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by **l2yangop** » Wed Apr 17, 2013 12:41 pm

I am 30, my wife is 27. Combined we make somewhere between 175-200k per year. We have no debt, and currently rent. In the next few years we plan to buy a home in the 300k range and have cash for 20% down. Our net worth between bank accounts and retirement (roth, 1 employer sponsored 403b, hsa) is around 110k.

We are thinking long term and are interested in determining what makes more sense tax wise. Having taxable brokerage accounts of index/bond mix or using some of our extra money to fund a whole life policy. I know everyone rails against them but what about the tax implications we are looking at in the future? I’m not convinced that deferring taxes with a 403b is going to put me in a lower bracket at age 65 given the debt our country has incurred and the fact that taxpayers are going to have to pay it off. That starts to make the tax advantages of whole life and death benefit scenarios sound better. Thoughts?

If we go with term over WL, does it make more sense to go with a 30 year level terms over a 20?

by **dhodson** » Wed Apr 17, 2013 2:43 pm

What makes you think the tax benefits are worth the huge costs?

To begin with you typically purchase WL with post tax dollars.

If you ever surrender gains are taxed as income and not better capital gains rate.

A vanilla WL policy won't have CSV equal to premiums for around 16 years with current dividends and dividends continue to fall and that doesn't even count inflation.

Taking loans from polices are typically at around 8% and can lead to crashing a policy especially in a decreasing dividend environment.

Investing in a tax efficient index fund gets a step up basis at death (as do all stocks).

by **mephistophles** » Wed Apr 17, 2013 2:48 pm

l2yangop wrote:That starts to make the tax advantages of whole life and death benefit scenarios sound better. Thoughts?

At age 30 I didn't find any death scenario that whole life insurance could make better.
ole meph

by **Frugal Al** » Wed Apr 17, 2013 3:07 pm

Good points made by DH and Meph.

While I understand your concern, there is currently nothing in the tax laws that would change the advice to not commingle investments and life insurance. Don't believe all the alleged tax benefits available with whole life insurance--much of that is based upon your dying or borrowing your own money at high rates, combined with their measly 4% to 5% return--anything higher than that is not guaranteed. Right now many life insurers are squirming in this low interest rate environment, right along with pension funds.

Based upon what you've told us about your situation, many here would argue you don't need any life insurance at this time, assuming the income is evenly distributed between you and your wife. If children are anticipated that would change things. Definitely look into disability insurance. Max out your tax deferred space as much as possible, including back door Roth conversions if necessary.

by **l2yangop** » Wed Apr 17, 2013 4:06 pm

I appreciate everyone's thoughts. We do have plans for kids so I think Insurance is definitely going to be a need. I was only considering WL as another means of diversifying our broader investment strategy.

by **Elbowman** » Wed Apr 17, 2013 4:13 pm

The drag of an extra 1-2% cost, compounded over 50-60 years, is going to trump any tax advantage WL could possibly offer.

by **dhodson** » Wed Apr 17, 2013 4:14 pm

There is no diversification with WL. The insurance company primarily buys bonds and treasuries but takes a big cut and passes the rest to you.

by **mullery** » Wed Apr 17, 2013 5:15 pm

A traditional WL policy doesn't make a very good investment as you no doubt have read in various posts on this website. The fees and commissions built-in to a typical WL policy take years to overcome. As dhodson said, the cash surrender value of most WL policies doesn't reach the amount of premium paid until somewhere close to year 15.

WIth that being said, I have a couple of WL policies. I opened one when I was younger and didn't know any better. It's about 8 years old now and it makes more sense to keep it in force than to surrender it at this point. The second is a newer policy that I decided to purchase after a lot of research. I think WL can make sense as long as you keep a few things in mind:

1. WL is more of a savings vehicle than an investment. It's a low-risk asset. Some place it in the bond % of their portfolio.
2. You should maximize other tax-advantaged investments (401k, IRAs, HSA) before considering a WL policy.
3. The want/need for a death benefit is something that matters to you. The attraction for me was to pass a tax-free legacy to my children. I see my WL policies as a bit of a hedge against spending my other retirement assets down to 0. In other words, I can spend my other assets to 0 and still have the WL to pass to my children tax-free.
4. Seek a policy of the right design, from the right company. In my case I bought an overfunded, blended WL policy from a major mutual insurance company that pays participating dividends. This type of design blends a small amount of "base" WL with a large amount of term insurance. The term is converted to WL each year until all of it has been converted. This keeps the agent's commission down significantly. The savings on commission goes into your policy as cash value right away which, in turn reduces the break-even point from 15 years down to 5 years or less. Overfunding beyond the minimum premium allows you to "dump" extra cash into the policy and convert the term to WL more quickly. This allows you to pay-up the policy sooner, before the term insurance gets expensive. The trick is to avoid dumping in too much cash or your policy will become a "MEC" (Modified Endowment Contract), which negates many of the tax benefits of the policy (except for the tax-free death benefit).

