Buy Term And Invest The Difference

[Full Throttle]

And given that MOST people take the cash and run, then it is clear they would have been better off putting their money into a better retirement investment.

I understand the point you are making and absolutely agree that if they are going to surrender the policy in the short run, there are much better options. I would argue that most of the policies being lapsed were sold incorrectly: they were improperly sold as being for cash accumulation, not the death benefit (I know many agents sell off the cash value ledger) or the policies weren't serviced after the sale and people forgot why they bought them. That absolutely happens, in one ear, out the other.

The problem with buying whole life, planning to leave that cash behind, is that if/when you get financially strapped in retirement, you end up having to collapse the whole life policy for two reasons.

Like I said above, the value of the life insurance is the death benefit, not the cash value. Here is an example: Joe needs $4000 per month of retirement income for himself and his spouse beyond what social security provides and we obviously want to plan for a long retirement to be safe.

Using monte carlo analysis, we know he can only take out about 4% of his retirement savings per year without taking a substantial risk of outliving his nest egg. To do so, he need around $1,200,000 to accomplish this. Let's say they don't have the $1.2 million necessary, what are the options? Beyond reduce lifestyle, maybe a SPIA for more certainty and a higher payout, maybe a reverse mortgage.

The problem, they lose that closely guarded home with a reverse mortgage and if they want to leave a legacy, the life only SPIA for the higher payout loses the legacy option. The life insurance death benefit can be used as a replacement vehicle to utilize an option like the one of the above and still leave a legacy. You will correctly argue that they could have invested the difference between the whole life coverage and term coverage along the way.

I've run the numbers many different ways and in enough circumstances, even though purchasing the whole life coverage you may end up having a slightly smaller nest egg at retirement age, it will actually produce more income in retirement with less risk along the way if they want to leave something behind. If I could care less about leaving anything behind, then I'll take the larger nest egg without the insurance, take a life only SPIA, and reverse mortage my home for maximum income, and have a hell of a time!

I use to be anti-whole life, "buy term and invest the difference" to the core until I started giving it an honest look and understood how it actually works in detail. I believe I was doing my clients a disservice in the past by not being an expert at how the product worked. You may come to a different conclusion, but I suggest running some actual numbers before doing so.

you end up having to collapse the whole life policy for two reasons.

First, you can no longer afford to pay the premium.

Second, you need the cash out of the policy.

Whole life proponents will argue, "See, that's the beauty of whole life, you can cancel it and get your money back".

As a side note, most of the policies I sell are paid up at age 65, so no premiums to cancel in retirement. If they need cash out the policy, we can absolutely do so without blowing up the policy. The death benefit will decrease and the legacy might not be quite as large, but it still accomplishes their goal. It can also be used as a supplemental source when the markets are down so you're not pulling money out during a down market (as we know the effects well of a severe market down turn at the front end of retirement).

I appreciate that we're having an actual dialogue instead of name calling. You and I may find we disagree, but we both want what is best for our clients.

 

[LGilmore]

Robert B,

what about when you premium offset a policy? Some people can stop paying into their policies and let them operate on their own so the insurance is there, not taking any current income and just running on it's own. Have done this for several senior clients and it does work and does work well.

thanks.

 

[Robert Barney]

Two similiar points:

"what about when you premium offset a policy?"

and

"most of the policies I sell are paid up at age 65"

The reason whole life works well for people who actually "need" whole life - and it's really not a NEED it is a WANT - is that whole life allows you to deliver tax deferred money to your estate tax free. That is why whole life out performs buy term invest the difference, assuming you are making a comparison using a level playing field and assuming your objective is the tax free death benefit when death occurs.

There just aren't many ways out there to accumulate money tax deferred, where the deferred investment converts and becomes tax free on death, which is exactly what whole life does.

Given that tax deferral is the name of the game in a whole life policy, you obviously MAXIMIZE the deferral benefit of a whole life policy by paying up the policy as quickly as possible. Paying up a policy really means building up a lump sum of capital in the policy, over and above the cost of carrying the insurance to that point, so that the interest earnings of that capital are sufficient to carry the future insurance costs of the policy for the lifetime of the insured.

