HOT TOPIC Thoughts on Whole Life Insurance as an alternative to banking?

[JScott]

The first thing I noticed here is that the 7-8% is pre-tax gains versus the 3-5% (which [and again I'm no expert] whole life return which is tax free?). Post-tax it would seem that the returns are very similar in nature.

Except for two VERY BIG things:

1. It's unlikely that long-term returns on whole life policies are anywhere near 3-5%. These policies only guarantee about 1.5%, and the 3-5% returns are based on recent asset performances, not long-term averages. I would model the guaranteed rate when doing the math, not the best-case number that isn't unlikely to hold long-term.

2. These are annual returns, and not compounded returns. Whole life policies charge exorbitant fees upfront, which reduces the compounded returns considerably. You can run the IRR scenarios yourself, but suffice it to say, any time a chunk of the investment is pulled out on day one, the compounded returns are going to suffer.

To set the stage here, I am about one thing and one thing only...finding the most efficient way for me to earn the highest risk-adjusted return on my capital possible.

This says nothing about passivity. Assuming that's the case, the best risk-adjusted returns will likely be generated through active income strategies, like starting your own business. If you're shooting for more passive (but not completely passive), that's when you should consider real estate strategies such as buy-and-hold (triple-net probably has the best risk-adjusted returns) or lending.

 

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[fluffhead]

This says nothing about passivity. Assuming that's the case, the best risk-adjusted returns will likely be generated through active income strategies, like starting your own business. If you're shooting for more passive (but not completely passive), that's when you should consider real estate strategies such as buy-and-hold (triple-net probably has the best risk-adjusted returns) or lending.

Agreed. Just read a pretty telling article that backs what you're saying. The upfront fees kill your IRR. The article I saw suggested that the cash balance at the end of year 7 was about 50% of what he paid in premium...that doesn't seem like a sound investment to me!

Not to hijack the thread at all, but where does one put assets while accumulating for a real estate purchase. I save all year and then once I hit a certain # I can allocate to REI, but how do I maximize my gains while I'm in the accumulation period?!

 

[Tom H.]

Sorry for resurrecting an old thread, I want to chime in because I'm a regular guy (not a financial professional) with a whole life policy.

My policy is structured for cash value, it's intended function is to act as a savings account more than anything else. The policy costs me money for the seven years (if you ignore that I am also buying the death benefit for my young family), it starts showing a positive return in year 7 and then increases by a guaranteed 4-5%. This is ignoring that it's a mutual company that pays a non-guaranteed dividend on to of the guaranteed returns. At some point around year 10 (I think), the expected dividends should cover my premiums.

I'm not interested in maximizing my return or building wealth through investment, I'm interested in safety and minimum risk.

My choice to use a whole life policy is largely influenced by my personal politics (or something like that). I don't trust banks, I don't trust Wall Street, if I could I'd keep all of my wealth in precious metals and similar assets. Since I do need financial services, I prefer to do business with a mutual insurance company that has been around since the 1800s.

I like that there are no tax complications to figure out with my policy and there are no assets, just a contact that guarantees I can borrow money at a prime rate, anytime, no questions asked. Also repayment of the loan is totally up to me, I don't need to replay if I don't want to i.e. I can spend it on retirement or emergency, don't have to wait to die to cash out.

I'm sure there is more money investing in equities, but that's not what I want to spend my time doing, and my goal is just to have an alternative to a savings account so that I have access to funds for entrepreneurial projects.

---

I want to mention a concept I didn't see in the previous discussion: all money your spend is financed. You either borrow and pay a fee, or spend your savings and forego earning a fee. With the whole life policy, it's like savings, but you never diminish your principal like you would with a savings account.

Well, my 2 cents!

 

[Tourmaline]

I've been researching building your own bank as well.

Everyone comparing using a life insurance policy as a bank and comparing it to investing seems to be missing the point.

The point is to:
A. Be able to finance anything your self, on your repayment terms, and capture some of the interest that would otherwise go to a bank. It gives a large amount of financial freedom.
B. Have a vehicle that guarantees growth of investment. Yes there are fees up front, but typically by year 7 the policy will pull ahead compared to bonds.
C. Not lose out on the opportunity cost of spending money - e.g. Buying a car in cash means the cash cannot appreciate.
D. Tax advantages, protection from creditors/being sued, with a perk of death benefit too.
E. After a long enough time you can make the policy pay for its premiums too.

