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The Whole Story: The True Rate of Return of Permanent Life Insurance
By Jason Oshins, Financial Advisor, MBA
Imagine your favorite epic film of all time – Superman, Godfather, Star Wars, or, if you ask your teenage daughter, Hunger Games. Each film draws you into a journey that only can be appreciated as a sum of many crucial parts unveiled methodically. Now imagine kicking back with your overly-buttered popcorn, being told by some sensory overload graphic to silence your cell phone, and watching your film, only to have the reel break after twenty minutes. Would you leave the theater with a full appreciation and understanding of the film’s brilliance? Absolutely not. Similarly, people view life insurance in a vacuum as opposed to one component of a larger strategy.
Life insurance is one of the most misunderstood elements of planning. We’ve all heard advisors extol the virtues of buying term insurance and investing the difference, emphasizing the opportunity for superior return in the market. This doesn’t tell the whole story. It stops at, well, the part where baby Superman gets catapulted into space inside an egg-like craft while his planet Krypton self-destructs. At best, it demonstrates a flawed understanding of “macro” planning, which accounts for the various moving pieces along with the interaction among these pieces. In a future article, we will address how the death benefit can enable access to much greater cash flow during retirement. With term insurance, the death benefit goes away when the policy lapses; with whole life insurance, this isn’t the case. For now, however, we’ll focus on assessing the “buy term and invest the difference” argument, putting aside the power of the death benefit and instead focusing exclusively on the cash value and its reverberations. This article constructs an intellectually honest analysis of the life insurance’s true rate of return (ROR).
Traditionally, the assessment goes like this – money invested in the market will offer a larger return than life insurance’s cash value. Flawed out of the gate, this viewpoint refuses to sit through the whole film. Sit back, silence your cell phones, indulge in your overly-buttered popcorn, and allow us to offer a true assessment of life insurance’s return, without cheating you out of the ending. To do this, we’re going to apply a three-part framework, as follows:
- Part 1: Cash value… we begin with the internal build-up inside the life insurance policy; growth is unencumbered by annual taxes 1 , so long as the policy remains in force;
- Part 2: Cash value + term savings… we add the money saved by avoiding term premium payments, as these payments no longer are necessary given the acquisition of permanent insurance;
- Part 3: Cash value + term savings + tax savings… we add the money saved by reducing taxes, as properly-funded 2 whole life 3 insurance doesn’t trigger annual taxes; this is not the case with mutual funds 4 , for which investors receive a 1099 each year.
For the purposes of the analysis, our client is a healthy 35 year-old male who obtains a $1,000,000 life insurance policy. In the first scenario, he purchases a 30-year term policy for $1,000 per year. Additionally, he invests $13,000 in the stock market. We’ll assume a generous 8% annual rate of return, year in and year out, in which case our client significantly outperforms the average investor in equity funds, who earned an annual ROR of 3.69% over the last 30 years, according to the most recent study from Dalbar 5 . For the second scenario, our client will make just one different move. Rather than putting the $13,000 savings allocation into the market, he uses it to acquire a whole life policy 6 . He then takes the $1,000 otherwise allocated to purchasing term insurance – which no longer is necessary – and invests it in the stock market. For these recaptured dollars, we’ll assume a 6% ROR net of taxes. We’ll apply the same assumption for the taxes avoided in this scenario. While the numbers change depending on the insured’s age, the framework applies irrespective of the age.
PART 1: CASH VALUE
We’ll start with the cash value, the internal build-up of money unburdened by taxes. This is the film’s opening sequence; so much is missed if the viewing experience ends here. Many focus exclusively on the policy’s cash value, ignoring the other rippling saving components, which this analysis will address shortly. For the first part of our assessment, we’ll begin – where the other viewpoint ends – with this as the foundational component of the analysis, acknowledging that more, much more, is yet to come.
