Long before I became a life insurance professional, the debate between the advocates of whole life insurance and those who extolled the virtue of term insurance had been raging. It continues even today 46 years after I first heard an agent say, “Buy term and invest the difference”–with the countering remark by another agent, “No legitimate investment can match the internal rate of return found in a whole life insurance policy.”
“Whole lifers” and “term-iters” will always debate the virtue of these alternatives for replacing human life value when an insured passes away.
Value of Whole Life Insurance
Dave Ramsey, a popular financial advisor has some rather strong feelings about the whole life industry and those who make their living in it. He compares the “savings” portion of the policy with other investments and draws the conclusion, “purchasing a whole life insurance policy is the worst vehicle you can use for investment purposes.” He suggests that no one other than those selling the product would consider its purchase and those who did purchase whole life product only got stuck with it. I did a little research and found the following which may help him and others see very respectable financiers and entrepreneurs saw a place in their financial planning for whole life insurance.
I wonder how Mr. Ramsey would respond to the following:
- Walt Disney borrowing against his cash value insurance in 1953 to help fund Disneyland, his first theme park, when no banker would lend him the money;
- JC Penney following the 1929 stock market crash using his life insurance policies as collateral to help meet the company payroll–had he not had ready access to capital, the company may have been forced to close its doors, adding even more people to the unemployment line;
- Ray Kroc when building McDonald’s did not take a salary during his first 8 years, and to overcome constant cash-flow problems borrowed money from two cash value life insurance policies (and also his bank) to help cover the salaries of key employees. He also used some of the money to create an advertising campaign around emerging mascot Ronald McDonald;
- Doris Christopher in 2002 sold her kitchen tool company, Pampered Chef, to Warren Buffett for a reported $1.5 billion. In 1980 she launched the company out of her home with a $3,000 life insurance policy loan;
- Foster Farms was founded in 1939 when Max and Verda Foster borrowed $1,000 against their life insurance policy to buy an 80-acre farm near Modesto, CA.;
- Senator John McCain securing initial campaign financing for his presidential bid by using life insurance policy as collateral. His use of his policy as collateral did not have the positive long term effect as the others but it goes to show you can choose to use your policy as collateral for whatever reason good or bad.
The above examples come second hand to me, but of the two which follow I have first hand knowledge because they were clients of mine during my insurance career. Even though they were not nationally known entrepreneurs, using their cash value policies brought about the same results.
“The Auto Haus” became a very successful auto parts and auto repair shop when two men combined their part supply expertise and auto mechanic repair skills. Wanting to protect their personal financial interest in the business and to provide a way for either to buy out the other, they set up a buy-sell agreement and funded it with whole life insurance policies with the business being the owner and beneficiary of the policies.
When Ed needed to move his family to Florida due to the deteriorating health of his wife, he desired to sell out and use his portion of the worth of the business to give him a start in another career. Since the company owned the two policies and Ed and Bob were the owners of the business, they agreed to cash in the policy on Ed’s life and borrow cash value from the policy on Bob’s to help offset the buy-out of Ed’s share of the business.
The business let the policy on Ed’s life with the loan against it terminate, thereby relieving the insurance company of the responsibility of maintaining future cash values or death benefit. Since the loan was initiated under one of the nonforfeiture provisions of the policy, which allowed cash values be used as a loan, no payback was required. The money also came into the business income tax free because the IRS counts a policy pay-out of this type to be a return of premium rather than a return of increase on a savings program. The only exception was, since the payout exceeded the premium paid in, the excess amount was subject to income tax requirement. This scenario left Bob with full ownership of the business with no encumbrance against it.
Since Bob now was sole owner of the business, he chose to pay back the loan against the policy on his life, thereby building his cash value reserves preparatory to his retirement. Later when he retired, the company used the cash values of the life insurance policy to fund the deferred compensation plan the company had set up for him. Again, cash value was used income tax free to the company while the payout to Bob was treated as a legitimate payroll expense and was accounted for accordingly.
Bob did have to include that payout on his 1040 IRS form but at a lower tax rate since his income was less now that he had retired. When Bob sold the business, the new owners maintained the premium payment on that old policy; so upon Bob’s death, since the company is beneficiary, the face amount will come into the business income tax free and can be used for whatever purpose it chooses to use them for. Proper planning with an eye to the future are still bearing fruits 40 years later.
Two step brothers inherited a car dealership in North Idaho. In their financial planning they chose to set up a buy-sell agreement so one could buy out the other at some later date. They also established a deferred compensation plan funded by whole life policies. Approximately 20 years passed when the one brother decided he wanted to step aside from the dealership and pursue other interests. They went to the cash values of their whole life policies to fund a portion of the buy-out agreement. Since the distribution of the cash value from these policies were treated as a loan, the proceeds came to the dealership income tax free. The distribution to the retiring partner was treated as stock redemption, so it also received favorable income tax treatment.
