I’m not a fan of whole life insurance. But since I continue to hear this absurdity that whole life is the only good option for individuals who are maxing out their 401k and IRA, I brought the financial experts with me in this post. 🙂
Let me set this up for you:
A client of mine recently referred me to a friend who was interested in buying whole life insurance as an investment.
He asked if I could review the plan that had been pitched to him.
He had been approached by a Northwestern Mutual agent with the same old song and dance about guaranteed return, tax-free accumulation, and tax-free access to your money.
The agent also pointed out that since my new friend was already maxing out his 401K and would make too much money this year to get a tax break for contributing to an IRA, (In 2016, the max for an IRA deduction is $71,000 if filing as an individual and $118,000 if married and filing jointly) that whole life is the only tax-efficient option for him.
(Insert sound of me banging my head against the wall)
The problem is, this prospective buyer is only 31 years old, has no wife or kids, and already has a 30 year term policy for $250,000. He is only making $100,000+ for the first time in his life this year. He made just $60,000 last year. Hardly a candidate for an $8,000 per year annual premium!
I see this every day!
Whole life is not your only investment option if you’re maxing out your 401k or can’t contribute to an IRA. Especially if you don’t even need life insurance!
Please consider the following prior to spending a penny on whole life insurance!
7 Investments to Consider Before Whole Life
If you haven’t already done so, I would first go to a CFP and offer them a fee to look at your entire financial plan before speaking to any agents about whole life.
Remember commissioned sales people generally make for horrible financial advisors since they’re hopelessly biased toward selling their OWN product first. CFP’s, such as those at AIO Financial, are not only responsible but have a fiduciary duty to tell you what’s best for YOU. I’m most comfortable recommending fee-only ones, since they aren’t compensated by which investment you choose.
Here are a few alternate investment ideas I would discuss with a CFP.
(Note: These are written for a W2 Employee in mind.)
#1 – Taxable Account
Multiple personal finance experts like Larry Ludwig from Investor Junkie and Eric McClain from McClain Lovejoy Financial Planning will tell you a regular taxable brokerage account is one of your best options.
With long term capital gains at just 20%, this option provides liquidity and flexibility (you can take it out whenever you want) and low expenses.
CFP and NerdWallet contributor Adam Funk, from SavingsCoach.com says:
Sophisticated investors don’t shy away from taxable accounts. For example, you’ll see them buy and hold Warren Buffet’s Berkshire Hathaway stock for years. It’s liquid if necessary and they don’t pay dividends, so they’re only on the hook for low, long term capital gains tax when/if they sell.
If you’re wondering how a taxable account could possibly measure up to a tax haven like whole life insurance, it’s probably because you’re focusing solely on the tax benefits of whole life. In reality, the tax benefits aren’t that great considering most people don’t even break even for the first 10 years in whole life. What good is tax-free access to funds that have no gains?
Plus, you shouldn’t just be considering tax benefits.
Todd Tresidder from Financial Mentor says, “It all comes down to mathematical expectancy, or net ROI after tax. The fact that an investment has tax benefits is great, but that’s only one aspect of performance! Say a stock is 100% taxable in a non-qualified account, but it has a 50% return. Its ROI is still incredible. That’s why if you’re simply considering the tax benefits of whole life insurance, you’re taking your eye off the ball.”
My personal opinion (if you’re not good at valuing companies) is to just invest in a handful of ETF’s that track the major indexes like the S&P 500 (IVV), the Aggregate Bond Index (AGG), and the MSCI Emerging Markets Index (EEM), among others.
You could simply fill out a risk assessment form on a site like WealthFront and instantly see (and mirror) the strategy they would put you in.
This way you don’t have to do any stock picking. But it would be wise to enlist the help of a Financial Planner or RIA here to help you take advantage of things like loss harvesting and rebalancing your portfolio.
#2 – HSA account
If you have a high-deductible health insurance plan, an HSA is an excellent place to invest for your retirement.
Roger Wohlner from The Chicago Financial Planner and author of “Health Savings Accounts – The Other Retirement Plan” says you can contribute to an HSA with pre-tax money, similar to an IRA, and withdraw the money for qualified medical expenses tax-free.
You can contribute $3,350 as an individual or $6,750 as a family in 2016, as well as an additional $1,000 “catch-up” contribution if you’re over age 55.
The best part?
There’s no maximum income that disqualifies you from contributing.
Qualified healthcare expenses include:
- long term care expenses
- Medicare & Medicare supplement premiums
- most medical and dental expenses
- vision care
- co-insurance and deductibles
- prescription drugs
Wohlner says that even though the funds must be used for medical expenses, it’s highly likely you will use them, citing a Fidelity study, which estimated that an average 65 year old couple will spend over $245,000 in health expenses throughout retirement.
#3 Variable Annuity
Variable annuities offer tax deferred growth but are taxed at ordinary income upon withdrawal. I’m told Vanguard has a good, low cost one.
But VA’s do have one very nice feature:
The cool thing about annuities is you can “annuitize” them, meaning you can take your income out over a fixed period of years, say, 10, 15, or 20 years. The benefit here is any taxable gains you’ve made over the years doesn’t hit you all in the first few years of distributions as you pull out those gains.
Instead the gains are spread out over the time period you’re taking the money. For example, if $500K of contributions turn into $1 million, and you take it all out at once, you’ll owe tax on a 500K gain. But you could take the $1 million over 20 years, so only about half of the income from it would be taxable.
#4 Rental Property
Elizabeth Colegrove from The Reluctant Landlord teaches investors how to add rental properties to their asset portfolios.
