If you’ve been around the life insurance industry for more than five minutes, it’s pretty likely that you’ve encountered all sorts of reasons as to why whole life insurance is bad. In fact, it’s probably the most maligned of any financial product.
A few days ago, we set out to find the absolute dumbest arguments against whole life insurance. The volume of bad and misleading information is almost astounding.
I say “almost” because, in nearly 20 years of selling whole life insurance, it’s hard to imagine anything that most personal finance gurus hate more. It’s not even that much of a stretch to say that there are some very popular people who’ve built financial-advice-giving empires tearing the product to bits (in theory).
Being a hater of whole life insurance seems to automatically identify someone as being part of some club. Maybe it’s the secret handshake personal financial bloggers use to identify one another?
Narrowing the List is Difficult
Admittedly, the amount of faulty logic that surrounds any discussion of why whole life insurance is bad makes it hard to choose the five worst arguments against it.
But we persevered.
One of the toughest parts of narrowing it down is that there’s so much overlap in the bad logic. What’s more…so much of what’s out there through a quick Google search or two is complete jibberish—it’s either written by someone who has a total lack of understanding or even in some cases by an automated writing tool (bad artificial intelligence).
Either way, the task fell upon us to narrow it down to five—mostly because it’s possible to cover the top five worst arguments against whole life insurance in the 30 minutes we confine our podcasts to.
None of these are new, in fact, most of the supposed “worst” attributes of that point out why whole life insurance is bad have been out there for at least a couple decades. I can personally attest to the fact that I’ve heard these from early in my career.
The Top 5 Reasons Why Whole Life Insurance Is Bad
Here are the top five—or bottom five depending on how you see it:
1. Whole Life Insurance is front-loaded
This is probably one of the most annoying statements that people make about why whole life insurance is bad. But why is that? Well, primarily because it doesn’t really make any sense.
What does it even mean?
We’ll have to speculate a bit on that as it’s tough to know with 100% certainty but what we think they mean is that when you buy whole life insurance, all the expenses are loaded up at the start of a new policy.
Okay, let’s play the devil’s advocate…
“You’re right, all the expenses are loaded at policy inception.”
Our follow-up question…
“Why does that matter?”
Think about this for a minute—nearly any asset worth owning that has the potential to create wealth in the future, comes with some acquisition cost or transaction cost. For example, the darling of the personal finance industry, real estate.
Ever studied a closing statement and done the math on what the true cost of buying that rental property or even your personal residence is? There is a list of expenses that add no value to the property you just purchased.
Now, that doesn’t make the front-loading of expenses bad, does it? Just the way most asset purchases function.
Also, just to be a thorn in the side of this silly argument, the expenses of a whole life insurance policy are not ALL front-loaded, there are ongoing expenses as well. Just like there are with real estate (to go back to our example)…property taxes, insurance, vacancy, maintenance costs etc.
Again, none of those costs/expenses make buying real estate bad any more than they make buying whole life insurance bad.
2. They keep your money when you die
If you buy whole life insurance, you build cash value over time. Some policies grow more cash value than others depending on a couple of things:
a. the particulars of the policy you purchased
b. how the policy was designed with respect to paid up additions riders(largely)
But no matter how much cash value the policy has accumulated through the years, when the insured dies, the life insurance company keeps the cash and only pays out the death benefit.
Or so the bad information informs you anyway.
Some very famous people (who shall be not be named specifically) have perpetuated this misconception—use your imagination—they host syndicated radio shows, have PBS specials, and speak with authority.
There is a shred of truth behind this argument, that’s what makes some of these particularly dangerous. Ever experienced a person that says something that’s technically true but mischaracterizes it to shape their own narrative?
Yeah, that’s the case here.
There are certain whole life policies that will absolutely keep your money when you die—the company will keep the cash value and pay the death benefit to the beneficiary.
Here’s how that type of policy would function:
Death Benefit = $1,000,000
Cash Value = $ 200,000
Insured dies and the beneficiary gets a check for $1,000,000.
This example is representative of a whole life policy structure that certainly exists. However, this is not a representation of how ALL of them work.
It’s disingenuous to suggest otherwise though thousands of pages on ye olde interwebs would have you believe this is how it works 100% of the time.
In fact, in most cases for the policies our clients own, the policy functions like the following example:
Original Policy Death Benefit = $1,000,000
Cash Value = $ 200,000
Insured dies and the beneficiary gets a check for $1,300,000.
Now, let’s make sure that you understand the terminology and how that would actually work. The life insurance company is going to pay the beneficiary the $1.3 Million and technically “keep the $200,000” of cash value.
But remember, the original death benefit was only $1 Million, so the beneficiary received $300,000 more than was originally planned when the policy was purchased.
So, basically, this argument against whole life insurance would only be true if the policy design, implementation, and execution were bad. The implication is that somehow or another the insurance company is pulling one over on ya.
That is just not the case—if the policy is set up correctly and funded adequately, your beneficiary(s) will receive far more than was originally planned and in many cases more than the sum of the cash value and death benefit.
3. They make you borrow your own money
The idea that you have to borrow your money and pay interest on it is half true…kind of. First, it would probably be a good idea if we all stopped attaching negative connotations to the words borrow and interest. It seems that there is a general trend toward implying that anyone who borrows money or who pays interest is somehow intellectually deficient.
It’s just not true and to believe borrowing or paying interest is ALWAYS bad is a gross oversimplification of finance. Over-leveraging assets is not a good idea, but we all get that.
When looking at this argument, however, the sentiment indicates that making you borrow your cash value is just another way the life insurance companies getcha.
It’s simply not true but it makes for a good story right?
