What You Need to Know About Whole Life Insurance – Episode 25

Dentists are often approached by life insurance brokers to purchase life insurance as a retirement savings plan. Whole life, variable life, or universal life. What are the arguments for using these types of policies? What are the arguments against them? In this episode of Dentist Money™, Reese and Ryan provide a fresh perspective on how dentists can approach life insurance decisions with more confidence.

Podcast Transcript:

Reese Harper: Welcome to the Dentist Money™ Show, where we help dentists make smart financial decisions. I’m your host, Reese Harper, here with my co-host, Sir Ryan Isaac.

Ryan Isaac: Hi Reese!

Reese Harper: Howdy, partner! How do you like our chances today? Are you feeling good about the show?

Ryan Isaac: I am. I think it is going to be a good show, per usual. Today, we are going to talk about life insurance, which tends to raise a lot of questions.

Reese Harper: Yeah, there are a lot of different opinions out there about the type of life insurance policy a dentist should own, how much, what kind, you know?

Ryan Isaac: Yep. We are going to do our best to set the record straight on that today, and in preparation for this, I thought I would check to see how long life insurance has been around and what got it started in the first place.

Reese Harper: Yeah, I imagine it was some insurance agent that walked up to some guy and said, “hey, I have a little bucks that says you are not going to die ahead of schedule. All you’ve gotta do is take a physical and pay be a little bit of money every month.”

Ryan Isaac: Yeah, just place a bet, something like that (laughs). No, from what I read, it all started in Ancient Rome, actually.

Reese Harper: Of course, as did most things in life.

Ryan Isaac: Yeah. There was a Roman military leader, and he created a burial club among his troops, so in the event of an unexpected death of a club member— which is kind of funny, an unexpected death among troops, I thought that was interesting— but the other members would pay for the funeral expenses.

Reese Harper: So, we are looking out for the soldiers families? Is that what is happening, so they wouldn’t have to pay for it?

Ryan Isaac: That would be intuitive, but not really. It actually had more to do with the fact that Romans believed anyone who was buried improperly would actually become an unhappy ghost (laughs).

Reese Harper: Of course. Also a very good reason.

Ryan Isaac: You don’t want to be an unhappy ghost. But the concept went away when the Roman Empire fell about 450 AD, so…

Reese Harper: So you are saying it died then?

Ryan Isaac: (laughs) yes. Life insurance literally died, okay?

Reese Harper: Just making sure I heard that right.

Ryan Isaac: You did. It took awhile for it to come back, but there were some policies offered in England in the 1600s, and then the American colonies started doing it in the 1700s. But then a lot of the large mainstay insurance companies that we know about today, they were formed in the 1800s. New York Life, Mass Mutual, John Hancock, MetLife, so…

Reese Harper: Yeah, you were telling me that some of the preachers back in the day didn’t like it.

Ryan Isaac: Yeah. They said it was the same as gambling. I mean, that is kind of interesting, but yeah. I think most of them have come around to the idea of insurance now. So, to get this conversation started, let’s start with the amount of coverage a person should have, and then we can move on to the different types of life insurance policies.

Reese Harper: Sounds good. This is something we spent a lot of time talking about. One of the financial elements that we analyze on a regular basis is called risk rate, and we do a deep dive into our clients’ risk management, or insurance coverage, and other types of risk. Life insurance is a big part of that, and we definitely have an opinion on how to calculate it.

Ryan Isaac: Yeah, right. So there is sort of this peace of mind aspect to knowing you have enough coverage, but there is also an economical side to it. So, we have been able to save our clients a lot of money by helping them understand what is and what isn’t worth paying for in there insurance. So Reese, give us a good rule of thumb for how much life insurance someone actually needs.

Reese Harper: Okay. The you need is driven by your current personal spending, what you spend in a year, and your other existing assets. Some people just take a random stab at it, and other people are more precise with their calculations. In our opinion, the ideal coverage amount is whatever allows your surviving family members to maintain the lifestyle they are used to having. So, that is how we calculate it.

