More and more people are asking the question, “Is Whole Life Insurance a Good Investment?” What are the pros and cons? As mutual funds and the stock market continue to disappoint investors, there is a gravitation to the safety and guarantees offered by whole life insurance.
I was talking with a client a few weeks ago who had bought a whole life insurance policy from his brother 24 years ago. Just like many people out there, he felt obligated to buy it because his brother was selling it (there’s a good chance you may have experienced this same situation). As the years went on, he continued to do as he was told, invest in stocks and mutual funds.
Fast forward 24 years. As he sat down with me, what he told me was interesting. It took him 24 years to realize that his whole life insurance policy was his best investment. It never lost money, and had outperformed the investments in his 401k (now IRA). He realized that the policy he had reluctantly purchased from his brother turned out to be the smartest financial decision he had made.
So back to the question, is whole life insurance a good investment? For my client, yes. For everyone? Depends…
I can assure you of one thing. A whole life insurance policy will struggle to outperform almost any investment in the first few years of the policy. You will be behind. Why? Because whole life insurance is just that… life insurance. It is not an investment account, and as such, is handled differently. The real benefits of whole life insurance take time, but just like the old proverb good things come to those who wait, whole life insurance needs time to be effective. Here at becomingyourownbank.com we utilize high cash value life insurance to speed up that time as well as the overall growth of the life insurance policy. You can learn more about how we do that here.
Growth of Whole Life Insurance
A study by Mass Mutual (right click to download) illustrates historical policy growth in different scenarios. Actual growth over a 28 year period ranged from 4.49% to 6.52%. When compared to what most people have to show for the last 20+ years, it is safe to say that the growth is very competitive. Its the classic case of the tortoise and the hair.
Even though the growth has been good, there are many more reasons people are using whole life insurance as an investment.
Stock Vs Mutual Life Insurance Companies
Whole Life insurance companies themselves are divided into 2 different types, stock and mutual. A stock company has stockholders, just like most large corporations, and profits are siphoned to these shareholders. As profits come in, shareholders are rewarded. Mutual companies, on the other hand, have no shareholders. Policyowners act as shareholders, and receive company profits in the form of dividends. I like to compare it to making a deposit at the bank, and that deposit giving me credit as a shareholder to receive company profits. A highly unlikely scenario at a bank, but a good example of how a mutual company operates. In looking for a way to maximize the use of whole life insurance as an investment, a stock company does not stand out as the place to go. Mutual companies provide the maximum value to the policy owner, and are an obvious choice to those looking at whole life insurance as an investment.
Whole Life Insurance Guarantees
Another key feature to whole life insurance is guarantees. These guarantees include a contractual, no loss provision, that ensures the cash value of your policy can never be reduced. It also guarantees a minimum growth on cash value every year.
Safety
Many life insurance companies have been around for over a century. Because their primary purpose is to pay death claims, they have no need to take risk with the assets they control. Life insurance companies are known for their ultra-conservative investments, and steady growth. I’ve often heard these aged companies referred to as “13-0.” Meaning they have not only survived 12 recessions and 1 great depression, but were able to produce profits all along the way. The companies we like to use have distributed profits, or dividends, for more than 100 years consecutively.
Tax Advantages of Whole Life Insurance
Dividends inside a whole life insurance policy are considered “return of premium.” This allows the policy to grow without taxation. Even though it appears to have the tax structure of a Roth IRA (tax free growth and distribution), there is one important item it doesn’t share. Government intervention. There are no limitations to a whole life insurance policy like a government sponsored plan. No age limitations, no contribution limits, and no penalties. Handled properly, you will never pay taxes on dollars inside your insurance policy.
The other advantage to whole life insurance is the ability to pass on money income tax free. Beneficiaries will receive the full amount of insurance without the loss to taxes. It can be, however, subject to estate taxes if not handled properly.
