Why Buy Whole Life Insurance

When people ask us, “why buy whole life insurance?”, our standard answer, though much wordier in conversation–because mainstream financial advice has failed you. Following the most popular advice from the investment industry and from the financial talking heads that frequent CNBC, the Wall Street Journal and Yahoo Finance will likely leave you confused.

Most of the people who write, report, and guest on those shows or sites are very much misinformed about whole life insurance.

What constitutes mainstream financial advice you ask?

It’s the list of the most commonly held advice given to Americans on those shows and site multiple times every day:

• Contribute the maximum to your 401k
• Use dollar-cost averaging to buy low-cost or no-load mutual funds
• Only buy term life insurance
• Buy and hold—the market always provides higher returns over time

If you are a student of personal finance, you probably nodded your head in agreement with that shortlist. That’s the sort of thing you’ll hear parroted over and over almost every day of the week.

We’re going to make a controversial statement regarding mainstream financial advice—it stinks. Let me be clear, encouraging people to be more thoughtful about spending habits, saving and investing is good work.

The problem is when those pundits decide to pick winners and losers among one strategy or another.

We’ve worked with people who have taken all of the advice that was offered up to them over the years. As a matter of fact, they followed it to a “T”.

They are financial overachievers. Highly educated, motivated, and earn much higher than average incomes.

But after following mainstream financial advice they’ve arrived at a similar conclusion to us. It doesn’t work very well and they’re not pleased with the result.

They have large 401k and/or IRA balances, have invested in low-cost options, and kept their expenses low relative to their income. Now what?

What’s the plan beyond that?

Three Reasons to Buy Whole Life Insurance

1. It’s Liquid.

   I’m ranking this one at number one for good reason. Brandon and I agree that liquidity is the best reason to own whole life insurance. We think that it should be a part of most financial plans.

   On the surface, saying whole life insurance and liquidity in the same sentence probably seems strange. But when policies are designed and implemented correctly from the beginning, access to cash is the crowning achievement for most people.

   I know that many of you are thinking about the first few years of a new whole life policy. You’re thinking about the fact that most policies have little to no cash value whatsoever in the first few years. Obviously, this is a problem since that is the source of liquidity.

   We’re not big fans of locking up tons of money that you can’t get your hands on if the spit hits the fan. But we are willing to admit that having to jump through a few small hoops can be a virtue for most of us. Especially if you have the, “like to buy big-ticket items on a whim” gene.

   Now back to the first few years of a new whole life insurance policy and the lack of liquidity problem. It’s a valid concern and can be a real problem. In fact, we’ve had to tell quite a few people over the years since we started this site, that the policy they bought isn’t quite what they thought.

   Unfortunately, it seems like a lot more people have that experience but never encounter people like us to help them navigate the murky waters. A few of them have gone on to publish a book and start their own sites where they dedicate themselves to hating on whole life insurance. We understand it’s tragic to see someone pay something like 100k in premiums over a few years to have something less than 10k in cash value.

   Those people inevitably ask, “how can you claim whole life insurance has liquidity, I won’t have any in my policy for a few years and nothing substantial for a decade or more?”

   Sadly, they’re not wrong in many cases. But not because it’s a problem with whole life. It’s a problem with how their policy was designed and implemented. If a policy is designed correctly, with the intent to generate as much liquidity as possible, you’ll have access to the cash from the very beginning.

   Good or bad has a whole lot less to do with the product itself and more to do with the design and implementation of the product.

   The truth is that you likely have an investment account that you have thought about accessing for an emergency but timing can make tapping that money a terrible idea. Not to mention if you’re selling highly appreciated stock, for example, there is a substantial tax consequence that follows.

   What if instead of having to hear about how disastrous it will be to take your money out, we could talk about how it’s perfectly ok to spend your money?

   We would never suggest you become a spendthrift but knowing that you can spend your money as you see fit without committing financial suicide is appealing.

   It’s unfortunate but for some reason, we (Americans)have adopted a paradigm that drives many of us to be asset rich (we hold assets that have value and inflates our net worth) but we’re cash poor.

   Liquidity is a wonderful thing. The problem most people struggle with is finding a safe place to warehouse cash that’s tax efficient and offers a decent return.

   Whole life insurance is the linchpin to leverage your liquidity as much as possible.

2. It's Market Neutral.

   The Wall Street marketing machine would have you believe that in order to build wealth you have to buy stocks (or products related to stocks). We talk to a lot of people who aren’t interested in having more of their wealth tied to the market. Not that they hate the market but they want to decrease their exposure to risk. Many of these people take on a substantial degree of risk every day.The fact is that most of our clients have grown their wealth through a controlling interest in a privately held business or by prudently setting aside a sizeable portion of the discretionary income from their earned income.

   They’re familiar with risk but they favor taking risks that afford them some degree of control.

   They make a conscious choice to buy whole life insurance as a part of their overall financial planning strategy. And you can rest assured they do not choose to buy it from us because we have an unusually convincing or unique sales presentation.

   No, they choose to whole life insurance because it works and they expect us to prove it to them before they ever fill out an application. Fortunately for us, whole life insurance works exactly as we tell people it does.

   But a lot of people in the financial services industry seem to struggle with the concept of market neutrality. It’s not a difficult concept to understand, so our suspicion is that the problems stem from poor training and education. Sadly, most of the training in the investment and insurance industries focus on sales technique and prospecting for new business.

   Many advisors are taught how to construct a “financial plan” thinking only of the finite basket of products their particular firm has to offer. We get it, a business can’t sell products it doesn’t offer, however, this tends to limit the scope of the risks that are evaluated. Here’s the point–there are financial risks that all of us face that exist outside the particular risks of owning stocks and bonds.