In this case, the policy on the retiring owner was allowed to have ownership changed from dealership to insured, who continued to maintain the policy on himself with now his wife being the beneficiary. Since the loan had a 6% interest rate and knowing he could get a better return through investing in stocks or mutual funds, he chose to pay the interest on the loan knowing the loan would be deducted from the face amount when he passed away.
In these two examples, the purchase of whole life insurance rather than purchase of term insurance allowed the individuals the opportunity to meet several objectives:
- Immediate source of cash in the event of an untimely death;
- Future source of cash to fund business growth;
- Funds for reducing business debt;
- Tax free cash value accumulation;
- Freedom from outside influence on how to operate their business; and
- Future funds to assist in smooth transition of business interest.
Common Error Regarding Cash Value
One other misconception should be addressed before going any further in this article, and that has to do with the the “savings” or “cash value” in whole life insurance policies.
One of the benefits of a whole life policy is the leveling of the premium to be assessed against the policy. These premiums are determined by projected rate of mortality, interest rates of return, operational expenses, inflation, dividend projections, numbers of lives to be insured, etc. These projections are made at the inception of the policy and projected into the future by as much as 120 years. Recognizing the responsibility to maintain cash reserves sufficient to meet their financial commitment, insurance companies usually used very conservative projections in setting these premiums.These projections are made also on the premise the funds will always be available to the insurance company to invest and manage, thereby allowing the premium to remain constant, never to increase over the lifetime of the policy.
They also recognized that in order to compete for potential customers’ discretionary dollars they needed to build into their contracts enticements attractive to them. Paying on something which could only be used when you die wasn’t very appealing, so something needed to address that issue. Consequently, found within whole life insurance contracts are items called nonforfeiture provisions, i.e., reduced paid up insurance, automatic premium loan provision, extended term insurance, and cash value provisions. These are values at no extra premium included in whole life policies to enhance the contractual agreement between the insured and the insurer.
Realizing the level premium concept was collecting more than what was needed to meet immediate death benefits, the company could allow insureds to borrow against the cash values. This would allow the insured to access the funds of the insurance company to borrow money at a lower rate than they might have to pay through another financial institution, with the ability to set the terms of payment. It also had the attractive incentive of being able borrow without having to justify the purpose of the loan.
This is where terminologies got confused. Insurance contracts were not set up to compete with investment tools, i.e., stocks, bonds, gold, silver, etc. The premium paid in was not intended to purchase a stock or bond with the goal in mind of a substantial rate of return on the investment. Even though interest projections play a role in calculating appropriate premium, they are not the focus of the premium projection.
Somewhere in the annals of time some agent made the mistake of referring to these cash values as savings and then further muddied the water by referring to them as “your money.” There is no place in the policy contract referring to savings or the cash value being the insured’s money. What should have been the selling point is the right you have as the owner of a policy to access the funds of the insurance company through the cash value provision of your policy. So, instead of referring to the cash value as your money or as a savings, it should simply be recognized as your contractual right to borrow from the funds of the insurance company.
It should be noted that a saving plan is accessible “upon demand” whereas an insurance company can defer making loan against cash values up to six months. This provision is one of the main reasons insurance companies came through the stock market crash in the 1920’s virtually unscathed. New York Life has in its archives a picture of long lines of people banging on the doors of banks attempting to get to their money–while sitting at desks outside the doors of the corporate headquarters, employees of New York Life are processing the requests from policyholders for loans against their cash value life policies with no panic involved. Pretty poignant!!
The question is often asked, “are you saving money?” If the answer is “yes” then the follow up “why?” is prompted. If the response is “no” then “if you could, why would you?” is an appropriate follow up. Either the “yes” or “no” response prompts answers like saving for college, buying a car, down payment on home, going on the cruise of a lifetime, saving for children education, or preparing for retirement. These are all relatively short on their horizon for being accomplished and don’t reflect a more meaningful reason. What a person is actually trying to do by saving money is attempt to create an estate. They want to leave something behind rather than just their footprints in the sands of time.
This estate is made up of two elements: 1) things that are already acquired; and 2) the potential income to purchase future assets. It should be acknowledged the source of these future assets is the future potential for earnings. Our attempt to build an estate generally has a period of time when we are learning how to produce; a time when we are earning, thereby transforming future potential into the acquired; and thirdly, depending on how well we performed in the earning years of our lives, it becomes the golden years of our lives or the yearning years of our lives. It should also be noted future earnings are always diminishing due to our inability to physically produce and time just running out. Time is the real culprit in this scenario, so what if we could eliminate that element?