Ryan Isaac: Okay, so if you are like, “I’m a poor student, or I just graduated and money is really tight,” then maybe just choose a coverage amount that represents the lifestyle you would be comfortable with for your family.

Reese Harper: Yeah, exactly. And to calculate how much you need, you take the amount of money you would like your family to have each year and multiply it by 30. This is the total amount of assets you would want to leave your family if you were gone. What that will do is it will basically allow your family to have a chunk of money big enough to support the way that you want them to life, or the way that you are currently living. You probably don’t need this entire amount, though, because you have some existing assets. You can subtract your investments, your cash, or the amount you have in retirement plans. And if you have any real estate equity in a condo or building for your practice, you can subtract that too.

Ryan Isaac: Okay, well what about the value of the practice itself?

Reese Harper: Subtracting it? I generally wouldn’t count on having it, because the equity can disappear really quickly depending on how long it takes to sell a practice. When someone passes away that is the practice owner, sometimes the practice immediately has less value. But if you have an associate or a partner that would cover and support their production for a while, then you might feel comfortable subtracting the practice equity as well. So take what you are spending, multiply it by 30, and subtract all the things that you have, basically.

Ryan Isaac: Okay. What about, do we count the equity in a primary residence? The home we live in?

Reese Harper: Not unless you would like to sell it or take a mortgage on the equity. Generally, we leave out the equity in the personal residence as part of the calculation.

Ryan Isaac: Well that is helpful to know, and maybe something our listeners hadn’t thought about before, so, hopefully that was helpful to somebody. Now, let’s talk about the different options for life insurance. This is where it gets really broad. You have term life insurance and you have permanent life insurance, the two main categories, right? With term life, you pay a certain premium each month that is tied to a death benefit; it is pretty simple and straightforward.

Reese Harper: Yeah, and there is are term life insurance policies that you can renew every year; they go up every year, but they last for a long time. Or you can lock in a fixed rate anywhere from five to thirty years. The goal with term life insurance is to minimize the annual cost of the insurance by reducing the coverage you need as your assets and net worth grow. So as you get bigger, and you become worth more, you reduce the amount of coverage that you need, using that same calculation that we talked about earlier. So for most people, this means that getting an annually-renewable policy is the best product. It allows you to pay for only the amount of insurance you need at given points of time in your life, and it extends your ability to get life insurance for as long as possible, you know? And I like it also, because it minimizes the cost at the age you are applying for it.

Ryan Isaac: Yeah, by quite a bit in some cases. Okay. I am going to ask about permanent life insurance, and I can already see your blood boil a little bit. The vein in your neck is starting to— I know you have some strong opinions on this, and just so the folks know, when we talk about permanent life insurance, we are talking about things like whole life, universal life, equity index life, and variable life insurance. Those types of life insurance policies essentially combine a term life insurance product, like a death benefit, with a savings or an investment account into the same product.

Reese Harper: Yeah, and I do have a few things to say about permanent life insurance before all of the haters comes at me. I will admit, there are a few times when it is not the worst decision. So if you have one of these products, don’t get all bent out of shape. Whether you should have one or not depends a lot on your situation, and the insurance company that you own it with. And just let me explain so at least you have all the facts before you start tuning out, okay?

Ryan Isaac: So, on of the first ones is that you mentioned term life, as it is self-explanatory, it expires. It has a term that expires. So, one advantage then of permanent life insurance product is that the death benefit, like the name suggests, is permanent.