The fact that you have interest being earned on that capital, and that the interest is in essence paying the insurance costs, versus you paying those costs out of pocket, is a great way to understand the tax deferral. For example, if the interest pays the premium, it does so without the owner of the policy being taxed on the interest. Otherwise, the premium for the policy must be paid using "after tax" dollars.

I have attached an Interest Adjusted Cost Analysis to help show the difference. The first product in the analysis is a Single premium no lapse U/L, the second product is the same product where the insured pays the premium each and every year. To make the comparison completely fair, I have increased the face amount of the single premium policy by the amount of the single premium. This means that the insured will gets $1,000,000 PLUS their original single premium on death. Had the insured not put the $125,000 premium into the policy, and left it in the bank instead, then the $1,000,000 policy death benefit AND the $125,000 in the bank, would both be in the hands of the beneficiary/estate.

As you will see, I used an interest assumption of 5% to get a rate of return that preserves the capital outside the single pay version of the policy.

In other words, if you put the $125,000 into a CD, and it was earning 5%, it would be enough to pay the premiums for the annual premium version for life. The problem is that the 5% interest would have to be added to the owner's tax return, and the amount of money would shrink because you have to pay tax. If the client is in a 40% tax bracket, they would actually have to earn 8.3% before tax, so that after tax they would have a net 5% to pay the premium.

Now I don't know about you, but there are very few places where you can get an 8.3% return on investment, fully guaranteed, for your lifetime. Needless to say, if the client wants the $1,000,000 of whole life, and has the $125,000 floating around, and if it is invested and producing a taxable return, the money would be much better off invested as a single premium policy is a no brainer.

A 10 pay policy is really nothing more than a financing of the single premium, where instead of putting the $125,000 in up front, you build it up over a 10 year period, by making 10 installment payments.

 

[Robert Barney]

Here is the attachment.

 

[Full Throttle]

A 10 pay policy is really nothing more than a financing of the single premium, where instead of putting the $125,000 in up front, you build it up over a 10 year period, by making 10 installment payments.

Absolutely, all insurance is essentially annually renewable term insurance paid in different ways.

Level Term = ART with the COI added up for the term period and divided by the lengh of the policy to keep the premiums levle.

UL/VUL = ART deducted out of a subaccount. If the rising COI is greater than the account, the policy lapses.

WL = same concept as UL, except the insurance company retains some risk by guaranteeing that if you pay your premiums, they will cover the COI (UL with a NLG is similar in this regard).

Single pay, 10 pay, paid-up at 65, they are all ways of simply financing the ART costs. The more you put in sooner, the more the time value of money works for you.

 

[DHK]

I understand WL to be done slightly different than what Full Throttle was suggesting.

I think of WL like a "lifetime mortgage". Follow me on this.

On a mortgage, the majority of interest is front-loaded into the first few years of the fixed mortgage.

Same thing with WL. The first 2-3 years has essentially ZERO cash value. Why? We're front-loading the mortality costs based on your age and underwriting classification.

After the first 2-3 years, the premiums are added in at ALMOST dollar-for-dollar.

In this way, WL is more like OWNING life insurance over any other form.

You can accelerate the performance of your WL contract by purchasing additional paid-up insurance riders (cash dump-ins).

You can also choose to use premium offset strategies by using your dividends to pay your premiums for you. (Usually a strategy available after about 20 years of the policy being in force).

Some people would say that the 2-3 years of zero cash value is why WL is a ripoff.

I don't think so.

If the remaining premiums are almost dollar-for-dollar credited to the policy equity, then the first 2-3 years provide:
- Creditor protection (varies by state)
- Disability waiver of premium for the life of the policy
- Accelerated death benefits (if selected)
- Permanent death benefit net cost to you is the premiums paid minus available cash value.

All these benefits are provided for the life of the policy because of the first 2-3 years of premiums paid.

