You didn't think we'd pass on a chance to tackle this mammoth of the financial planning world did you? A hotly debated notion for years and years pioneered by a guy who started a company to hawk term insurance under a simplistic mantra that appealed to the common folk that was later picked up by every stock broker and “financial expert” that had something to sell that wasn't life insurance.
So are we readying our spread sheets and insurance illustration software to blow the friable theory of decreasing responsibility asunder? Hardly, we talk about insurance all the time, the last thing we need is to make this place any more boring–besides, we know the numbers work in our favor, that's why none of us are really afraid of the termites. If mountaints of numbers and methodology are your thing drop us a line and we'll discuss it in detail. Depending on the feedback, we might go real pro and dedicate a blog post to it–an extra special treat for the holidays.
Why then are we going to waste your time with a silly post about one of the most giggle-inducing “theories” of modern personal finance? Because believe it or not BTID is a topic I find remarkable fascinating. Not because I'm an infatuated practitioner (not even close) but because it's a great example of how in marketing, you don't have to tell the truth, you just can't flat out lie.
While the exact source of BTID has a somewhat varied origin, most commonly credit it's creation (and certainly it's advancement) by Arthur L. (A.L.) Williams. As the story goes, Arthur began his anti-permanent insurance crusade following a rough life created by the death of his father who died prematurely. Unfortunately Arthur's dad didn't have enough life insurance, and instead of blaming his misfortune on dad's piss-poor insurance/financial planning, A.L. chose to go about it the way many Americans do, by blaming someone else. In this case the insurance agent was the fall-boy as Arthur decided to exclaim the obliquely obvious point that if his father had purchased term insurance with his life insurance premium dollars he would have had a higher death benefit, which would have benefited Arthur and company much much more–I'm betting that if daddy Williams had known when he was going to die, more life insurance would have been a top priority no matter how much it cost.
So, angry over his economic adversity, Art set out to set the world on fire with a brand new idea. He wanted people to buy term insurance, and when they objected over the loss of cash value, he simply told them to invest the difference (ok, so maybe the development was a tad more complicated than than, but this is a blog post not an unauthorized biography). Art went on to found the A.L. Williams & Associates an insurance company today more commonly known as Primerica (the company synonymous with BTID).
So what's the central premise of this so called piece of financial “wisdom?” Simply, you skip on the expensive permanent insurance premiums, buy term insurance, and take the money you're spending on the permanent premiums and invest it in things like
stocks mutual funds (very few termites ever ascend to a point in their career where they attain a Series 7 license, let alone sell a large number of stocks).
Now, here's what's magical about the way Art did it, and why the wheels fell off for everyone else. Art and early BTID-ers went around replacing permanent life insurance (read, working with people who already owned and therefore were paying premiums on permanent life insurance). This way, he could replace the life insurance in force with term insurance, perhaps get them a bit more then they had already, and then redirect the rest of the money into something else.
The replacement market is a large and somewhat dirty market, where insurance agents of all sorts hangout looking to make a buck. This isn't to begin some tirade against replacing insurance contracts, but you should always be careful whenever an agent makes this sort of recommendation.
Modern BTID-ers (at least those working at Primerica) often talk to people who haven't done much of anything (let alone purchase something like whole life insurance) and just sell the term insurance, they aren't licensed to sell investments yet, so they figure they'll worry about that later. Or on the other side of the coin, modern day investment specialists at your favorite big name wire-house take care of your investments first, and figure they'll get around to looking at your life insurance at some point (once they've sold you enough
stocks, no actually mutual funds because these guys tend not to be licensed to do that either, to afford the lease payment on that new BMW).
Does it Work?
Instead of diving into assumed rates of return and arguing what I think the actual rate of return on large cap equities is long term, I'm instead going to stick with a much more simplistic view on all of this (the engineers et. al. will be unimpressed, but even they would do well to heed the following advice). I'm going to instead stick with my guns, the Infinite Banking et. al. notion, that allows me to do things with my money, and offer support to me and my family that BTID–no matter how complex the market research behind the Registered Rep. or Investment Advisory Representative is–cannot. To illustrate my point, I'm simply going to go to the BTID mecca and take a look at their advice for college planning.
College Planning 101 The Primerica Approach
Tip number one (which should put a smirk on the face on any LEAP-ster, you'll know why in a minute) is Start Now. According to Primerica starting as soon as possible helps you keep up with rising costs (they don't explicit point out that time lost can not be regained, but there's certainly an implication). So Primerica does agree that a dollar saved is a dollar earned, and that money in savings has a leverage-able power for future earnings (maybe we aren't so different after all).
Next on the list is the somewhat obligatory Compare Plans, which is basically just a moment for them to drop names of the two most commonly recognized savings tools for college planning (Note recognized, used is perhaps a different story [see page 15]).