Reese Harper: Exactly. And when you want the death benefit to be there when you die, no matter when that it, then permanent insurance can make some sense. There are other ways to accomplish charitable giving or wealth transfer not using insurance, but that is where a lot of people use it for. They use it to pass on money to a charity, or they want to pass on money to a family, or specific institutions. And so a lot of times, that is the only type of insurance that can really work. And it does make sense in those situations, but I would only use that in the case for a really wealthy individual, and we would probably define that by someone who has more than 50 times their annual spending in net worth. So, you know, if you spend 200,000 a year and you are worth ten million or more, then maybe this conversation starts coming up because you are worth 50 times more than what you spend in a year. And that just means you are never really going to be able to spend all your money and retirement is going to be very comfortable and you are probably going to have a lot left over, so permanent insurance can start to enter the conversation for some people.

Ryan Isaac: Okay. Let’s talk about some of the other arguments for permanent life insurance products. You hear people talking about the guarantees or the guaranteed rates of return on these. Do you want to talk about that a little bit?

Reese Harper: Yeah. So what you are referring to now, and we kind of maybe jump to the conclusion on this, but you know, we said it earlier that you combine an investment component or a savings component with life insurance. And that is what Ryan is talking about, here, is that the guaranteed rate of return is applying to the investment or savings component within the life insurance. And it is true, life insurance companies are in a really unique position to offer guarantees on certain types of annuities and life insurance policies. But those guarantees are only as good as the company’s ability to pay them. It is just like a bond that is guaranteed by any other company like Microsoft, or Exxon Mobil, or another large corporation.

Ryan Isaac: Okay, so your point is that there are other ways to get a guaranteed rate of return?

Reese Harper: Yeah, I wouldn’t let that be the rationale for me to buy insurance, because there are guarantees built into it, because there are a lot of ways to get guaranteed rates of return. Guarantees are based on the company’s ability to pay those returns. And the problem is, the guaranteed return always results in a lower rate of return than something that is non-guaranteed. Because it costs a lot of money to put a guarantee in place, and you have to take on additional risks, right? And so, most permanent life insurance policies have a guaranteed rate that is really quite low, and a non-guaranteed rate that is a lot higher. And in sales pitches, sometimes the agents will talk about the guaranteed rate of return to help people feel comfortable, but then they will really be showing or illustrating non-guaranteed rates. So if you look at a life insurance illustration, you will see two columns, and one will have a guaranteed rate, and one will have a non-guaranteed rate. And just know that the non-guaranteed rates of return, they are just best estimates; they are projections. Just like you could do on any investment that you have. Any bond, or any guaranteed investment product.

Ryan Isaac: Okay. Another argument for permanent life insurance that you hear is that you are saving money instead of spending it on term premium, and so a lot of agents will refer to this as renting versus buying your insurance policy.

Reese Harper: Yeah, and my response to that is that buying permanent life insurance doesn’t mean you are saving money on the insurance costs. There are costs inside of the policy that you can’t see, the permanent life insurance policy, and those costs are buried inside your monthly premium, but the product is sold as if there are no costs. Like, all of your premium is going right into the savings account inside of the policy, which isn’t the case. There are a lot of costs that are inside of there.

Ryan Isaac: Yeah, and that sometimes in misconstrued as well, where agents will want you to think that your entire premium— maybe not just agents, but people’s understanding is that your whole premium that you pay is added to your savings or investment account portion of the insurance policy every month, and that is just not the case.

Reese Harper: When in reality, there are actual additional hard costs that insurance companies have to pay to insure you with a permanent policy beyond what term insurance costs.

Ryan Isaac: Yeah, what are some of those expenses in these policies?