The Loan Provision
Another appealing feature of whole life insurance is the ability to collateralize cash value. As part of the whole life insurance contract, the insurance companies is obligated to issue you a loan based on cash value. These loans are not subject to credit approval, income verification, or other documentation, and require no repayment structure. In other words, policy loans are flexible to adapt to policy owner circumstances.
How To Accelerate Cash Value
For those that are more interested in cash value growth than death benefit, it is often wise to accelerate the cash value accumulation of a policy through paid up additions and lower death benefit. By decreasing the death benefit, base policy costs are also decreased, leaving more room for premium to be place in paid up additions and ultimately cash value. It creates immediate cash value and quicker growth. I recommend checking out our whole life insurance resource page to learn exactly how we do this.
So for my client the answer to the question “is whole life insurance a good investment?” was yes, but that doesn’t mean its for everyone.
Jake
Tony April 26, 2012 at 7:23 am
Technically speaking, as well as from a compliance standpoint, WL is “not” an investment vehicle. It is a life insurance policy that has a “savings” component. To say that WL is an investment, implies risk.
Aixa Mangual July 6, 2012 at 4:57 pm
A must read! Esto es parte de lo q hago.
Jake Thompson July 6, 2012 at 11:12 pm
Thanks for the share!
Donna July 30, 2012 at 2:35 pm
I have had a whole life insurance policy,since 1959 The face value $2,500.00. At one point, I took out a loan, then paid it back with interest. The type of Whole Life policy is referred to a “paid up at 65,” which supposedly means the annual premium,of $30.65 no longer needs to be paid. Supposedly, when I die the $2,500.00 insurance policy is given to my heirs. Why should I keep this policy?
Jake July 30, 2012 at 5:44 pm
Donna, what would be the reasons to not keep the policy?
Joe January 8, 2013 at 6:02 pm
Why anyone who thinks taking a loan out on their so called “savings” is a good thing is preposterous. In addition also wrong when the above said, “require no repayment structure”. If the client does not pay back the “loan” with interest then the “loan” amount with the interest will be deducted from the death benefit.
In addition, if the WL policy were to ever laps, be surrendered, any loan taken from the cash value will become taxable as ordinary income.
In my opinion, anyone who says that WL is good, never read the contract.
Jake March 8, 2013 at 12:06 pm
Joe, thanks for your comments… I am just now reading them.
The idea of taking a loan out is pretty simple. Your money is going to grow to X over any given period of time. If you withdraw and use cash, you are stunting that growth. This forces you to keep the money on the path its on. You don’t want to be the reason your money doesn’t grow.
The loan balance coming out of the death benefit is one of the best parts! Where is the downside in paying off a loan with the death benefit?
And finally, yes it can be taxed if you cancel your policy (the whole point is to never cancel the policy BTW, there is no reason to), but the profits are taxed at capital gain rates, not ordinary income…
Sounds like you might need to reread the contract my friend…
Omar March 20, 2013 at 2:31 pm
Awesome article Jake. I’m in the process of converting part of my term life to WL. I’m now in my mid 40s and just saw it as another avenue to add to the nest egg. I was able to also take advantage of my health status when the term life was purchased which helped with the WL premium. I plan to convert another chunk in a couple years. Do you have a listing of best paying dividend companies?
