Whole life insurance isn’t one of Dave Ramsey’s recommendations for good finances. And let’s face it, even if it was, it still wouldn’t be one of the more exciting things in the financial world to discuss. For such a “lame” option, we sure talk about it a lot. Which begs the question–if it is so “lame,” why is it even an option to begin with? With all the prejudice and bias that is out there (on both sides) the question remains: How is the whole life insurance world staying afloat? Is there something to be said for this nondescript insurance option?
The Two Sides
When it comes to whole life insurance, there are essentially two “camps,” or philosophies about its use and the best way to use your money when it comes to being insured and preparing for retirement.
Camp #1: The Dave Ramsey and Suze Orman camp. Their philosophy says you should buy term life insurance, a much cheaper alternative, and invest the rest of the money you would have spent on your whole life policy premiums in something that will give you a higher return. They despise whole life/permanent insurance, and insist it’s foolish to put money in something earning 2%, if it doesn’t lose you money to begin with. Instead, get the cheaper alternative, and use the money leftover to pay down debts, invest in higher yielding investments, and so on. By the time your term life insurance expires, your investments and financial responsibility will be able to see you into comfortable retirement after your kids are leaving home and on their own.
Camp #2: Insurance companies and salesmen make up this camp, and emphasize the powerful, true potential of whole life policies. To them, everything good in the world starts and ends with whole life insurance. To do anything else is just gambling. They extol the fact that you can [eventually] earn 4.5-5% in the cash value of the policy–on an after tax basis. And that goes without mentioning the fact that it’s accessible at any time, with no volatility or risk involved. At the end of the day, they would say it comes out about the same as “gambling” and “risking” the stock market after losing earnings to fees and taxes. Plus, the permanent/guaranteed death benefit associated with the whole life policy can help immensely for estate planning services. As for the “buy term and invest the rest” crowd, this camp would argue that the people who intend to do this actually end up “buying term and spending the rest.”
Valid points are made by both camps, even if the projected returns are quite different. But who is right? Both of them, actually.
In Defense of Whole Life Insurance
Let’s start by going through a few of the accusations made by Camp #1’s Dave Ramsey and the like.
- The first problem isn’t anything said by Camp #1, it’s the nature of their argument to begin with. Comparing term and whole life insurance as methods of investing just isn’t quite accurate. Think of whole life’s cash value more like a security or bond alternative asset. You just can’t adequately compare an asset with the security of a bond to a stock that goes up and down on businesses that have the potential to fail. Instead, compare whole life insurance policies to something more liquid like a CD.
- Camp #1 forecasts the returns of a whole life policy as around 2%. Meanwhile, the insurance companies advertise 5%. Again, both are technically right. Most policies don’t “break even” until they’ve been active for around 7 years. And nearly half of policies are canceled within the first 10 years. That 2% figure, then, is an average that includes policies that were canceled before they reached the anticipated 5% returns.
- The assumption that other assets can bring higher returns than the cash value of a life insurance policy seems true on the surface. A Roth IRA bringing in 10% should be better than a life insurance policy at 5%, right? Well, remember that the recommended withdrawal rate from a Roth IRA is only 4%. (So, if you have a million dollars in there, most people would recommend only taking out $40,000 per year.) Meanwhile, a whole life policy can also yield $40,000/year without traditional stock market risks. The tax free status of these policies adds another competitive advantage Dave Ramsey and Suze Orman neglect to mention.
- Another point made by Camp #1 argues that the sale of most whole life policies is motivated by insurance agents hoping for a larger commission. While conflicts of interest can exist and this probably does happen sometimes, most agents are genuinely in it for the right reasons.
- “Insurance needs to be insurance. Investments need to be investments. You should never combine the two ever, ever, ever!” This quote from Suze Orman in reference to cash value life insurance is actually the exact opposite of our strategy. Instead of weakening the effectiveness of the investments, it’s actually possible to make this combination of life insurance and investing strategies into something entirely unmatched in either industry. (Who’s going to tell Suze?)
Taking Whole Life Insurance to the Next Level
Now that we’ve worked to defend whole life insurance, we want to share a way to combine its benefits with the leverage and investing strategies that camp #1 advocates as an alternative. As it turns out, these two industries don’t have to be like oil and water–they can be like peanut butter and chocolate.
Introducing: the Flex Method, a technique that builds whole life insurance policies up to maximize their cash value earnings using leverage.
The Flex Method carefully designs policies built for strong cash growth (rather than strong commissions). These policies are able to overcome the “ugly period” more quickly, meaning they are able to break even and yield returns much sooner.
Then, after the policy is started and in motion, premiums are then paid via bank loans. These loans are backed dollar for dollar by the cash value of the policy, which provides an inexpensive lending rate and trust from the bank. We’re also able to add additional money from the bank into the policy, so it can grow faster–and earn more money.
Debt can be scary when used to invest in other assets. If the stock market goes down or real estate isn’t profitable, you can be left with a lot to pay back. Life insurance, on the other hand, is guaranteed to not go down. Dividends and growth are announced each year in advance, so you can know and plan for exactly what to expect. If your cash value is earning 6% and the loan is costing you 3%, you’re making a 3% profit on the bank’s money. This isn’t staying debt free, it’s becoming what we call “debt neutral.”
Can Whole Life Insurance/The Flex Method Help With My Emergency Fund?
Dave Ramsey has also given some great advice about keeping an emergency fund–some advice that the Flex Method is able to take to the next level. (We’re not here to argue with this point!) He recommends something along the lines of having $1,000 in cash in your home, plus enough in the bank to last you anywhere from 3-9 months without income.
Because accessibility is such an important part of having an emergency fund, you can’t exactly put it into stocks or similar assets, because the last thing you want is to have to take your money out at a loss if the market is underperforming. In the case of long term bonds, you might earn some interest, but not even be able to access the money. So what can you do? Well, you can keep it in the bank at 1%, or you might be able to find some short term bonds and (maybe) earn 2.5% before taxes. Not exactly exciting options for the person hoping to have their money work for them.