Tip number 3 is Don't Neglect Retirement. While it's very nice that you want to send Johnny or Suze to school, you shouldn't do it at the sacrifice of your good times in your golden years. They'll figure it out themselves and besides, they have a lot of working years ahead of them compared to what you have left.
Tip number 4 is a shameless plug for Primerica's recruitment efforts. They suggest that you boost your income by perhaps getting a part time job or, even better, starting a Primerica independent practice (bad financial planning begets more bad financial planning and the vicious circle remains unbroken).
Recently Primerica decided to readdress the paying for college topic in a more recent post on their web site blog. This time they dropped the shameless plugging of the Primerica Opportunity in decided to be a little more on point. Keeping true to the old adage that brevity is the soul of wit, they kept their advice to just four bullet points. They where:
- AP Exams The idea here is the more AP exams your child takes the more base-level requirements your child might have knocked out before they even report for orientation. This keeps costs down giving them the ability to perhaps graduate earlier (assuming they don't get the bright idea to become a triple major, graduate with a dual degree, or eye graduate school).
- Stay Close To Home. Instead of shipping off to the college of your dreams, why not commute from home to a public state University, or better yet, skip the first couple of years at a traditional 4 year degree and take all the basic stuff (like Math and Writing) at a community college. Besides, if Johnny or Suze shows up to the 4 year degree school of their dreams 2 years late, there's a good chance they'll miss the opportunity to meet some friends who might have helped them establish bad habits (read: beer drinking extravaganza!). It also, shuts down some opportunities to sample other offerings the college or university might have, but BTID is a place where rigidity is excellent and besides–like a good friend of mine points out about those useless Women Studies courses–school isn't supposed to be fun.
- Rent Text Books. Based on all the money I spent on text books I never opened while in college, I'm a little open to this one. Of course, then I remember that when I actually did open some of those books (like 24 hours before a midterm and they actually stayed open for that entire 24 hours period) I'm not so sure renting would be optimal. Of course, if you like being at the mercy of others and constantly complaining and worrying about things over which you have no control, chronic over exposure to the stock market is probably your thing.
- Stretch Your Savings. This one got me excited when I first saw it because I thought for one fraction of a second that maybe Primerica had decided Art was wrong, but no. What I
figuredhoped was advice about the nifty and extremely useful feature of life insurance policy loans that still earn dividends, I instead got some crap about how opening an Educational Savings Account could be a great way to somehow improve my ability to pay for college.
Following on my long held belief that journalists are
lazy overworked and given unrealistic deadlines (I did graduate from Syracuse University where I met many a communications major) poking around news articles for additional planning tips yielded similar dogged advice. Start savings as soon as possible, apply for financial aid, get a part time job, got to community college, and (the one that made me giggle) don't sacrifice your own retirement. Seems as though Primerica is right, after all everyone else is telling me to do the same thing.
However, we already know that Americans are chronically undersavers, and with student loan debt over-taking credit card debt, I begin to question if maybe we're doing something wrong. How does insurance and infinite banking help take care of college funding and help mom and dad maintain retirement accounts? Consider this…
The 529 Plan Save it and Dump
Traditionally we hear a lot of financial gurus lauding the use of the 529 plan. For those who don't know it's a state (or educational institution) run investment pool (mutual funds) that offers various investment options to you with the intention that the money will go towards certain educational expenses. The contributions aren't tax deductible (for federal income tax purposes, but some state deductions or credits may be available), but if distributions go towards “qualified educational expenses” the distribution is not taxed. If the money is withdrawn and does not go towards qualified educational expenses then any portion of earnings withdrawn is taxed as regular income plus a 10% penalty tax and it is possible for your state to recapture taxes that would have been owed if you hadn't contributed the money and instead paid state income tax on it. Further, 529 plans have a weird hybrid of FIFO/LIFO distributions. Distributions are actually a blend of the proportional amounts that represent basis and gain. So, if you had a 529 plan with $100,000 in it and $75,000 was your basis with $25,000 in growth and you withdrew $10,000 $7,500 would be from basis and $2,500 would be from gain (meaning if not every dollar goes to education, there's always a small chance that you'll have to pay some sort of tax if there is money left over and you withdraw it from the account).
Now that we have most of the fundamentals out of the way. The 529 is the plan of choice because…because someone convinced people who had access to the media it was a good idea. The plan is designed to accumulate wealth (take your hard earned money and hold on to it for a while) and then allow you to one day open the flood gate and watch it all go away (my daughter, and the last 20 years of my life, go to XYZ University!). BTID would tell us to buy cheap term so we had plenty of money to dump into the 529 (and it's especially important, because you'll need to budget for both your 529 and your 401k). And after about 20 years we'd have no life insurance, no money in the 529, and (if things played out like they did over the last 20 years) no money in our 401k (cheap low blow warning!).
