Why is Dave Ramsey Hating on Northwestern Mutual?

Today, I’d like to respond to a clip from Dave Ramsey’s television show on Fox Business where he talks about life insurance as being “terrible” and how buying term and investing the difference is a better strategy than using any type of cash value life insurance. Just to clarify before I begin, I agree with lots of what Dave Ramsey has to say about getting out of debt, cutting up credit cards, and putting a stop to out-of-control consumerism.

But, when it comes to life insurance, he’s dead wrong. In my response, I’m particularly going to focus on his attack of cash value life insurance.

Hold Your Horses, Dave

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His first misconception about cash value life insurance is that it’s a terrible cash accumulation tool. Of course, I absolutely agree with Dave Ramsey’s view of the way most agents structure cash value life insurance. When directed by an incompetent or unscrupulous agent (both are equally bad), cash value life insurance naturally stinks as a tool for accumulating cash.

That’s why it’s important to work with a professional that knows what they’re doing. Otherwise, cash value life insurance is a terrible place to put your money. However, with the guidance of the few of us who both know how and choose to structure these policies properly, there can be huge benefits of the cash accumulating variety.

A few important basics to always keep in mind:

1.  Remember money inside a cash value life grows tax deferred according to section 72e of the IRC.

2.  The death benefit is paid out income tax free according to section 101a of the IRC.

3.  And section 7702 of the IRC explains how the value inside a policy can be accessed without a tax consequence.   That potentially tax free income can make a huge difference in your retirement plans, especially if you think tax rates increase in the future.

So, what do you think…are taxes going up, down or likely to stay the same in the future?

In light of the rising deficits, among other things, I think it’s safe to say taxes can’t go anywhere but up. If we take the numbers Dave Ramsey uses in a common example, a 32-year-old male who’s making 40k per year should be using 15% of his income to buy term life insurance and mutual funds.

Dave says growth stock mutual funds are the right investment for all of the money you would be using on a cash value life insurance policy. This is the classic buy term, invest the difference advice.

In other words, buy a really cheap term life insurance policy, take the difference of what you would have spent on the cash value policy, and plow it into growth stock mutual funds.

By the way, he always recommends you buy 10x your income in life insurance death benefit.

Does this sound familiar?  If not, watch a little of this video to get a taste (skip ahead to 5:21; that’s where it gets really good).

Sound familiar?  If not, watch a little of this video to get a taste (skip ahead to 5:21, that’s where it gets really good)

The idea is that in 20 years, when the term policy runs out, the money accumulating in the growth stock mutual funds will have outpaced the death benefit, and therefore, the death benefit will no longer be needed.

On the flip side, Dave proposes that funding a cash value life insurance policy with that money is a horrific mistake. In classic Insurance Pro Blog fashion, I intend to argue that point with the help of some numbers. As far as we’re concerned, all talk and no facts equal a whole lot of nothing.

Let’s compare the two strategies and the shortcomings with an example.

Tom is a father, 32 years old with two children and an income of $40,000 per year. Using Dave’s math, we’ll take $6,000 (15% of his gross income) for the retirement plan. According to Term4Sale.com, Tom could purchase a $400,000 20-year term insurance policy at a cost of about $217 per year if he’s in perfect health and doesn’t use any sort of tobacco products.

That leaves Tom with $5,783 to invest into growth stock mutual funds. We’ll assume that he earns an 8.0% rate of return over that time frame. Yes, this rate of return is much less than the 10% that Dave Ramsey often talks about, but given recent history, I think that 8.0% is more realistic (in fact, we prefer to use something like 6% when we help our clients plan for the future).

If I look at the investing calculator over at Dave Ramsey’s website, it tells me that Tom should have $285,753.12 (this is the gross number) after investing $5,783 per year for 20 years.

Note:  Other things that should be taken into consideration are taxes and costs but his calculator doesn’t provide those options.  With mutual funds you will have both to consider.  Now, tax rates are difficult to nail down but let’s just use a 15% federal tax rate because with Tom’s income and having two kids, that’s probably not that far off.

If I look at the investing calculator over at Dave Ramsey’s website, it tells me that Tom should have $285,753.12 (this is the gross number) after investing $5,783 per year for 20 years.

Sorry To Burst Your Bubble, But….

Prudent financial planning isn’t based on a set of unrealistic rules. For one thing, assuming an 8% rate of return when helping a young guy like Tom plan for his future is just plain irresponsible. What if he doesn’t hit 8%? After 20 years, it’s too late to go back and put more money away. The genie’s out of the bottle at that point.

As Brandon and I have stated many times, chasing investment returns is a poor solution for not having saved enough. Plus, after 20 years, Tom is 52 years old and has no life insurance under Dave Ramsey’s model.

How many people do you know at 52 who have no need for life insurance?

I’ve been in this industry for 13 years, and I’ve only met a handful of people who were in that position at 52. What’s more is that none of them made $40,000 a year.

Please don’t misunderstand me. Term insurance is a valuable tool, and most people like Tom should own more of it. But, the reality is that most people’s lives don’t move in a straight line from point A to point B, a reality that the buy term, invest the difference crowd seems to ignore.

Back To The Numbers

If Tom were to use a policy structured correctly – the way we do for our clients – he would pay a premium of $6,000 annually, which would buy a death benefit of $400,000. In 20 years, he could request that the policy be “reduced paid-up,” and his death benefit would be $558,488 with a cash value of $213,895.

While it’s true that the cash value isn’t as much as the $285,753.12 he would hypothetically have if he invested the difference and managed to net 8% compounded, he can take his insurance cash value income without a tax consequence if it’s executed properly. Also, if he chooses to leave the cash value alone, it will continue to grow, and his policy will continue to earn dividends.