We’d be remiss to disregard another notable flaw in the standard analysis. Typically, the comparison ignores the difference in risk between a mutual fund and the cash value in a life insurance policy 7 . Cash value doesn’t decrease; it’s built on guarantees and augmented by annual dividends. This is fundamentally different from an investment, which swings wildly from positive to negative, depending on the year. As such, the return in the first scenario is significantly riskier than that in the second scenario. Nonetheless, the ROR of a whole life policy still is healthy, even when the assumptions are stacked against it by comparing it to this far riskier alternative.
Using our healthy 35 year old, the policy’s cash value alone results in:
PART 2: CASH VALUE + TERM SAVINGS
In the next part, we address the term insurance component. If our client purchases whole life insurance, does he still need to acquire temporary insurance to cover the $1,000,000 death benefit? Absolutely not. As such, we recapture the annual $1,000 term cost he now avoids, along with all its future growth. To reiterate, we’ll assume a rate of return of 6% net of taxes on this recaptured money. As you can see below, we are now settling into the growing plot and developing characters of our film. We nurse our supersized drink for fear of missing the coming scenes due to a necessary bathroom break. We are beginning to appreciate the developing sum of the parts.
After parts one and two, we’ve established that whole life insurance provides a long-term ROR competitive to that enjoyed by the average investor invested in mutual funds. Let’s see what part three reveals.
PART 3: CASH VALUE + TERM SAVINGS + TAX AVOIDANCE
Taxes – I’m yet to meet somebody who likes paying them. They certainly provoke strong feelings. It’s only fitting that our analysis concludes with this provocative subject. If our client allocates savings to whole life insurance, does he still trigger taxes on these dollars? Absolutely not. When money is in the market, what does the IRS expect to be paid at the end of the year? That’s right… taxes. Investors receive a 1099, and they pay taxes based on their investments’ activity and performance. A properly-funded whole life insurance policy grows unencumbered by taxes – not a penny goes to Uncle Sam.
By making a single move, putting the $13,000 savings allocation into whole life insurance instead of the stock market, our client significantly flattens his taxes. Over time, as we see, these taxes are of great consequence. Moreover, in addition to the extensive year one tax savings, our client benefits from the annual growth of this additional money. When we add these tax savings to the cash value and the term savings, we see that the life insurance has no reason to apologize.
Superman, Godfather, Star Wars, and the like are favorites from generation to generation. For each film, every scene builds on the prior to unveil a powerful story, and only when viewed in its entirety can the film’s true brilliance be appreciated. The same is true for life insurance. Typically, the “term and invest the difference” analysis disregards key components, essentially telling an incomplete story. This article remedies that flaw, presenting a more appropriate framework. By including the term savings and tax avoidance, the ending is dramatically different. The resulting rate of return is competitive with a far lower risk profile. But the true power is in the death benefit. In the first scenario, it goes away when the insured is 66. In the second scenario, however, this isn’t the case. Stay tuned for a future article in which we’ll focus on how a guaranteed wealth replacement mechanism – the death benefit – can unleash the ability to enjoy significantly more wealth during retirement.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The information provided here is believed to be reliable but should not be assumed to be accurate or complete. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. All investments involve risk and may lose value. Past performance is not a guarantee of future results.
 Guardian, its subsidiaries, agents, and employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.
“Properly funded” means the policy is funded below MEC limits.
 Whole life insurance is intended to provide death benefit protection for an individual’s entire life. With payment of the required guaranteed premiums, you will receive a guaranteed death benefit and guaranteed cash values inside the policy. Guarantees are also based on the claims paying ability of the issuing insurance company. Dividends are not guaranteed and are declared annually by the issuing insurance company’s board of directors. Guardian has paid a dividend every year since 1868. Any loans or withdrawals reduce the policy’s death benefits and cash values, and affect the policy’s dividend and guarantees. Whole life insurance should be considered for its long term value. Early cash value accumulation and early payment of dividends depend upon policy type and/or policy design, and cash value accumulation is offset by insurance and company expenses. Consult with your Guardian representative and refer to your whole life insurance illustration for more information about your particular whole life insurance policy.