Reese Harper: Well it is a super long list, but we could start by just saying there are commissions that are different, and there are higher amounts of commission to sell those types of policies. They are more complicated to explain, and insurance carriers pay a higher commission to agents to sell those, because they take more effort. And it is a product that— you know, for whatever reason, the commissions are higher. That is the best-case kind of explanation. I think at some level, you could be cynical and say, “the commissions are a lot higher, because the costs get buried easier,” and it is easier to just say, “we can sell more of these, and it is not as easy for consumers to digest the costs and the premium, and so…” There are commissions that are very expensive; there are benefit programs that they have to pay for. The insurance agents work for agencies and brokerages, and those brokerages have benefit programs, and so the life insurance companies will pay more to help support those sales efforts. A lot of the costs have to do with sales initiatives. But then there are special state premium taxes. If you pay a permanent life insurance premium in the state of Utah, the last illustration I saw was a 2.25% tax on your premium. Now, you don’t really see that, because the insurance company just takes the money and pays the state premium taxes, but it is a cost. I mean, that is more than a mutual fund in a lot of cases. Maybe one other cost to think about is that these state premium taxes really do add up over decades, you know? So you don’t have to pay those, and life insurance companies don’t have to pay those for term insurance contracts.

Ryan Isaac: Okay. What about the cost of the insurance itself inside of the policy? Are the costs of a permanent life insurance policy, are they the same as the costs of a term life insurance?

Reese Harper: Yeah, the cost of insurance, they call that the COI sometimes, it really depends on the policy and the carrier. For whole life, the costs of insurance are a lot higher than those of term insurance, especially initially. Whole life is kind of like a level— the cost of insurance is kind of like a level term policy that lasts forever. I mean, until your assumed death, the endowment point. There is a point in the life insurance policy where eventually it matures, and that is usually out in age 100 or something like that. And so you are overpaying today to lock in a cost of insurance that will stay fixed forever, where if you just paid the cost of the annually renewable term, it might be 5% of the cost or something. And so, it just depends on the carrier. For whole life, it is like that way, and for universal life and for variable life, the costs slowly rise over time. And sometimes, they are very similar to the costs of term, but in some cases, they are a lot more. It just depends on the carrier and if they have a field force or an agency to support. There are some carriers that don’t and so those costs resemble term insurance really closely.

Ryan Isaac: Okay. You hear the argument a lot that permanent life insurance offers a tax-free income when you reach retirement as one of the— I mean, that is the selling point I probably hear the most about is the tax-free retirement, right? Do you want to talk about this a little bit?

Reese Harper: That is true. There is an opportunity to get tax-free withdrawals out of a life insurance policy. They are actually loans that you can take out of your policy as you get to a point where you need them. It is a possibility, but it is not a reality for most people. At first blush, it sounds really appealing for obvious reasons, but in order for the person to be able to borrow money against their policy tax free, a lot of things have to go right, and these vary a lot from company to company. So I always tell people, before they pursue this strategy try to go find someone else who is doing this right now in retirement. Someone who is living in retirement on tax-free income from an insurance policy, and see how happy they are with their situation. And from my perspective, just anecdotally as a financial advisor who is having conversations with hundreds and maybe even thousands of people over the years, the ratio of people that think they are going to do it who actually do it… I mean, I have to say, for every hundred people who tell me they are going to do it, I find one person that is actually doing it. But you will see real estate investors who are living happily on rental income. You hear that a lot, like, “I can build up rentals and then live on that income.” And you see it happening pretty frequently, and so you know it might be a reality for some people. I have met a lot of mutual fund investors who are living happily on dividends, and interest income. You have seen that a lot; I have seen that a lot. Business owners who are living off the profit of their company, or a dentist who is living off the profit of a few locations? I have seen all of those kind of things, and I see that regularly. For every ten people who employ it, there are one or two who are actually pull it off. But I have never met a permanent life insurance— you know, I don’t want to say never, but I rarely rarely meet permanent life insurance policy holders who have said, “you know, this worked exactly like I thought it was going to.”

Ryan Isaac: Okay, so then the big question that everyone is thinking: why doesn’t this strategy pan out the way it is proposed?