Does that seem like a fair exchange of value to you?

It does to me. This is the power of cash value life insurance properly executed by an agent who cares about what’s best for the client.

If you’re interested in learning more of how this works and how it might benefit your situation, get in touch with us.


5 Responses to “Why is Dave Ramsey Hating on Northwestern Mutual?”

  1. Jeff Hexter says:

    What? No mention of the access to the cash value without penalty via policy loans?

    Comparing that little feature to IRA penalties, loss of principal appreciation due to emergency fund use, and those computed taxes will really make the insurance plan look better.

    I totally agree – Ramsay is so right when talking about debt reduction and credit card control, but so wrong about properly structured cash-value insurance. I’ve thought that ever since I read his book Total Money Makeover. It’s as if he got bad advice once and assumes all similar advice is bad.

    Great post. Care to run the numbers with tax assumptions included? Perhaps calculating what the tax would have to be for breakeven?

    • Brantley Whitley says:

      Honestly, had a hard time posting today, at this point, we’ve covered so many things, it gets a little harder each week to come up something fresh unless someone or something has provided us with something worthy of discussing.

      You certainly bring up a great point about policy loans and I probably should add more about how you actually access those cash values. For what it’s worth, the example I used was actually a participating whole life which I probably should have mentioned as well.

      There are so many ways to favor any type of properly structured cash value life insurance vs. a buy term invest the difference strategy. I suppose what bothers me most about Dave Ramsey and Suze Orman is that they talk about everything in absolutes. One thing I rarely do is to say that something is ALWAYS one way or the other. That sort of thinking is incredibly small-minded and gets us into all sorts of trouble.

      As for the tax discussion, that’s a good one to have and perhaps one that we can address in the future, thanks for the idea! The difficulty in getting deep into the numbers regarding taxes is whether Dave is talking about investing in a traditional IRA, Roth IRA, or a plain old taxable brokerage account. Additionally, mutual funds can have so many different types of taxes–short term capital gains, long term capital gains and plain old income tax if you are withdrawing from a traditional IRA, 401k, 403b, SEP IRA, 457 or PSP. And so many different state income tax rates as well (for those of us who have a state income tax).

      It shocked me to hear him say something about Northwestern Mutual so specifically…never heard him mention them in particular.

  2. Jeff Hexter says:

    I read your response Brantley, and then I saw an article from the LA Times reprinted in my local Cleveland Plain Dealer: Retirement accounts raided – 25% of Americans use money now.

    I didn’t see in the article what average amount was used, or what the average tax rate on those amounts was, or even what the average retirement savings accounts held… But if 25% of US Workers are raiding their retirement accounts, isn’t there at least a significant worry that access to money per-retirement ought to be considered.

    This may be a MUCH bigger deal than Ramsay thinks. And may make his advice less useful.

    • Brantley Whitley says:

      Jeff, Brandon and I talked about one of the big problems with 401ks in episode 25 of the Financial Procast. It seems that so many people have been led down the path to believe the 401k is some sort of divine retirement gift and have plowed money into the plans without thinking about the need for liquidity outside of their qualified plan. Don’t get me wrong, the 401k can be a useful tool in your retirement planning arsenal, however, the problem is that a great many people pour money into the 401k without having adequate savings elsewhere and then when they have a financial crisis, they raid the retirement plan. We all know that accessing qualified money before you’re 59 1/2 is terribly inefficient and really hits people hard…especially if they find themselves unemployed.

  3. Andy says:

    Brantley,

    While I know you and Brandon are in no way “anti-investing”, the scenario outlined here leaves nothing for those willing to take a bit of risk. Others could complain that 15% is just too much. Even I can see a couple of counterpoints to take some of this heat off but they may be worth mentioning anyway.

    First, at 32, it’s reasonable to expect Tom’s income will increase in the next 20 years. As his cash value safety net is now set, he can invest a portion of his increased income if he so chooses. If he is concerned about needing more insurance, he can opt for a rider allowing him to do so periodically. This can answer the first concern at least in part.

    Then there is the problem of savings. If one has a 15% tax bill, tithes 10% and invests another 15%, this only leaves 60% or $24,000 per year to live on. It can be done but no one’s living high on the hog here. The “good” news is, Tom’s wife, Mary, is likely to be working at least part-time. Either way, it seems most families end up living paycheck to paycheck… they spend what they have and buy the rest with the old credit card. Savings? What’s that? You mean the change in the couch that gets harvested now and then?

    Enter the cash-value insurance emergency fund. The cool thing most people can relate to is the monthly payments (premiums in insurance-speak)are paid each month like any other bill. This removes the discipline necessary to build that savings account. If you can stash some cash in a bank account, all the better, but isn’t nice to know you’re adding to a nice pile every month automatically? And, by the way, that pile gives you a far better return on your money than any stingy bank.

    Naturally, if that 15% figure is uncomfortable for insurance, I doubt if putting it at risk in the markets would raise that comfort level much. On the other hand, not only does cash-value insurance provide a reasonably secure, easily accessible source of cash, it also protects a family financially should tragedy strike.

    Yes, Ramsey’s BTID also offers protection, but at significantly more risk. Not just the risk that comes with investing, (Remember the mantra for investment people is always ‘Don’t invest anything you can’t afford to lose.’) but also the risk of needing affordable insurance in 20 years. Add to that the risk of “just not having the money to set aside right now” — something many of us Baby Boomers are coming to grips with right now — and you’ve lit the fuse to a potential powder keg.

    Andy

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