Colegrove says that besides the equity you can gain from owning a rental, there are several other benefits of being a landlord including:
- Positive cash flow
- Tax deductions – You can depreciate your rental
- 1031 exchange – Time to sell your rental? That doesn’t mean you have to pay taxes on your gains yet. You can roll your money into a new property using a 1031 exchange.
Real estate offers lots of tax breaks and potential diversification of your asset portfolio.
If you’re too anxious for owning a rental, you might try investing in REITs. REITs allow you some of the same benefits without owning the property.
#5 US I Bonds or EE Bonds
Larry Ludwig from Investor Junkie said another way to add safety to your portfolio and get some tax benefits was using US I Bonds or EE Bonds.
I Bonds earn interest based on a combined fixed rate and inflation rate. EE Bonds just earn a fixed rate.
They’re both STATE tax free but not Federal. You may be able to use them for higher education and avoid federal income tax too.
#6 Non-Deductible IRA with Conversion to Roth
This idea was first proposed to me by Eric McClain from McClain Lovejoy Financial Planning.
McClain says if you make too much to contribute to a Roth, consider making contributions to a non-deductible IRA. Writing for FiGuide.com, McClain says:
Later, you can convert these non-deductible contributions to a Roth account but would not pay tax on the “basis” contributions. This strategy is often referred to as a “backdoor” Roth contribution.
In other words, you can contribute today to an IRA (even if you make too much to contribute to a Roth), wait a few days or a few weeks, and then convert to a Roth. Kimberly Lankford at Kiplinger says you’ll only pay tax on the gains you made while the funds were in the IRA.
McClain and Lankford both stress that the tax treatment of Roth conversions becomes much trickier when some of the IRA funds being transferred were “pre-tax” contributions, and urge you to speak with a tax professional before making any moves.
#7 Invest in Yourself
An excellent way to invest your money and get tax benefits is to start your own business.
A business enjoys tax breaks on phone, home office, mileage, etc.
…I recommend working in a business where “anyone” could be your client. For example, just about everyone I know is either a life insurance client of mine or a prospect. That makes for a lot of deductible meals.
If starting a business intimidates you, get started in a network marketing company!
All the product development, branding, and marketing are done for you. All you have to do is share with your friends and family.
It’s super low cost and the tax benefits are tremendous.
If you’ve never considered this before, I’d recommend Yoli, which my wife, Brenda, is active in.
(Disclaimer: I am not a financial planner. This is not to be considered investment advice, only considerations that may be better than whole life. I recommend speaking to a CFP before making any investment decisions.)
Stupid-Simple Reasons Whole Life Insurance is a Mistake
I’d like to end this article with a few more thoughts about whole life.
Now, I’ll admit there are a few rare cases where I support whole life as an investment (It works in a couple estate and business planning type cases, and in the rare instance where someone doesn’t care about return and just wants a safe, conservative investment) but this isn’t one of those cases.
But I don’t typically endorse it as an investment.
Here are some of its low points:
- High fees
- “Forced” contributions (see my rebellion page)
- Low returns
- It’s “expensive” as far as permanent life insurance goes
- To go along with that, here are a few resources for you to check out that mostly point out the negatives:
Tools and Resources Discussing the Above
These resources do a great job of explaining the pitfalls of whole life:
- Whole Life Insurance Rebellion Page – this is a movement I started against Whole Life, actually. It’s not that I’m completely against whole life, mostly against the way its sold so aggressively to people who aren’t suitable for it, but check out point #1 on this page – https://www.insuranceblogbychris.com/whole-life-insurance-rebellion/
- Financial Mentor – http://financialmentor.com/financial-advice/life-insurance/whole-life-insurance/19216 – Former Hedge Fund Manager, Todd Tresidder goes into a lot more detail about forced contributions here, as well as lackluster tax and liquidity benefits.
- Term vs. Whole Life Calculator on my site: https://www.insuranceblogbychris.com/term-vs-whole-life-insurance-comparison-calculator/
“Who is ‘Right’ for Whole Life?”
If someone is already maxing out all other tax favored investments, and is just looking to diversify their portfolio with something that doesn’t earn a very good return but is a good, consistent, conservative investment with some liquidity (and of course, life insurance), then they should definitely look into it. It’s one of the safest places you could put your money.
A key factor, though, is affordability (and not just affordability today but affordability for the entirety of the policy) because if you stop making your premium payments (especially during the first 10 years of the policy), and can’t pay it back plus interest, your policy is likely to lapse.
Agents with “Commission Breath”
Whole life agents are notorious for recommending policies with hefty premiums, so be sure not to pay more than what you can afford. Say you are quoted $2000 per month… if you make $60K-100K per year, I’d say “hell no!” If you make 150K+ per year, and your income is super consistent, then I don’t have a problem with it.
…Of course, again, I would look into the investments below first.
“How Can you Say It Has a Low Return? My Illustration is Quoting a 10% Dividend!”
A 10% dividend is a little misleading. The dividend only gets paid on the cash value, which first gets reduced by cost of insurance and policy fees, so it’s not like you’re getting 10% on all the money you’ve put in. In fact it takes most policies 7 to 10 years just to break even.
Or let’s put it in simpler terms.
Let’s say I take $100 from you, and then offer you a 20% return (or dividend) on whatever amount of money (after fees) that finally makes it to your “investment account.” But after I deduct fees and commissions, all that goes into your “investment account” is $50. In that case 20% on $50 doesn’t sound so good, does it?
Do you agree with me that you should look into other investment alternatives before buying whole life?
What other alternate investments would you recommend (or have had success with) that you can share? (Think about total net return – not just investments with tax breaks.)