Consider this. What if there were a way you could qualify for and establish, within 45 days, the size of your estate and after two years never have it taken from you by any circumstance–not even the passing of time? (You may find it interesting to go the article on this website called “Two Financial Institutions” for insights to cash accumulation alternatives).
You can establish the value of your estate by going to an insurance company offering whole life insurance, filling out an application, meeting underwriting requirements, and paying the first month’s premium. When you fill out the application, you designate what amount you want your estate to be–say 2 million dollars. If the insurance company agrees you have that kind of financial worth to someone, they issue the policy with the one stipulation you must meet for the lifetime of the contract, that being the premium payment kept current. With a stroke of a pen, you just removed the time factor for building your estate. If you were to pass away after just one month in a car accident or any other way of losing your life other than suicide, or material misrepresentation, your estate receives the full face amount of the life insurance policy.
This appears to be all well and good, but the drawback is you can never get any value out of this yourself. You have to die in order for the estate to be funded. Not quite so appealing, but wait the rest of the story. If you purchased whole life insurance, living benefits are available to you while you live. Remember earlier in this narrative, an explanation was given describing how premiums are calculated to keep them level over the lifetime of a policy? Recall that some of the premium collected was placed in a reserve to be called upon as the cost of mortality increased? Well, you have access to that reserve by virtue of the nonforfeiture provision of cash value. You can borrow against the policy for the temporary reasons for saving, i.e., buying a car, purchasing a home, children’s college expenses, extra cash at retirement–and you don’t have to ask for permission, even if you wanted to buy a chicken farm.
It does take time for the cash value to accumulate to where it would be available to you for your personal use but considering all the benefits of the insurance, a little discipline and patience will pay dividends in the future.
Internal Rate of Return in Life Insurance Contract vs. Interest Rate of Return on Investments.
Even though I have tried to keep from calling the premium payment and subsequent cash value an investment, some will still place that payment and cash value in the arena of investment. Giving in to those, I would offer the following to be considered.
Let’s say you decide you want to be a millionaire by setting aside $500 every month. Here is a chart at various levels of return (compounded monthly) showing how many years it would take you to accomplish your goal. (The Motley Fool, LLC [US] https://www.fool.com/investing/2018/08/15)
Rate of return After 10 years 20 years 30 years 40 years
3% $70,045 $164,561 $292,097 $464,187
5% $77,965 $206,373 $417,863 $766,189
7% $87,047 $261,983 $613,544 $1,320,062
10% $103,276 $382,848 $1,139,663 $3,188,390
Keep in mind you must never miss a monthly payment, never withdraw any amount, must negotiate through the income tax implications, and must deal with the volatility of the marketplace–a pretty tall order.
If you died anywhere along the way, your beneficiary will receive the accumulated amount in your financial portfolio. He or she becomes subject to inheritance tax, ordinary income or capital gain taxes, and any applicable estate taxes. Let’s suppose you die during the first month of your journey. The only thing returned to your beneficiary would be the $500 plus interest.
Suppose you purchased a whole life insurance policy with a face amount of $1,000,000 with a monthly payment of $500. By contract the guaranteed cash value will grow every year and will at age 100 equal the face amount of the policy. Anytime along the way, accumulated guaranteed cash value is available for your use income tax free. Even though not guaranteed, dividends paid by the company can accelerate the amount available to borrow.
Suppose death occurs during the first month of this policy, what happens?
The face amount of the policy is paid to the beneficiary who receives proceeds ordinary income tax- and capital gains tax-free plus no estate tax if administered correctly.
If this purchase were treated like an investment and you wondered what your rate of return would be, it would be a 2000% rate of return in that first month. Hard to fathom but doing the math simply verifies that fact.
Work Horse of Insurance Industry
In the discussion of the value of whole life insurance versus term insurance one thing is clear–both types of insurance have kept the promise to pay when funds were needed the most. Which is more valuable?–the one in force the day of the insured’s passing.
Grieving mothers who can maintain their dignity by not having to marry the first meal ticket down the road; little children who can still have warm meals, their own beds to sleep in, and clothes on their backs–could care less if the means to have these essentials in their lives came from term insurance or from whole life insurance policy. All they know is their mother or father loved them enough to secure these blessings even in their passing.
Less than 5% of all term insurance policies have ever paid out a death benefit, which has left the heavy lifting in regards to fulfilling the life insurance promise to whole life insurance. The name “life insurance” goes beyond the insured because it can’t reproduce the life of the deceased; but it does provide a quality of life for the beneficiary by providing the funds for mortgage payments, comfortable transportation, health insurance premiums, food, clothing, education, etc. It is a marvel that society has created this instrument to alleviate the fear of of an uncertain financial future when a life is terminated too early.