Reese Harper: Yeah, I mean… I feel like expenses have a lot to do with it. It is very expensive; there is a very long break-even period, and the third thing is probably just natural life events that occur, right? During the first twenty years of your career, most of us have a lot of income fluctuations. We have a lot of need for flexibility for our investment portfolio, and most life insurance policies do not offer flexibility, even if someone tells you it does, right?? And whole life policies, they required a fixed premium payment. If you miss premium payments, the policy can start to eat into cash, and run out of money quite easily. And we have life events that come up, you know, that require liquidity. And most people who employ these strategies, they haven’t thought through it quite carefully enough, so they end up overcommitting to funding their policies. In a best-case scenario, what you will see happening is someone does plan effectively, and just doesn’t quite overcommit. They just do a little bit, and then at the end of the day, usually what they end up doing is keeping their policies and passing them onto charity and doing wealth transfer. But you know, I just feel like with the whole life policies, it is a fixed payment, and it is a hard field to stick with. And when they need cash, they slow down, or borrow against it, and they start borrowing money out at too early of an age. And with the variable or universal policies, even though they offer flexible premium payments, meaning they will have a minimum payment, but then they will have the one they ask you to pay, it is not as flexible as you would think, even though the premium payment might be flexible, because you have to put a lot of money into it in the early years and not mess with it so that it can get to a point where it supports all the costs that are in the policy. And so, these products have a ton of moving parts, and it is not as easy to successful manage the interest you owe to the insurance company, because when you borrow the money out, you owe them interest. And then you have to calculate the right amount to borrow, and know how much you need to accumulate in the policy to successful fund your income goals. And so, it is just a really complicated picture, and after me explaining this three or four times in the last five minutes, I am just thinking, “now I know why a lot of people just end up getting confused” (laughs).

Ryan Isaac: Okay. Now, you mentioned something about your investment inside these policies breaking even, and it kind of takes quite a while to get to the point where you even have a positive return inside of these. And I think it is a huge misconception people believe right off the bat— you will probably touch on this one— when they are quoted, things like the rate of return or crediting rates, they assume that day one they are getting this guaranteed rate of return, and their investment is protected and growing from day one, but it takes a while.

Reese Harper: You are right, man! It is probably one of the most negative aspects of these policies. If you have ever purchased ones, you know that there are a lot of expenses in the first ten or more years, and you have surrender penalties which will take away money if you take anything out, or you can have a really large upfront cost, and so you will put a lot of money in and you won’t see anything in your savings accounts. And it is essentially the same thing in my mind. I’m amazed at how many people are like, “you know, it’s not really that expensive. I can see all my money in my policy right when I put it in.” But then there is a surrender charge that if they take the money out, they lose all their cash. No matter what, folks, if you pay a lot of expenses and a commission up front so that your cash is at zero, or if you pay a big surrender penalty, it is the same thing, and I think it is important to remember that.

Ryan Isaac: Okay. Another big advantage that people talk about is borrowing money against a life insurance policy. That is another big reason why people buy these policies. But aren’t there other and less expensive ways to actually borrow money?

Reese Harper: Yeah, that is a good point. And borrowing against an investment isn’t something that is exclusive to life insurance policies. Big misconception. Life insurance policies are assets you can borrow against, but you can get margin loans or loans against your bank accounts, against mutual funds, bonds… I mean, a lot of your investments, you have the ability to borrow against them, and they are just simply a loan from the bank that holds the money, and they allow you to borrow against your investment portfolio, just like a life insurance company will. And similar to the life insurance policy, you are not going to have to pay income taxes on the money you borrow. When you borrow money against an asset, they asset keeps growing, and it stays in the account, but you have to pay interest on it. Margin loans are just a lot less expensive. They don’t have as high of interest rates as what you will usually find inside of life insurance policies.

Ryan Isaac: Okay. A couple more things as we start to wrap this up here. Proponents of permanent life insurance also talk about the protection your investments have against creditors when it is inside of a permanent life insurance policy.

Reese Harper: Yeah, and I think that is something that is probably a little bit of a misnomer. I mean, I wouldn’t buy a life insurance policy just out of creditor protection. I mean, your qualified retirement plans, like your 401k, have really strong asset protection and creditor protections, and a lot of wealthy families will use liability insurance, or trust, or corporations to protect their assets. So creditor protection isn’t a good enough reason, in my opinion, to invest in permanent life insurance.