While a life insurance company does primarily invest its general account in bonds, they do purchase a large number of private issue bonds and direct-issue corporate bonds which saves on some of the internal investment costs. They also invest in some other asset classes not easily obtainable by the average investor including private equity, commercial real-estate, etc. In short, they have huge "buying power" as an investor, some of which may benefit the return on your policy.

Regarding the "living benefit" of a WL policy, loans are probably the best way to access the cash in a WL policy. While you pay interest on the loan, you are also paid dividends on the full CV of the policy, including the amount you are borrowing. Some companies pay the same dividend rate on borrowed funds (non-direct recognition) while some pay a lower dividend (direct recognition). If you plan to access the money with loans, non-direct recognition may be best suited. If you plan to leave the cash in the policy alone, direct recognition will probably produce the best return. My research has shown the "spread" between the interest rate and the dividend rate on borrowed funds can range anywhere from 1-2% depending on the company.

I basically see WL as an asset class similar to bonds with less volatility than a bond fund, especially in a rising interest rate environment.

I hope this helps a little.

Matt

by **Elbowman** » Wed Apr 17, 2013 6:48 pm

mullery wrote:The savings on commission goes into your policy as cash value right away which, in turn reduces the break-even point from 15 years down to 5 years or less.

I think "break-even point" is the wrong phrase here. You are referring to the point at which the CSV is equal to the total premiums paid, as if the alternative is putting the cash under your mattress. But you wouldn't do that, you would invest it. If you compare the surrender value of a WL policy to investing yourself in low cost index funds, there is no break even point. Before cost, your WL provider will not produce a better risk adjusted return than the market for any extended period of time. After the (substantial) costs, it will trail the market, so at no point in the future does the expected value of WL CSV surpass the expected value of DIY investing.

by **mullery** » Wed Apr 17, 2013 7:02 pm

That depends on what you are investing in. You have to compare a WL policy with a comparable investment. Compare it to short to intermediate term bonds. Don't compare it to equities.

WL makes no sense for the short-term investor. You need to hold it for several years.

The rate of return on the cash value of a policy can reach 4-5%. Death benefit can be even higher depending on when you die. You then have to consider that the death benefit is tax free and it starts to look even better.

by **dhodson** » Wed Apr 17, 2013 7:41 pm

you need to compare it to appropriate alternatives. If you are investing over your entire life (which is what whole life does) then no comparing it to bonds isnt appropriate. It also lags bonds in return. A policy currently purchasing assuming dividends dont go further down will have around a 5% death benefit and not CSV. The guaranteed is a lot lower. You are comparing returns to a different time period with different dividends. Most people would put their "bonds" in their tax advantaged accounts and stocks in after tax. That way you can also tax loss harvest. It makes much more sense and you are unlikely to have a negative return for the first 15 years (and that even assumes the non guaranteed dividends).

I do agree that after purchased or held for a while, its usually best to keep it. Ignoring the first 10-15 years and then saying its great isnt appropriate to someone who hasnt purchased it yet. Thats because you have already lost a ton of money and there isnt a way to get that back. It isnt bc it was a smart idea to start with.

by **dhodson** » Wed Apr 17, 2013 7:51 pm

As you mentioned you arent necessarily paid a dividend based on the csv before the loans. That is only with non direct recognition loans which typically also are companies which have lower dividends. There is no free lunch here.

it is not true that wl is a hedge against spending all your assets. The bottom line is you have less money to spend bc its spent on a whole life policy. If you happen to run out of money, having whole life doesnt help you out bc the csv is lower than what a return would be from appropriate investing. If you happen to live longer than expected then the policy can easily crash as well making all gains taxed as income (and you lose the death benefit).