Pretty good deal for the long-term, ownership minded client!

 

[Robert Barney]

Full Throttle wrote:

Single pay, 10 pay, paid-up at 65, they are all ways of simply financing the ART costs. The more you put in sooner, the more the time value of money works for you.

Well almost...

A whole life policy has two essential components:

1. ART to fund the actual insurance portion

2. A cash reserve which together with the insurance portion creates the total death benefit.

When you pay a whole life premium, a portion of that premium pays the ART mortality coverage that year, and the balance is added to a reserve of actual money which builds up over time.

The reserve contributes to the policy in two ways.

First, as the reserve grows the cost of insurance will eventually shrink because the reserve is making up a growing portion of the total death benefit, and the insurance is used to make up the difference to the total death benefit if there is a claim, Remember, any cash in a whole life policy is not paid on top of the death benefit, it is paid as part of the death benefit.

Second, the reserve earns an investment return. The investment return is like an internal premium paid to the policy, and it is used to assist in paying the insurance costs or building the reserve.

Eventually a policy endows, meaning that the reserve is equal to the death benefit. At that point there is no actual insurance element required to pay the death benefit. In traditional whole life policies the endowment was at age 100 (theoretically), and on newer whole life policies the new endowment is 121 (once again, theoretically). If you need the theoretical aspect explained, I am happy to go there but let's try to keep this simple.

A policy becomes paid-up when the investment earnings of the reserve (the internal premiums) are sufficient to both pay the future ART insurance costs and build the reserve to it's planned endowment.

The investment earnings of the policy (the internal premiums) are not taxable, the tax on those earnings is deferred. At death the deferred investment earnings convert and become tax free on death.


Therefore, the more money you can shove in earlier, the more work that is done by the investment earnings, and the more tax deferral that you are able to take advantage of.

 

[Franz Kafka]

Full Throttle wrote:

Single pay, 10 pay, paid-up at 65, they are all ways of simply financing the ART costs. The more you put in sooner, the more the time value of money works for you.

Well almost...

A whole life policy has two essential components:

1. ART to fund the actual insurance portion

2. A cash reserve which together with the insurance portion creates the total death benefit.

When you pay a whole life premium, a portion of that premium pays the ART mortality coverage that year, and the balance is added to a reserve of actual money which builds up over time.

The reserve contributes to the policy in two ways.

First, as the reserve grows the cost of insurance will eventually shrink because the reserve is making up a growing portion of the total death benefit, and the insurance is used to make up the difference to the total death benefit if there is a claim, Remember, any cash in a whole life policy is not paid on top of the death benefit, it is paid as part of the death benefit.

Second, the reserve earns an investment return. The investment return is like an internal premium paid to the policy, and it is used to assist in paying the insurance costs or building the reserve.

Eventually a policy endows, meaning that the reserve is equal to the death benefit. At that point there is no actual insurance element required to pay the death benefit. In traditional whole life policies the endowment was at age 100 (theoretically), and on newer whole life policies the new endowment is 121 (once again, theoretically). If you need the theoretical aspect explained, I am happy to go there but let's try to keep this simple.

A policy becomes paid-up when the investment earnings of the reserve (the internal premiums) are sufficient to both pay the future ART insurance costs and build the reserve to it's planned endowment.

The investment earnings of the policy (the internal premiums) are not taxable, the tax on those earnings is deferred. At death the deferred investment earnings convert and become tax free on death.


Therefore, the more money you can shove in earlier, the more work that is done by the investment earnings, and the more tax deferral that you are able to take advantage of.

I'm far from being an expert on WL but what you just described sounds like UL. WL is not UL with co. taking risk on guaranteed column. WL is a level term just like 10, 20 or 30 year level term. The only difference is the term is for "whole life" instead of 10, 20 or 30 years and there are non-forfeiture options in case you don't make level premium for the whole life with surrender value being one of them. This is how I learned and understand WL. Please enlighten if I'm missing something.