One thing I've recently been wrapping my head around is that there is no guaranteed rate of appreciation of the cash value of a policy. But that it will appreciate is guaranteed. Cash value is tied to the present value of the death benefit, it's not appreciation based on any securities rather it's appreciation based on inherent value of the policy itself.

It's kinda like bonds in a sense? The present value of a bond is a reflection of what a bond will be worth when it matures. The cash value of a policy is a reflection of what the policy will pay out upon death.

I'm interested in if anyone else has actually implemented this.

I find it super interesting that the super rich take advantage of whole life insurance policies too!

 

[Tom H.]

I've been researching building your own bank as well.

Everyone comparing using a life insurance policy as a bank and comparing it to investing seems to be missing the point.

The point is to:
A. Be able to finance anything your self, on your repayment terms, and capture some of the interest that would otherwise go to a bank. It gives a large amount of financial freedom.
B. Have a vehicle that guarantees growth of investment. Yes there are fees up front, but typically by year 7 the policy will pull ahead compared to bonds.
C. Not lose out on the opportunity cost of spending money - e.g. Buying a car in cash means the cash cannot appreciate.
D. Tax advantages, protection from creditors/being sued, with a perk of death benefit too.
E. After a long enough time you can make the policy pay for its premiums too.

One thing I've recently been wrapping my head around is that there is no guaranteed rate of appreciation of the cash value of a policy. But that it will appreciate is guaranteed. Cash value is tied to the present value of the death benefit, it's not appreciation based on any securities rather it's appreciation based on inherent value of the policy itself.

It's kinda like bonds in a sense? The present value of a bond is a reflection of what a bond will be worth when it matures. The cash value of a policy is a reflection of what the policy will pay out upon death.

I'm interested in if anyone else has actually implemented this.

I find it super interesting that the super rich take advantage of whole life insurance policies too!

Your point "C" is one I try to point out to people. When you take a policy loan you don't diminish your principal.

I will look at my illustration and try to think about your question regarding cash value appreciation. I believe my illustration is based on the assumption that I max out paid up additions, with a guaranteed appreciation of 4%. Then my cash value is a combination of some percentage of my normal death benefit, plus 100% of PUA. The PUA is what makes the whole thing function as your own "bank".

 

[FastLaneSoCal]

Your point "C" is one I try to point out to people. When you take a policy loan you don't diminish your principal.

I will look at my illustration and try to think about your question regarding cash value appreciation. I believe my illustration is based on the assumption that I max out paid up additions, with a guaranteed appreciation of 4%. Then my cash value is a combination of some percentage of my normal death benefit, plus 100% of PUA. The PUA is what makes the whole thing function as your own "bank".

I will chime in here and mention some of what I do with and for clients. This is informational only and I am not trying to change anyone's mind or sell anybody anything. I don't care if people agree or disagree with this approach, but figured I might be able to add some clarity for those fortunate enough to have built substantial wealth or on the road to doing so. I have found much value from others' posts here, so perhaps I can share some myself.

In this environment of huge deficits - damn near close to $28 Trillion and climbing...

https://www.usdebtclock.org/

we feel higher taxes (income, cap gains, estate) are inevitable since our politicians will never stop giving out handouts and will definitely not end social security, medicare, medicaid.

So, we seek out any tool available to plan and mitigate taxes whenever possible. Permanent life insurance has some of the best tax treatment of any vehicle: tax deferred growth, Income tax free death benefits to heirs, and tax-free distributions (since they are taken as loans). Notice I said permanent, not Whole Life (which is only one form of permanent life insurance).