While blending, overfunding, buying a high early cash surrender policy etc helps it still wont solve the problems and you are being generous with your 5 year example given current dividends. 8-10 years is more like it.

In a rising interest rate environment, whole life dividends will eventually improve but the lag is usually 6 years.

by **HomerJ** » Wed Apr 17, 2013 7:52 pm

l2yangop wrote:I appreciate everyone's thoughts. We do have plans for kids so I think Insurance is definitely going to be a need. I was only considering WL as another means of diversifying our broader investment strategy.

Term life to protect your dependents...

People worry too much about taxes... Life insurance salesmen LOVE people like you... But here's the real math.

$100,000 in the Total Stock Market Index Fund in a taxable account costs you $50 a year in expenses, and you'll get $2000 or so a year in dividends... Even at the highest dividend tax rate (20%), that will cost you $400 in taxes. So your $100,000 account will cost you $450 a year...

$100,000 in a whole life policy has ZERO taxes (Whee!), but costs you $2000-$3000 in expenses... (2%-3% in expenses instead of the 0.05% Vanguard charges)

Personally I don't think spending $2000-$3000 a year to save $400 in taxes is a very smart idea... but life insurance policies are so complicated you probably won't even notice the $2000-$3000 hit, so you can still feel good about the $400 you're "saving" (You "might" notice a few years down the road that you have given the insurance company $60,000 so far, but your account balance only shows a cash value of $48,000, but if you avoid reading your statements too closely you can avoid that kind of pain)

by **HomerJ** » Wed Apr 17, 2013 8:01 pm

mullery wrote:The rate of return on the cash value of a policy can reach 4-5%.

This is misleading... Whole life companies basically get the same returns as bonds (because that's what they invest in) minus their expenses... Salesmen love to show the 5%-6% number many whole life policies have returned in the last 30 years, but they fail to mention that the Bond Market returned 8%-9% a year over the last 30 years...

If Bonds return only 3% over the next 30 years, Whole life policies aren't going to return 5%, probably more like 1%-2%. It's going to be whatever bonds return, minus their cut... So why not just invest in bonds yourself?

Even a Bond fund in a taxable account is much cheaper than any whole life policy... Dividend taxes are not that high. 15% for most people, 20% on the high end.

by **dimdum** » Wed Apr 17, 2013 8:20 pm

When I was looking at insurance needs, I evaluated both WL and its various iterations Vs. Term and investing the premium I save myself.

I compared 100k WL quote with death benefit of 250k Vs 250K 30 yr term plus investing saving in fixed 3 fund portfolio (35% bonds, 45% stocks, 20% Intl).
I was able to break even in on day 1 plus I still get 250K of death benefit during 30 yr term (used index return for 3 fund portfolio for past 20 yrs, no rebalance).

At 20 yrs I stop paying premium (as per WL policy).

After 30 yr, the term expires but my investment was around 270K, whole life guaranteed cash value was way less.

Edit: Tax - Even with 30% taxes, my investment was way ahead.
(sorry don't have exact Numbers)

by **mullery** » Wed Apr 17, 2013 9:31 pm

I don't want to spend any more time discussing the merits or shortcomings of WL. Suffice it to say it is a hotly debated topic as the OP alluded to. So much so that I felt obligated to do hours of my own research before I could make an educated decision on whether to purchase a policy and exactly what to purchase.

Back to the OPs questions. It sounds like you have a need for life insurance. You mentioned you are about 30 years old. A 20-year term policy will cover you until age 50. That may not be long enough. Do you have kids or are you planning to have some? If so, you may want to remain insured at least until they graduate from college. By age 50 you may be more or less "self insured" with your retirement savings, but if you died when you were, say, 52 I don't know if your spouse can withdraw from your IRAs as a beneficiary without paying a 10% early withdrawal penalty. Maybe someone familiar with estate planning can help answer that one.

I don't know how I feel about using WL as a way to access cash tax-free in retirement. You'll incur the difference between the dividend rate and the loan rate as a cost of borrowing the money. I probably wouldn't take a loan from the policy that I didn't intend to pay back in a relatively short period of time. I would also pay the interest out of pocket and not deduct it from the policy's cash value. I know there are a lot of people who purchase WL with the intent of using the "living benefit". I don't personally intend to use it that way, but may do so if future needs dictate.