   Just to frame this, here are some situations we’ve personally witnessed: tough fight with cancer, losing a job, being sued because your teenage driver caused a car accident, your parent needs some sort of long term care, or your spouse dies suddenly. And think about the person who had 80+% of their liquid net worth invested in a balanced portfolio of stocks and bonds their 401k in mid-2008 planning to retire at the end of the year.

   What does this have to do with whole life insurance and its market-neutral position?

   The market can fall hard, just like we saw in the last decade during the financial crisis and the current cash values of your whole life insurance policy didn’t budge. Cash values will not go down and at the very least will increase as a result of the guaranteed rates on the policy.

   That’s valuable peace of mind.

   It’s true, that when the market bottoms out and runs like a hot streak at the blackjack table, your policy isn’t going along for the ride. The financial pundits and personal finance gurus will point to whole life insurance as being left behind. Because of its market neutral position, the cash value of your whole life policy will not react to the market’s run.

   But here’s the beauty of buying the right whole life insurance policy with the right design…

   It performs as it should regardless of market booms or busts. There are factors that can affect the rate of return on the cash value of your policy (interest rates, the investment return of the company, etc.) however, remember that insurance companies are engaged in running a profitable business. When you own a participating whole life policy that pays dividends, you participate in that profitability.

   And don’t forget, you’re coupling this market neutrality with point #1, the fact that your cash value is liquid. You can tap into it with a quick phone call and have your money in a few days.

3. No Worry About Taxes.

   If you have a large and ever-growing balance in your tax-qualified retirement accounts (401k, IRA, 403b, 457 et. al.), you could be in for a rude awakening when you begin withdrawing money.

   Every dollar is taxable. That means a decent chunk of the money you’ve accumulated in tax-qualified accounts is going to ultimately be paid to the IRS.Following mainstream financial advice means that you are effectively entering into a partnership with the IRS.Not to worry, the IRS has plans for your partnership and whether or not you choose to accept it–is irrelevant.

   As the late Senator, Daniel Patrick Moynihan once said:

   “Everyone is entitled to his own opinion, but not his own facts.”

   Here are the facts: The United States currently spends nearly sixty percent of the federal budget on four things: Medicare and Medicaid (27%) Social Security (24%), and the interest on the National Debt (7%).

   Since 1913, when the government first re-imposed the income tax, our tax rates have been volatile at best.

   The first income tax rate was 1%. By 1943, the highest marginal rate was 94%. Government spending is an addiction fueled by tax revenue. Fast forward to today. The top marginal tax rate is only 37%.

   Unless you can accurately predict what the tax rates are going to be in the year you choose to take money from your 401k (or rollover IRA), you really have no idea how much money you have.

   Choosing to help put whole life insurance into its proper context involves a fair amount of learning to go “against the flow” of mainstream financial “wisdom”.

   It’s not just about the market neutrality (though that is certainly valuable), and it’s certainly not about the likely return (stocks will almost surely win long term).  It is about understanding that personal finance is much more strategic than anything else.

   How does whole life insurance help us with the tax situation now and in the future?

   Any cash value that you have will earn interest and accumulate dividends. Those gains will compound without any tax consequence to the policyowner. That sounds a lot like tax-deferral, similar to what you can get from your IRA or 401k but that’s not the only benefit whole life insurance cash values have to offer.

   With any sort of cash value life insurance, you are able to take advantage of FIFO (first in first out) accounting. There are two basic methods of accounting that apply to tax-deferred accounts.  One is last-in-first-out (LIFO) and the other is first-in-first-out (FIFO). The names of each method define how they function but here’s a brief explanation to add clarity.

   LIFO means that any money taken from the policy is accounted to whatever money was most recently accumulated (the gain). So, when you receive money from any product that relies on LIFO, you will be receiving the gain which creates a taxable event.

   On the other hand, FIFO means that you have the ability to receive whatever money was first contributed (cost basis). That means the when you receive money from a product that uses the FIFO method of accounting, you are getting a return of your cost basis first. This does not cause a taxable event. You’ve already paid taxes on that money before you paid the policy premium in the case of whole life insurance.

   Hopefully, it’s clear that being able to take advantage of FIFO is a huge leg up. Here are some specific benefits: you can withdraw the money at any time because there are no tax ramifications, withdrawals have no impact on other sources of income (Social Security is an obvious example here), and access to your money doesn’t cause any further tax issues.

   When you combine its market neutrality, its stable return, its shelter from capital gains taxes and its ability to create a tax-free income, you have an incomparable financial tool.

   As mentioned above, whole life insurance uses the FIFO accounting method but that’s not all. Remember, you also have the ability to take a policy loan and those loans are not recognized as income for tax purposes. Just to be clear, distributions of cash value can be taken to your cost basis (total premiums paid) with no tax implication. Then you can take policy loans after you’ve exhausted your withdrawals up to your cost basis.

   That’s not the formula you have to use and most likely you’d only use that exact formula if you were going to receive an ongoing income stream from your policy. Most people just use policy loans if they’re dipping into their policy cash value to make a purchase, investment in real estate, etc. That way they can pay the loan back and still grow the cash. If you take withdrawals, you will decrease the cash value that’s earning the dividends and interest.

   When your premium dollars flow into the whole life insurance and you have accumulated cash value, the money grows tax-free and be accessed without a tax consequence. You simply have to make sure that you complete the process correctly. Please don’t let that sound scary, it’s not complicated and its something our clients do often.

   If taxes aren’t something you cherish or if you’d rather avoid the future implications of unknown tax rates, whole life insurance may be a product for you to consider more seriously.

Is Whole Life Insurance for You?

Want to know if life insurance belongs

 in your financial plan?  Contact Us today to find out.