Ryan Isaac: Okay. Another thing you hear is this argument that your 401k is a risky investment and the stock market is rigged so therefore… you know. But the insurance.

Reese Harper: Yeah, and this is a really commonly repeated myth. 401ks are evil, and life insurance is safe. And 401ks are just an account type, remember that. They are not an investment, so the investments inside of your 401k are completely inside of your control to select. You can buy a conservative investment almost identical to what you are going to find inside of a life insurance product. You could buy corporate bonds, or leave it in money market, or keep it in cash, and all this can be part of your 401k, right? Your 401k is just an account, and it is not risky or conservative, it is up to you to decide how much risk or how much up and down movement you want in your 401k.

Ryan Isaac: Yeah, and you have talked about a lot of this in other podcasts, you are touching on the same things. A big misunderstanding is that investors believe that all of their investments are in the stock market, but financial markets aren’t stock markets. You can, like you said, buy bonds, money markets… you can do a lot of different things, which are the same things you can purchase inside of insurance, too.

Reese Harper: Yeah, I mean, it is important to separate in your mind the difference between investments and the accounts that you are actually investing in. It is just a matter of knowing how to properly build and diversify your portfolio.

Ryan Isaac: Okay. Well let’s wrap this up and bring us home here, and offer the listeners some parting advice to ponder about life insurance.

Reese Harper: Let’s hit three of them. First, permanent life insurance is optional, okay? It doesn’t offer significant advantages over term insurance for most people, alright? And it is a very small percentage of the population in very small percentage of circumstances that need to consider this. For the most part, it is oversold and it is over-promoted, and it is sold to the wrong market, okay? The second thing to remember is, using permanent life insurance as a savings vehicle, a place to invest for retirement, has major implications on your personal financial plan, and you shouldn’t be getting advice strictly from an insurance agent who is paid on the amount of premium that you pay into the policy. You have to consult a financial advisor or someone else who you trust, an advisor you trust, who has a more comprehensive understanding of your overall tax situation, your estate situation, your investment portfolio, and your debt reduction plan. And getting tax-free income from a policy isn’t a good enough reason to invest. You can get the same benefit with less complexity using a broadly-diversified investment portfolio. That is number two. The third one I would say is that compensation that people receive for selling permanent life insurance policies is very high, and it can make even the most well-intentioned people oversell you. So, even your best friend from high school (laughs), even your father-in-law, alright? Even your brother. Your twin cousin, okay? (laughs) you have to get advice from someone who isn’t getting paid to sell you a policy, and I’m worried that too many people, they don’t own enough insurance, but they are spending a lot of money on insurance types that they might not need. This is one of them. And I would rather see people have the right amount of life insurance than try to stretch their budget and force permanent insurance to fit, and then cut their disability insurance short, or not fund something else. So, to all my agent friends out there— and you know that I believe this, but a few of you are doing a really really really great job. But there are too many insurance agents who are not providing the right kind of insurance advice, and permanent insurance ends up getting used by too many people who don’t have any business owning it.

Ryan Isaac: Okay! There you have it, folks. The man speaks truth.

Reese Harper: I feel like that was a mouthful we tried to plow through.

Ryan Isaac: We did, it is an important one. Thanks for listening, and thanks for joining us. We hope you will take some time to give us some feedback on this. If you go to our website, dentistadvisors.com, at the top, there is a little tab called “Listen,” and you can use the comments section of this episode to ask questions or give us feedback. We would love to hear from you. When you are on the website, you can also schedule a free consultation if you have any questions. And don’t forget to visit us on Facebook, right? Dentist Advisors’ Facebook page; you can keep tabs on us and see all the very exciting things that we are doing.

Reese Harper: Facebook! Carry on, folks.

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