to have down payment money sitting around that could be used in a retirement account or for paying down loans. I'd probably just plan to save up a down payment later, either late in residency or fellowship or once you become an attending. The other option, of course is you can use a doctor mortgage loan and then you wouldn't have to do. Then you wouldn't need the down payment anyway. And you could use your money for things that are likely to give you a better return, such as maxing out retirement accounts or again, paying off those student loans. All right, the quote of the day for this podcast comes from Robert Dorigozzi, MD. And he says if you do wish to splurge a little to loosen up, do it after there is 1 million in the bank and after the mortgage has been paid. I think that's good advice if you're.

Looking to boost returns, lower taxes, and build wealth. Join the WCI Monthly Real Estate Opportunities List for tips and strategies to maximize your real estate returns and for introductions to exclusive investment opportunities, expect educational emails that introduce you to syndicators, fund companies, online courses, and online real estate platforms. Go to whitecoatinvestor.com Rei Opportunities to sign up today. You can do this and the White Coat Investor can help.

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