TJ April 26, 2013 at 2:21 am
What I fail to see in the “infinite banking” concept is the advantages over purchasing traditional securities (stocks, bonds, options), leveraging them against loans, and using real-estate and corporations as a tax shelter. Most of these videos seem completely off current loan/interest/appreciation rates without even mention of inflation. I have a somewhat moderate/high mortgage rate at 4.25%, an installment at 6%, student loans at 3.8%, and in the past 3 years have earned 12% in stock appreciation (including dividends). Current whole-life insurance policies have so many hidden fees. Yes, they are tax free and you can borrow against them, but the corporations issuing the life insurance already pay taxes out of your expected return AND your cash value is always lower than your policy. I have a military scholarship for school so my student loans come back to me as a refund. Sure, I could invest in a whole life insurance policy… but why would I miss out on those years of 12% and trade them for roughly 4% (when its all said and done, this is the true realized return of investment on a GOOD whole life insurance plan). I prefer traditional banking methods because I can always borrow against my loans for a more competitive interest rate to pay on other loans, therefore making a profit. Home values rise after 30 years at about a 7% rate on average. Plus, inflation has historically been 2% for a total of 9% rate of return on real estate investments, so any loan under that amount is considered an improvement. For 1000 down I bought my first home with a 620 credit score. Renters pay income, inflation and appreciation go up. 20 years from now my 800/mo mortgage will be at least the equivalent of paying 400/mo now for the same house. Meanwhile, I’m earning 9% annually on $130,000 of borrowed money I paid 1000 for. I can draw against this equity at any time for another loan. If my apr is 4.25% and 9% is my roi, then anything in the ballpark of 5.75% is a profitable loan. Still not sure why whole life insurance is such a big option. Seems more like a sales pitch to me. Anything that doesn’t list disadvantages first should be highly scrutinized.
Jake April 26, 2013 at 10:18 am
TJ – thanks for the comments.
I won’t drag this out, because I think you need to live through a couple stock market cycles and interest rate cycles to appreciate this, but here’s my reply.
The stock market will never produce 12% returns ever year. The last 3 years is hardly representative of history. As a random stat, Nasdaq hit a high of over 5,000 in year 2000. Today is just over 3200. Hasn’t even come close to coming back. Most people don’t do well in the market.
Interest rates are at an all time low. If you lived through the 80s you paid 21% if you were a prime borrower, more if you weren’t. Chances are they will go up again. What you are suggesting above is not a long term approach, and is certainly not predictable.
And finally, a high cash value life insurance policy is completely liquid. At anytime I can take my funds and put them elsewhere. If 4% is not enough, as you say, then that money is accessible, and can be invested. There is no limitation, but it will reduce your tax liability on your gains.
Again, like I say, you may have a little change of tune down the road. Most of the people that embrace this type of strategy have lived long enough to know that what you are planning for has already failed them.
Good luck.
TJ April 26, 2013 at 11:19 am
Ok, so maybe the 12% stock market return won’t happen every year. But, the dow has still risen 7% annually since inception. I cannot bank with a life insurance policy. If I need funds to pay a bill, I immediatly sell a couple shares and it’s done. If I need funds through a policy, it takes at least a few days. Also, from what I gather is that these whole life policies generally just index the S&P 500 anyways, so I’m not seeing the overall benefit. Life insurance is guaranteed through one company, yet equities are guaranteed through many, and most traditional banks are FDIC. If I take a cash value out of my equities months after I invest them, I am either positive or negative. With insurance I am negative unless I wait for a much longer period. Insurance companies can fail like any other corporation and are not necessarily guaranteed to last or provide descent returns throughout the next 50 years of my life expectancy. It seems to me that it’s just like trusting another corporation to handle your money whether its a bank, mutual fund, or insurance they all seem to be the same. However, thank you for your response and I would love to have you convince me otherwise, but I have yet to see considerable evidence proving otherwise. I don’t see a problem with life insurance as a diversification strategy, but to consider it banking seems a little far fetched. Unless they issue checks and debit cards….then i would be more than interested.
Jake April 26, 2013 at 11:31 am
Again, not sure you quite understand it like you might think. There are different insurance products, and whole life insurance (which we recommend) is not tied to an index, or the market. You are referring to Universal Life, which is far different.
A mutual insurance company is owned by its policy holders, so all profits go to us. Most of these companies are over 100 years old, and have produced profits every single year – including during the great depression. Much safer than anything else out there. They don’t take risk, so they will outlast anything out there.
I certainly don’t think this is for you at this point. Give it a couple years, and you may reconsider.