Matt

by **slowandsteadyone** » Wed Apr 17, 2013 9:40 pm

mullery wrote:I don't want to spend any more time discussing the merits or shortcomings of WL. Suffice it to say it is a hotly debated topic as the OP alluded to. So much so that I felt obligated to do hours of my own research before I could make an educated decision on whether to purchase a policy and exactly what to purchase.

Back to the OPs questions. It sounds like you have a need for life insurance. You mentioned you are about 30 years old. A 20-year term policy will cover you until age 50. That may not be long enough. Do you have kids or are you planning to have some? If so, you may want to remain insured at least until they graduate from college. By age 50 you may be more or less "self insured" with your retirement savings, but if you died when you were, say, 52 I don't know if your spouse can withdraw from your IRAs as a beneficiary without paying a 10% early withdrawal penalty. Maybe someone familiar with estate planning can help answer that one.

I don't know how I feel about using WL as a way to access cash tax-free in retirement. You'll incur the difference between the dividend rate and the loan rate as a cost of borrowing the money. I probably wouldn't take a loan from the policy that I didn't intend to pay back in a relatively short period of time. I would also pay the interest out of pocket and not deduct it from the policy's cash value. I know there are a lot of people who purchase WL with the intent of using the "living benefit". I don't personally intend to use it that way, but may do so if future needs dictate.

Matt

Whole life policy discussions threads should be deleted on sight.

You say this is "hotly debated" but the only people I ever see advocating whole life policies have about 10 or less posts in their posting history here. Everyone else is firmly in the "no whole life" camp because that's the only camp that makes sense.

by **mullery** » Wed Apr 17, 2013 10:46 pm

Slowandsteadyone, is that all you are going to contribute to this thread? Why dont't you take a minute to answer the OPs questions? I see your are at 17 posts since joining last month. Does that make you an expert?

by **dhodson** » Wed Apr 17, 2013 11:15 pm

He seems to understand better than others.
Even ole meph who sells WL admits the numbers don't work.

by **mephistophles** » Wed Apr 17, 2013 11:42 pm

slowandsteadyone wrote:
Whole life policy discussions threads should be deleted on sight.

You say this is "hotly debated" but the only people I ever see advocating whole life policies have about 10 or less posts in their posting history here. Everyone else is firmly in the "no whole life" camp because that's the only camp that makes sense.

Whole life threads are almost always hotly debated and produce lots of posts. Other hotly debated topics are annuities of most stripes, gold, market timing and $5,000 watches. We need all of these threads to keep the blood hot and pumping in an otherwise, sometimes, boring forum full of numbers, academic studies, recitations of fundamental boglehead beliefs and slice and dice vs. index funds.
ole meph

by **mullery** » Thu Apr 18, 2013 12:04 am

I have read several posts by Ole Meph in my lurking around these forums and I respect his opinion because of his experience in the life insurance industry.

Speaking of hotly debated topics, including annuities, I just finished reading William Bernstein's "The Four Pillars of Investing". I was surprised to hear how, in certain cases, it makes sense to purchase a variable annuity for investing in asset classes such as REITs. He does go on to suggest purchasing such an annuity from a low-fee provider such as Vanguard. Still, I was surprised to read anything resembling support for an insurance product. The point I took from that example was not that VAs are great for REITs or that VAs are fine as long as you buy them from Vanguard, but rather that VAs can be effective at adding certain asset classes to their portfolio for some investors depending on their ability (or inability) to invest in a tax-deferred account. I never would have had that perspective without reading the book. That alone was enlightening.

So rather than instantly deleting threads on whole life, annuities, precious metals, and $5000 watches, let's see what others have to say about them. One of the things I really like about The Bogleheads forums is that there is usually a certain amount of social grace amongst the community. Not always, but usually.

by **Frugal Al** » Thu Apr 18, 2013 6:10 am

mullery wrote:WIth that being said, I have a couple of WL policies. I opened one when I was younger and didn't know any better.

