I know this probably seems like a topic I discuss repeatedly, however, we still receive emails almost daily from people who are being shown cash value life insurance policy illustrations (both whole life and indexed universal life insurance) that grossly misrepresent the most efficient use of cash value life insurance as an asset class.
The emails we receive are from people who are looking to make use of the strategy, not innocent bystanders that were “lucky” enough to have a life insurance agent sicced on them by a friend. (If you know a bit about the life insurance industry’s traditional sales prospecting methods you’ll understand that jab.)
To be sure, there a more than a few ways to skin the cat when it comes to designing a cash value policy whether it’s participating whole life or indexed universal life insurance.
Proper Design of Cash Value Life Insurance is Non-Negotiable
When it comes to designing a policy to maximize the growth of the cash surrender value, there’s a right way and wrong way.
I know that probably seems a bit harsh in an industry where the answer “it depends” is among the most common. But proper, efficient design of a policy really is an absolute.
Now, that being said, the company and product that come out on top can depend upon a person’s age, their health, their level of financial commitment and the length of funding period they choose. That’s why we are so rigorous in our process to identify the “best” choice for our clients.
It’s not that we favor company x over company y. It’s just that sometimes company x will work most efficiently and sometimes company y is the clear winner. Other times the water can be a bit more murky and the whole life product at company x is slightly better than the indexed universal product at company y at achieving the stated goal of our client.
We learned a long time ago to throw out preconceived notions about what we think will work best for a particular situation. Instead, let the empirical evidence tell the story and get out of the way.
In that vain, I thought today I’d share with you something I found in a post over at Reddit. To make things easier for you, I’ve quoted the question/scenario as it was posted originally:
This is another post about cash value life insurance. I am aware of previous discussions on the topic, such as:
However, I am in a different situation than previous posters. Here are the facts:
- I am 28, married, making $170K/year.
- I want life insurance and a tax efficient way to save money for retirement.
- I do not qualify for a Roth IRA.
- I need an investment with some degree of liquidity in the medium term. This requirement RULES OUT a 401(k) for me. I am very familiar with the way a 401(k) works, and I have ruled it out for now, for very good reasons. If a commenter makes an issue of this I will be happy to explain.
A few points to hopefully narrow the discussion a bit:
- I have a LOW risk tolerance. The riskiest product I will consider is a mutual fund. I prefer index funds.
- I am not bothered by the fact that the person who would sell me a cash value life insurance plan would be a salesperson who gets a hefty commission. I would like reddit's assistance in evaluating the product on its own merits.
My options, as I see them, using $26,171 / year are:
1. Buy term life insurance for 20 years, invest the rest in index funds, mutual funds, bonds, whatever,
2. Buy into this cash value life insurance plan.
I asked the agent to model this choice: his life insurance plan (using the lowest dividend rate that Northwestern Mutual paid in the last 20 years as a dividend rate – 5.85%) against the scenario of purchasing 20 year term life insurance and investing the difference, with a 6% return. Throughout, I asked for an assumption of 35% TOTAL tax rate (which reduces the 6% return to 3.9%).
Here is the model: http://imgur.com/a/JELeD (Column 4 represents the term+invest scenario, Column 5 represents the cash value in my policy, which I could take out entirely with a 2.8% tax burden)
Now I understand that this product is universally derided online, in places like Reddit. However, now we have a model to use as a discussion point.
Using that model as a guide, what say you, Reddit?
EDIT: Since everyone mentioned the 401(k) issue: I have about $200,000 in student debt at interest rates averaging 7%. If I don't care about liquidity I can get a guaranteed 7% “return” by just paying off these loans. So – among investments that don't offer me access to cash, that would be my choice.
Now, I don’t intend to debate the “buy-term and invest the difference” issue as I just posted quite a bit about that very issue last week when I talked about Dave Ramsey’s disdain for all things cash value life insurance.
Instead what I intend to do is offer up some specifics that would make the case more compelling for this guy (if he knew we existed and we’d actually gotten a chance to talk with him) who posted over at Reddit.
And he did us such an awesome favor by providing us the illustrations he received from Northwestern Mutual.
This allows me to show all of our readers some numbers and demonstrate why the hunch the original poster had was spot-on but alas the agent he contacted fumbled the ball on the goal line.
For quick reference, I've embedded the illustration he obtained from Northwestern Mutual.
And so, begins the proverbial muddy water.
Yes, this is an illustration of participating whole life insurance policy from a company that is generally regarded as being one of the best in the industry. We could argue that point but nonetheless NML is generally held in high regard.
Truthfully this is not a critique of Northwestern, it is however a live example of how this particular agent completely missed the stated goal of the client.
This guy is 28 years old and is clearly looking to put a significant amount of money into whole life insurance as a low risk asset that will provided him with liquidity in the event that he needs to access the money in the future and a substantial death benefit for his family when he dies.
Notice column 5 of the illustration, this gives you the projected cash surrender value basted on the current dividend assumptions. Now, look over at column 6 and you will see the guaranteed cash surrender value for the policy. Based on what this client is telling us in his post, these columns are where we should focus our attention.
Because he said, “I want life insurance and a tax efficient way to save money for retirement.” and he also said, “I need an investment with some degree of liquidity in the medium term. “
Based on this illustration from the Northwestern agent, he pays a premium of $26,171/year and his cash value is projected to be $3,416 in year one. Hope I've made this easy to follow along, if not and you have questions, please feel free to contact us for any clarification.
Now, let's take a look at a policy illustration the way we would have designed it. No, this is not a Northwestern Mutual illustration but instead from another top tier company who offers a very competitive participating whole life contract. (I've withheld the name of said company because they are a bit sensitive about this sort of thing, however, if you'd like to see the whole thing I'll be glad to share with you privately)
So now that I've shown you both of the illustrations, the one prepared for the client by the Northwestern agent and the one I prepared as we design them for our clients, can you see the difference?
Notice the column heading in our illustration titled “Total Cash Value” in the green block that says “Non-Guaranteed Assumptions”. This is the cash surrender value as compared to Column 5 of the Northwestern Mutual illustration.
The Northwestern illustration has a cash surrender value of $3,416 in year 1 and ours has a cash surrender value of $22,874 in year 1.
How is that possible? There has to be some trick to this….right?
Well, no not particularly, it's all in the design of the policy. It's all about designing the policy to suit the needs and wants of the client. In this case, the client was looking to maximize his return on cash, so that's what I did in my design.
If you follow those columns on down the gap never closes. At his age 65, the Northwestern Illustration projects a cash surrender value of $2,501,157 vs. the illustration I ran which projects a cash surrender value of $3,161,782. That's a difference of $660,625.
But I mean really what's a few hundred thousand between friends?
Wanna know what really bothers me about this case study?
The client is still considering a move forward after seeing this illustration from Northwestern Mutual. That's not a bad thing mind you, but imagine how much better he could have it?
He could even have a much more efficiently designed policy from Northwestern not even taking our illustration into consideration. It may not be the best (hard to say one way or the other on that) but it could achieve his goal in a much more powerful way that would probably make his decision really easy.
So, why did the agent not show him the best Northwestern had to offer? Well, could be one of two things:
1. He/She just didn't know any better or
2. The agent doesn't want to sell a more efficiently designed policy because the commission drops substantially (70-90% decrease)
Not sure which is worse but either the way the client is on the losing end of the deal.
I hope you can better see how the devil really is in the details and understand why we are so passionate about helping people get exactly what they want out of their cash value life insurance.
If we can help you, please feel free to reach out to us for assistance. We're always glad to help!