In pouring over financial statements and reports from a handful of the largest issuers of participating whole life insurance, the revenue generated from policy loan interest is a sliver of a sliver of a sliver. Companies include in the assets held by their general account and they do make money from policy loans albeit insignificant.
And before you ask, this also includes a couple of companies that are charging their policyholders 8% on loaned values. It’s still a minor component of income-producing assets.
Think about this for a second in a completely logical way…wouldn’t life insurance companies be encouraging their policyholders to take more loans if it were a major source of revenue for them?
Wouldn’t they spend more time mailing out notices to policyholders bestowing the virtue of taking policy loans?
We’re talking about companies with billions of dollars in assets that have teams of super sharp people that guide the investment decisions within. If they believed that there was a bunch of easy money to made from policy loans, wouldn’t they do it?
Maybe so but more importantly, the companies that offer whole life insurance like to remain competitive with one another and generally speaking, taking advantage of your policyholders…(you know, the people who pay the premiums) isn’t a great business practice.
Not to mention there are tangible benefits to borrowing from your cash value. In fact, there are specific reasons that you would actually want to borrow from your policy.
4. It’s smarter to “self-insure”
This argument is kind of patronizing in how it dismisses the value of whole life insurance. In fact, it focuses on the absurdity of needing to have life insurance at all after you’ve reached retirement age.
The implication of this belief is that by the time you’ve reached the normal retirement age (65+), you shouldn’t have any need for life insurance anymore. Because ya know, only dumb, irresponsible people would have less than enough liquid cash on hand to take care of things after they die.
Here’s the kind of thing you’ll read:
“See…you just take your money, put it in a Roth IRA and invest it in the market”
The idea is that if you do that, you’ll accumulate so much money that you won’t need life insurance anymore. Why would anyone who is 80 or 90 years old need life insurance?
One thing’s for sure, this sort of thought had to have been originated by someone in their early 20’s who’s never experienced the series of curveballs life throws your way. It’s not that they mean any harm by pointing out such things, it’s just that they don’t yet have the perspective necessary to understand the hubris behind them.
Almost every instance that we’ve seen someone present this logic comes from the perspective of looking back over 30 or 40 years (hypothetically of course) and seeing how everything worked out perfectly. The children are all grown and successful. The retirement accounts are filled to overflowing from all the smart investments in low-cost index funds.
Everything you planned at 24 has worked out just as you envisioned…right?
By now, most of you are at least smiling to yourself because you can see the folly in this sort of thinking.
We’ve talked to dozens of people in their retirement years who bought whole life insurance a few decades ago. They still own it and in some cases, they’re still choosing to pay the premiums each year.
Do they need the policy for the same reasons that they bought it back when they were in their 30’s? Obviously not.
Do they plan to use the cash value for anything? Most of the time…no.
As most of you already know, priorities have a way of changing. These folks don’t need the death benefit to support their spouse raising the children and paying for college anymore…those times have passed now.
But the whole life insurance is listed in the asset column of their personal financial statement just like all their other assets—real estate, bank accounts, brokerage accounts, retirement accounts, collectibles etc.
And it’s an asset that they consider to have performed quite well—in the conversations we’ve had with them. Looking back, most of these folks could certainly self-insure at this point, however, there’s no way they could’ve known that 30 years ago.
5. Returns are bad
It’s horrible. You could do so much better than the returns of your cash value in whole life by dumping most of your free cash flow into real estate and index funds.
That’s the argument anyway.
This one is a little bit of a head scratcher to those who truly understand the value that any sort of cash value life insurance policy brings to the table. We often see scenarios where a series of random dollar amounts are paired with hypothetical rates of return—most commonly 8% and then compared to illustrated values of a life insurance policy.
Yes, it turns out that if you pull arbitrary numbers from thin air, you can always find a way to beat the returns on the cash value of a whole life policy.
By the way, you should look at this post where we discuss the overuse of 8% as a rate of return in many savings and investment scenarios.
But the real question is this: the returns of whole life insurance are bad compared to what alternative?
It’s not that hard to find something that beats something else. A Toyota Prius gets better gas mileage than a Ford F-150. So what?
If you need to pick up a new refrigerator from the appliance store down the street, I’d rather have the F-150. You’d rather not have to hoist that heavy beast up and strap it on top of your Prius.
A CD isn’t better or worse than an S&P 500 index fund based solely on the rate-of-return. Both are just tools that have very distinct characteristics and should be used to achieve different goals.
The real danger of chasing returns is that it distorts those things that you can control as it relates to your money. You cannot control the rate-of-return. You can control your financial behavior and the factors that have a much greater impact on the success of your financial future.
But for most people, focusing on the rate-of-return or on the expenses of a particular investment diverts the focus from our own financial deficiency. The truth is that most of us (myself included) have a blind spot with something in our life that is costing us far more than less-than-great-returns or out-of-control-internal-expenses.
The luxury of hindsight offers us the chance to look back
When you get to the point that you are going to retire or at least be at a point in your life where you feel that you should have a certain amount of money saved, 60’s or 70’s for most, you could look back on what you did versus what you could have done and you could at that point figure out what the best option was by evaluating the rate of return.
But here’s the thing…prior to that moment, there would have been no point in your life that you could make that same evaluation. You won’t know how things work out until you get there.
If you look around for…
…why whole life insurance is bad…there’s no shortage of information that makes useless comparisons. And there is a theme that runs through all five of these arguments and that is that none of them uses any real data to substantiate their claims.
Any attempt for them to do so results in more conjecture and hypotheticals.
However, in our vigilance to provide you with as much truth as possible relating to all things whole life insurance, there are 3 legitimate reasons why whole life insurance is bad and we’ll share them with you in our next post.