There are two areas where we use life insurance (other than coverage for untimely death):

1) Massively over funding policies to accumulate large amounts of cash to taken out tax-free 10-15 years later (allowing for some great compounding) for a variety of purposes - retirement income, travel, long term care needs, etc...The products we use are more flexible than whole life, allow for some nice potential upside linked to various equity indexes, while not participating when those indexes are negative for a given year. The power of this compounding, uninterrupted by negative returns is very real. When taking the money out there is no tax - since it is a policy loan so not income. The KEY is that while the money we take out is charged interest, that interest is paid by other cash in the policy AND the amount we take out will still earn investment credit. So, we play the arbitrage of paying interest of 5% on tax-free withdrawals and earning something above that (close to 2% spread since I have been working with these).

We are essentially just "borrowing" the life insurance chassis to take advantage of the tax benefits and thus efficiently design policies to have as little death benefit as possible (before becoming a MEC which is taxed differently). It is akin to a Roth IRA - but my clients and most of you on this forum make too much money to put money into Roth IRAs and even so the contribution limits are really low.

2) Buying huge policies in various efficient ways to provide tax free liquidity to heirs upon death - or 2nd death if a married couple. While the estate/gift tax exemptions are currently $11.7 Million per spouse...it is highly likely these will be greatly reduce - perhaps even this year. Any assets over and above these exemptions are subject to 40% Federal estate tax which is due from the heirs 9 MONTHS LATER AND MUST BE PAID IN CASH. This is where the life insurance comes - instant liquidity to pay these taxes so illiquid assets (real estate, closely held businesses) don't need to sold to pay the bill.

Some of my clients are working with attorneys to proactively gift some of their assets to Dynasty trusts which are irrevocable and for the benefit of their kids/grandkids. Believing the $11.7 Million exemptions will be reduced, they are using the exemption for gifting during life. This is complex with many moving parts, but a sounds strategy for the right person/family - especially when gifting assets which will appreciate significantly...because those assets will now appreciate "outside of the estate"...

For those assets left in their estate we calculate what they might conservatively compound at and then make an educated guess where estate tax exemptions and rates might be and then design strategies to ensure the liquidity will be there at the time the heirs need it.

When the solution is life insurance we often take advantage of low interest rates by borrowing at very low rates to pay huge premiums for short periods of time (typically 10 years). There are some great lenders making these loans and since they are 100% collateralized at all times - through the death benefit or a combination of the cash value and and liquid accounts) and thus lend at attractive rates 12 month LIBOR + a spread. Currently around 2.65% right now.

Most of my clients are wealthy and entrepreneurial and very focused on IRR. So while they "could" make huge premium payments they prefer using leverage when it makes sense. In this case they feel good about using OPM (other people's money - in this case the banks/lenders) and having those dollars put into a vehicle which has comfortable averaged well over 6% for decades - thus arbitrage. They often know what their own IRR is meaning what they can earn by reinvesting in their business, or real estate. So, not only are they very likely going to earn a spread of a few % over their loan amounts, they don't have the opportunity costs of using large amounts of their money for insurance premiums and can earn at their own favorable IRRs. (The do usually pay some amount for interest out of pocket, but it is very small as a percentage of premiums). Ultimately, the loans will usually be paid back from cash out of the policy perhaps 15 years later or so.

In some cases, clients will write off interest on these loans by classifying them as "special purpose loans" for their company...but I let them decide that with their CPAs. I have heard arguments for and against this being legitimate so I stay away from advising in this area where I am unqualified...

For anyone still reading, I may have spurred more questions than providing answers. I would just caution anyone from expecting to use GOOGLE to find quality advice on any mainstream financial topics. The "Script" as @MJ DeMarco would say is to max out your 401k, use over the counter mutual funds or index funds, buy term if life insurance is needed or whole life to "be your own bank". None of what I do will be easily found in a Google search and there is much complexity - including quality of lenders, insurance companies, client suitability, understanding risk, conservatively projecting, etc...

I tell my successful friends/clients that they are the 1% of the 1% the wealthy (which they truly are in a global perspective) and to use "solutions" peddled to the masses easily found on the internet b/c of SEO means they are missing out on ideas and strategies available to them because of their wealth and success.

Whatever you do, keep an open mind and don't blindly accumulate and invest without factoring in in income and possibly estate taxes on your future wealth. Thanks to MJ and many others for creating and cultivating this "most excellent" forum. (spoke in my best Keanu Reeves voice from Bill and Ted's Excellent Adventure)