Perhaps some individuals, like Mr. Ramsay’s rush to judgment, should be tempered. There is a proper place for each of these methods of providing cash assistance in the public square.
Permanent Solution to a Permanent Problem
We live in an age where problems are solved in a half hour TV programming; where financial obligations are met with, can I pay it monthly; if it’s broke throw it away; or “I’ll cross that bridge when I get there” mentality.
Yes, there are some things which can be looked upon as being temporary or short term in their nature, but even some of them tend to ebb and flow, i.e., credit card debt, refinancing a home mortgage, buying a new car, spending for vacations, etc. Most financial concerns have a more permanent impact. Our spending seems to always exceed our income, so thinking we can make up the shortfall we continue to live above our realistic means.
In an article written by Elyssa Kirkham of GOBankingRates, found at (Time.com/money/4258451/retirement-savings-survey/) titled “1 in 3 Americans have no Retirement,” she describes how 3 Google Consumer Surveys ask consumers to respond to the query: By your best estimate how much money do you have saved for retirement. The surveys gave these categories and recorded the responses:
Less than 10k- 23%
10k to 49k- 10%
50k t0 99k- 8%
100k to 199k- 8%
200k to 299k- 5%
300k or more- 13%
I don’t have any retirement savings- 33%
(These figures lump everyone from millennials to senior citizens preparing for retirement. One can find how these figures breakdown by groups by visiting the website noted above.)
Of some note is that women are 27% more likely than men to have no retirement–63% have 0-10,000 in savings at age 55, while 52% of men have 0-10,000 at age 55. Even more sobering is the realization that women need more in retirement due to increased medical costs and tending to live longer.(ibid.)
So, if we use the learning/earning/yearning income model, the one in which we will be consuming but not producing has the potential of requiring most of our financial assets– the yearning or golden years.
Cameron Huddleston, Life and Money columnist for GOBankingRates suggest the problem is procrastination rather than economics. “People naturally tend to focus on the bills that are due today–and the things they want now and assume they’ll have time to save for retirement later. But before you know it, 20 or 30 years have passed away; you’re approaching retirement age but you don’t have enough saved to retire.”(Ibid.)
Again, with the long term approach to life and retirement, whole life insurance enters the picture as a pretty decent way to prepare for the economic needs of retirement.
If a young person, male or female, were to establish the monthly habit of saving 5% of their monthly income with some of it being used to purchase a whole life insurance policy, they could have a nest egg to supplement their financial plan. If he/she didn’t make it all the way himself, his beneficiaries would reap the reward of his foresight. The monthly life insurance premium payment out of the savings is critical because if the payment isn’t made, there is an immediate consequence of losing the death benefit and future earnings. This then is the permanent solution to satisfy a permanent problem. It is the one egg in your retirement plan which is guaranteed to hatch.
The man who recruited me into the insurance profession was a “born again” Christian who felt very strongly his religious convictions. He compared an insurance agent’s position closely to the role of his Christian minister. He describe the difference in these terms that the “man of the cloth” provided spiritual salvation while the insurance agent provided economic salvation, both essential to the welfare of mankind. One of the power phrases he used to motivate a father to purchase life insurance was the scripture, “But if any provide not for his own, and specially for those of his own house, he hath denied the faith, and is worse than an infidel.” (1 Timothy 5:8 KJV Bible).
On more than one occasion I heard him firmly but kindly counter a reluctant client who used the rationale the Lord would take care of his family since he was a believer with this statement:
“Do you believe we are all God’s children?”
“Then you must believe He loves us all the same?”
“You believe you have the capability to take care of your own if you choose to do so?”
“Then where in the line of those who need to be provided for will your family be with all the other people of the world who do not have the means to take care of themselves? Wouldn’t it be fair for Him to take care of them before he would provide for yours?” “Let’s find a way for you to take care of your family’s needs just in case the Lord needs to focus on the others before He can get to you.”
A conversation would normally ensue with a review of family needs and how they could be financially attended to.
Life insurance and particularly whole life insurance holds out the promise that no child will ever have to go hungry and no family will have to leave the comfort of their own home.
It has been said the only difference between an old man and an elderly gentleman is how well he prepared for the future. A good whole life policy along with other forms of cash accumulation speaks highly of that man’s life choices–economic salvation at its finest.
(Glen B. Marks, CLU, retired after 42 years as an insurance agent obtained his MPA degree from Brigham Young University and his CLU designation from the American College. The article above is his own opinion gleaned from many years of selling and servicing clients’ insurance needs.)