 

[Franz Kafka]

Full Throttle wrote:

Single pay, 10 pay, paid-up at 65, they are all ways of simply financing the ART costs. The more you put in sooner, the more the time value of money works for you.

Well almost...

A whole life policy has two essential components:

1. ART to fund the actual insurance portion

2. A cash reserve which together with the insurance portion creates the total death benefit.

When you pay a whole life premium, a portion of that premium pays the ART mortality coverage that year, and the balance is added to a reserve of actual money which builds up over time.

The reserve contributes to the policy in two ways.

First, as the reserve grows the cost of insurance will eventually shrink because the reserve is making up a growing portion of the total death benefit, and the insurance is used to make up the difference to the total death benefit if there is a claim, Remember, any cash in a whole life policy is not paid on top of the death benefit, it is paid as part of the death benefit.

Second, the reserve earns an investment return. The investment return is like an internal premium paid to the policy, and it is used to assist in paying the insurance costs or building the reserve.

Eventually a policy endows, meaning that the reserve is equal to the death benefit. At that point there is no actual insurance element required to pay the death benefit. In traditional whole life policies the endowment was at age 100 (theoretically), and on newer whole life policies the new endowment is 121 (once again, theoretically). If you need the theoretical aspect explained, I am happy to go there but let's try to keep this simple.

A policy becomes paid-up when the investment earnings of the reserve (the internal premiums) are sufficient to both pay the future ART insurance costs and build the reserve to it's planned endowment.

The investment earnings of the policy (the internal premiums) are not taxable, the tax on those earnings is deferred. At death the deferred investment earnings convert and become tax free on death.


Therefore, the more money you can shove in earlier, the more work that is done by the investment earnings, and the more tax deferral that you are able to take advantage of.

I'm far from being an expert on WL but what you just described sounds like UL. WL is not UL with co. taking risk on guaranteed column. WL is a level term just like 10, 20 or 30 year level term. The only difference is the term is for "whole life" instead of 10, 20 or 30 years and there are non-forfeiture options in case you don't make level premium for the whole life with surrender value being one of them. This is how I learned and understand WL. Please enlighten if I'm missing something.

 

[Robert Barney]

I'm far from being an expert on WL but what you just described sounds like UL. WL is not UL with co. taking risk on guaranteed column. WL is a level term just like 10, 20 or 30 year level term. The only difference is the term is for "whole life" instead of 10, 20 or 30 years and there are non-forfeiture options in case you don't make level premium for the whole life with surrender value being one of them. This is how I learned and understand WL. Please enlighten if I'm missing something.

Here is the difference. At the end of a level term period, such as 30 year term, the policy terminates (unless you pay the ART renewals).

At the end of the level period of a whole life policy, the plan endows, meaning that the face amount is equal to the cash value. How can that be? Because the excess money you were paying, over and above the costs of ART, was building a reserve so that the insurance element shrinks to nothing, and the reserve is equal to the fact amount.

In a 30 year term the reserve bubbles to a peak, somewhere around the 20th policy year, and then begins to diminish until the end of the 30 year term.

In level term, the reserve runs out, in whole life it does not. You cannot outlive the insurance coverage in whole life.

This is actually an interesting point when it comes to UL, ESPECIALLY NO LAPSE UL.

I am being asked by some subscribers to my comparison software, to include new categories for no lapse UL where the premiums and coverage are guaranteed to age 100 or age 105, with the coverage terminating at that point. Proponents of those new categories will point out that the premiums are lower than a corresponding to age 121 plan. Yes, premiums are lower but there will be some people insured under those scenarios that will outlive the coverage.

Why?

Because in the 121 calculation the policy reserve is planned to increase and endow.

In the 105 calculation the policy reserve is planned to increase and then diminish in later years.

The client is taking the risk, in paying the smaller premium, that they will outlive the coverage. That is not a risk that I would be personally willing to take for the difference in cost.

Worse, if the client's coverage expires, due to the reserve dissapearing, then there is no chance that the client can continue the policy because at that point they would be faced with ART premiums that are so enormous, that there is no way they could afford them.