So let's say you save $10,000 per year for 18 years. If you got 4% per year on this plan you'd have roughly $267,000 saved for college. And (assuming college costs continue to rise) you'd spend all $267,000 to put a child through a 4 year degree at a decently ranked private university (and probably the same amount at a not so decently ranked school just the same). After the the checks have been written and the bills have been collected the money is gone.
So, now let's assume you saved the same amount but you did something ridiculously foolish. Something like place that $10,000/year into a highly blended participating whole life policy (Dave Ramsey's back neck hair just shut up). Let's assume the IRR figures out to the same 4% (remember I like to under promise and over deliver). Now, at year 19 or so you'll take your first policy loan. But something fascinating is going to happen. Instead of shoving 100% of your 529 into a fixed account paying practically nothing (because principal preservation is paramount) and drawing out year number one's tuition bill (let's say exactly 1 quarter for easy figuring) and losing the interest earned on that 1 quarter (that's just under $67,000 by the way)…
Wait, lets stop right there and do a little math. After the $67,000 check is cut, and the remaining balance earns interest (let's say its 2% on a money market or something) You've earned $5,340 in interest. Keep this in mind, now back to our original thought…
…we'd take a $67,000 policy loan from the life contract. Yes the policy loan bares interest, let's call it 3.5% or $2,345 (yes the people in the know will point out that sounds kind of low, but I'm keeping the returns in dividend rates low so I had to adjust interest charges too). Now, we didn't need to adjust the investment option of the cash value in the life policy (in fact we can't) so it will continue right along at about the same rate. So, we get 4% on the remaining $200,000 right? Wrong! We get it on the entire $267,000 (NDR at work baby!) some $10,700 or so dollars.
Now, once we get college out of the way and the kids are off into the 9-5 world. Most financial gurus insist the way to make up for the loss in wealth is to “get serious” about retirement savings. But remember when they were all about starting early? Seems like this was a good idea back when it benefited their paradigm for college funding. Anyway, let's say get serious now means you're going to add an additional $20,000 to your retirement planning. $20,000 over 20 years at 4% is just under $620,000.
Now, what if the $20,000 per year simply went into paying back the policy loan? It would take roughly 17 years to pay back. Meanwhile the original $267,000 that was there after 18 years continues to grow as if nothing ever changed. Motoring right along at 4% (hypothetical) it becomes $684,000 and if you add $20,000 to it in years 18, 19, and 20 (you have the available resources since the loan is now paid off) your balance becomes just a hair under $750,000. A $130,000 difference between the invest, dump, and invest some more and the I'll Be the Banker (remember saying that at the beginning of a game of Monopoly) approach (yes there was a spreadsheet somewhere underlying some of this, but I promised not to crack one out, so I'll resist).
Meanwhile after the first 20 years or so, most BTID fanatics would have run out of life insurance and needed to make an additional (and much privier) purchase. Not so with the IB approach. Additionally at retirement (let's assume the end of the second 20 years) the BTID fanatic would have most likely said goodbye to his second 20 year term policy (hope he bought his wife a really nice happy retirement present). Not so with the IB strategy. In fact, take note of the fact that the entire time this IB approach has been going on, there has been life insurance in play, and despite providing even more cash in the end, the life insurance remains (in fact it has no doubt grown exponentially beating out the size of any term death benefit). Doable? You better believe it. So what did it really cost to “buy” that expensive whole life policy? And where is it going to go once Mr. and Mrs. IB head into retirement with their extra 130,000 duckets? Nowhere.
Also, which scenario had a stronger likelihood of playing out given risk adjusted rate of return? The S&P 500 is currently down 1.65% year-to-date if that's of any help in choosing your answer.
Don't Take a Shower…
Buy Term and Invest the Difference is an intellectual fraud. A fraud built on a shaky premise of over exaggerated returns (if we go back to the 529 discussion, anyone know of one that has done well?) and mostly unrealistic depictions of term life insurance in practice. It's championed by people who either A.) want to replace permanent insurance products and simply use the price difference as a sales technique (Primerica for the most part) or B.) want to invest all that money into other financial products. As the late Sid Friedman once pointed out, it's simply a tactic to get people to divert money to something else. If investing is your chief strategy why not try to cheapen expenses else where, like don't buy cable and invest the difference, eat hamburger instead of steak and invest the difference, and (my personal favorite) don't take a shower–just go for a walk when it rains–and invest the difference. You look just as silly doing any of these, and you probably cause yourself far less harm than if you actually attempted to buy term and invest the difference.