 Non-qualified investments generate taxes each year; qualified investments result in deferred taxes. The analysis assumes a non-qualified investment.
 Dalbar, Inc. is “the financial community’s leading independent expert for evaluation, auditing, and rating business practices, customer performance, produce quality, and service”. Published in 2014, its most recent Quantitative Analysis of Investor Behavior” shows that investors’ average annual return in equity funds is 3.69% for the past 30 years and 5.02% for the past 20 years, substantially underperforming the market.
 This is a hypothetical whole life illustration and is not representative of an actual Guardian whole life insurance policy. This hypothetical illustration is intended to show, in general terms, how a typical participating whole life insurance policy might work. The values are based on Guardian’s current annual dividend, which is not guaranteed and declared annually by Guardian’s Board of Directors. If purchase of a Guardian whole life insurance policy is being considered, a full illustration with guaranteed values and other important information must be provided.
 Risk is measured by standard deviation. For context, the standard deviation of the S&P 500 from 1973 to 2012 is 18.13. The standard deviation of US Treasury Bills, a proxy for life insurance’s cash value, is 3.35 over this same period. Source: Matson Money, Inc.
ABOUT THE AUTHOR
Jason Oshins is a Financial Advisor with Wealth Strategies Group. He works closely with clients throughout the country to increase wealth during lifetime, improve income during retirement, and provide a greater legacy upon passing, while also protecting their estate from taxes, inflation, and market volatility. He specializes in the areas of estate planning, investments, retirement planning, insurance planning and design, disability protection, long-term care, wealth transfer, and business planning. Jason obtained his MBA from the University of Michigan in Ann Arbor. He can be reached at (702) 735-4355 x218 or at [email protected] .
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS) 6455 S. Yosemite Street, Suite 300, Greenwood Village CO 80111, securities products/services and advisory services are offered through PAS (303-770-9020). Financial Representative, The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. Wealth Strategies Group is not an affiliate or subsidiary of PAS or Guardian.
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Is whole life insurance right for you?
Follow our advice to assess this most misunderstood coverage
We’ve long advised younger, budget-conscious families to buy term life insurance. The main reason—it offers bargain-price protection that pays a large benefit to your survivors if you die during the typical 20- to 30-year term of the contract. Consequently, we’ve tended to short-shrift whole life insurance because it’s a murky mix of life insurance and savings or investment vehicle that builds cash value after several years and into the future—again, as long as you pay the premiums, which can be 10 times as high as those on a same-sized term policy.
Our advice—that term life is a better deal for most families—hasn’t changed. But because bigger annual premiums result in larger commissions for insurance salespeople, sooner or later an agent may try to sell you a whole life insurance policy, also known as “cash-value” and “permanent life.” But whole life is a lot more complicated than term, and you should understand how both types work.
The confusion starts with the fact that whole life insurance combines two financial products—life insurance and an investment—into one that is supposed to serve your needs over your entire lifetime. But life is unpredictable, and the circumstances that drove your initial purchase can be very different a decade later. A period of financial stress, say, may prompt you to eliminate the high annual payment and surrender the policy for its cash value.
Running the numbers
To grasp the value of whole life insurance, you need to see how it and term life insurance operate in practical terms. We got term and whole life quotes from AccuQuote, an online broker that sells policies from about 100 insurers nationwide, for a 40-year-old Illinois man in perfect health who wants a $500,000 policy with level annual premium payments (click to enlarge the chart, right).
When you’re young and have a family, term life insurance (dotted-red, then solid red line) provides a big death benefit for a bargain price (turquoise line). But at age 70, in our example, the 30-year term protection ends. That’s also when the term life starts becoming prohibitively expensive because of the insured’s age and declining health, and the increasing probability of death.