Sorry about your luck. Please don't encourage others to make the same mistake. As for being surprised about an insurance product being endorsed, it's all about optimizing results and using the right tool for the job. Part of that is identifying exceptions to the rule. WL has it's place, and few products perform as well when it's kept in that place. Frustrating for the insurance industry is that there are so few places where it's really effective, and so many more where other financial tools/practices would be better utilized.

by **dhodson** » Thu Apr 18, 2013 7:41 am

Since you brought up VAs.... Reits are very tax inefficient. Thus if one wanted to hold a very tax inefficient product beyond what they can hold in their tax advantaged accounts then if you hold such a product for a long time like 30 years and use a low cost one like via vanguard then finally it can actually works. Without both combinations then not really. Of course one doesn't really need to purchase reits and most who want to can within a tax advantaged account. This is a small percent of people.

by **HardKnocker** » Thu Apr 18, 2013 7:49 am

Question for the OP:

Did you come up with the WL idea yourself or have you been in contact with a WL insurance agent?

by **l2yangop** » Thu Apr 18, 2013 8:43 am

Before I answer that I first want to thank everyone for their contributions. I really appreciate all the time some of you invested into answering my question. I was indeed approached (not pressured) by a friend who is in the industry and asked about what our retirement plans look like. He has been nothing but honest in the years I have known him so I do trust him not to sell me something I don’t need. He quoted me for 20 year level term, and also for a product that converts from term to WL. That was when I started researching and posted here.

by **MN Finance** » Thu Apr 18, 2013 9:06 am

One more concept to mention. It appears you were looking at this as a savings vehicle, which is clearly not appropriate. To the insurance side: consider the mortality pricing for whole life vs term. Whole life policies are required to be paid out 100% of the time because everyone eventually dies (probably the number is something like 98% since people fail to collect.) Term policies probably pay put 10% of the time (total guess). As such, premiums reflect this risk difference for the insurance co.

by **Bmac** » Thu Apr 18, 2013 9:16 am

1. At your ages, with no house and no children, it doesn't appear you need any life insurance at all. Or at least very little. Do either of you have any group life through your employers?

2. Why only one Roth and one 403b? You would probably be better off really focusing on maxing out all available tax-advantaged savings space and additional taxable savings. This will give you the best future "investment taxation diversity."

My recommendation would be to wait on getting any life insurance until you have a house and/or children. Then get term life policies that will cover the period needed (say 20 years, roughly). If you are healthy it should be possible to get inexpensive term policies into your late 30s, at least (I didn't get any life insurance until our first child when I was 39). In the mean time, focus on saving at least 15-20% of your gross, combined income annually. Invest that using the Boglehead philosophies espoused on this forum (low cost index funds, asset allocation, rebalancing, etc.). That will give you your best chance for achieving a comfortable retirement nest egg

by **l2yangop** » Thu Apr 18, 2013 9:30 am

1. We are planning for kids in the next couple years, God willing. I do have group life through my employer but it is for only 3x my annual income which is not sufficient once we have kids (not to mention should I ever lose/leave this job).

2. Only one Roth because we haven't bothered opening one for my wife since we will likely be phased out by next year or the following. She does not have a 403b offering or employer sponsored retirement.

So in the future, our only option (tax advantaged) will be $~17k in my 403b, and 7k to HSA.

by **dhodson** » Thu Apr 18, 2013 9:40 am

you can backdoor the roths at a higher income.

in case you didnt know, i actually probably have more whole life than anyone in this thread (unfortunately). The problem is once purchased, you are stuck without any good options. I know you feel the insurance agent has been good to you but i have to tell you thats the way all sales people appear who are successful regardless if they are honest or not or have your best interest at heart or not. There really isnt any good reason for him to be presenting this to you except to see if you will bite. Insurance agents get their training from the insurance companies. That has a big effect as well on their thinking.

by **Bmac** » Thu Apr 18, 2013 10:13 am

It seems like your group life would be adequate until you have kids.

Also, you should definitely consider the back door Roth. That can be an additional $11,000 between you and your spouse. Search this forum or the Wiki regarding back door Roth. The combination of 403b, Roth and taxable accounts gives great future tax diversification.

by **mullery** » Thu Apr 18, 2013 10:31 am

l2yangop, a few more things to consider.

You didn't mention what % of your combined income is from you and how much comes from your wife. If you are the primary breadwinner, you may want to provide more protection for your wife. Group plans are fine for some basic protection, but 3x your current salary may not be enough to sustain your wife if her income is a relatively small percentage of your combined income. Will she need to continue her education to bring her income up to afford your current lifestyle?

You are both still young and without children she may be able to cope financially without your income. Just something to think about. With a combined income in the $175-200k range, a cheap term policy should be a miniscule portion of your budget and may not be a bad idea.

Thursday, May 2, 2013

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