A traditional whole life insurance policy purchased at 40, keeps the death benefit in force beyond age 70, as long as premiums are paid (dashed-blue, then solid-blue line). Whole life premiums are steep, though: $6,760 per year vs. $660 annually for the term policy. But the “excess premium” goes to guaranteed savings, which build cash value over time (light-gray line).
Alternatively, you could buy the 30-year term policy and each year invest the difference between the whole- and term-life premiums in conservative 10-year Treasury notes. (T-notes are a comparable alternative to investing in whole life, in terms of liquidity, risk, and resulting returns; a stock mutual fund would not be comparable.) In this illustration, which assumes that the current 2.17 percent 10-year T-note rate remains level, the T-notes can provide a higher return on your money (dark-gray line) vs. the guaranteed return (light-gray line)—but no death benefit past age 69.
So one value of whole life is the continuing death benefit (dark-blue line) for your heirs while you continue to build cash value.
But some whole life policies also pay dividends based on the insurer’s financial performance. Those returns, not guaranteed but likely, can be reasonably estimated. When the dividends are used to buy additional “paid-up insurance,” that can add an estimated $500,000 to cash value by age 90 (light-blue line) and boost the death benefit to $1.1 million (gold line).
However, the average annual rate of return—1.5 percent for the whole life guaranteed cash value, 2.2 percent for the Treasuries, and 3.5 percent for the whole life possible cash value—is undercut by inflation, currently about 2.2 percent per year.
So your savings tread water while providing lifelong life insurance, and you can pass on the assets tax-free to your heirs.
Whole life insurance can provide benefits while you’re still alive. Check out the worthwhile long-term care rider.
Timing is everything
The name of the game is to hold on to your policy until you die. About 4 percent of whole life policies per year lapse, according to a study of 47 million policies issued by 20 insurers over more than two decades, by LIMRA, an industry research company. That means the value of a whole life policy depends on how long you own it. Here’s what to look for:
Less than five years
Our advice: If you worry that you won’t be able to maintain those high whole life premium payments for even a few years, buy term insurance instead.
If you dump your policy around the 16th year, your cash surrender value plus the value of the insurance you received will be about what you put in. So that’s the earliest you can drop the policy without losing your shirt.
Our advice: If you’re wealthy, you can probably gamble on whole life over that long period. If you’re struggling, go with term.
Two decades and beyond
As our chart shows, if you steadily maintain your payments for two decades, the returns on whole life, including dividends, start significantly pulling away from the term plus Treasuries alternative. Meanwhile, surrender charges have usually disappeared, if you want to cash out. “If you hold a cash-value policy long enough, it can compete with alternative investments of comparable risk,” says Glenn Daily, a New York City fee-only life-insurance consultant.
Our advice: Higher-income folks in the 20+ years club have options: If you’re building a legacy for your heirs and have the money to keep going, the rising return trajectory and insurance coverage should give peace of mind. If you need to leave whole life, you can.
Whole life provides a death benefit until age 100 to 121, depending on the policy, but you have to keep paying the premium as long as you live. However, for an additional premium, if you become disabled before age 65, the insurance company pays the premiums for the rest of your life.
This mixed bag of potential benefits and costs is complicated enough for consumers to navigate, but poor disclosure robs consumers of the information they need to comparison shop.
Although most states have adopted model disclosure regulations promoted by the National Association of Insurance Commissioners, no state or federal agency requires them to mention such basics as investment-management fees, rate of return, and (with the exception of New York) sales commissions.
Insurers also don’t disclose what part of the annual premium goes to pay the life insurance vs. savings components of the policy. If you don’t know how much is going to your cash account, you can’t accurately calculate your rate of return on that asset.
That makes it difficult to compare one policy with others. And yet there are large differences in prices among companies for essentially the same coverage, industry experts say. Brian Fechtel, a chartered financial analyst and 27-year life-insurance agent, says commissions on whole life can be 130 to 150 percent of the first-year premium.
“If the industry disclosed the commissions, whole life sales costs would have to come down to be competitive,” Fechtel says.