What are the structure problems with whole life insurance?

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jaro
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What are the structure problems with whole life insurance?

Post by jaro » Sun Feb 11, 2018 5:17 pm

Someone pitched me on whole life insurance, not as life insurance per se (since I do not have any dependents) but as a way to invest tax free. When I came to these boards to do some research I found that whole life gets such an icy reception that actively managed equity funds look beloved by comparison. Now I am wondering what the fatal flaw with whole life is. Variable annuities seem to have their uses, for investors in high tax brackets who have maxed our their tax-advantaged accounts and want to hold tax-inefficient assets like REITs. Whole life policies have some advantages, such as allowing you to access your money before age 59 1/2 and allowing for tax-free rather than tax-deferred growth. They are often offered by mutual insurers whose structure is similar to Vanguard's in that their are no equity holders demanding profits.

So why is whole life insurance such a comprehensive failure? I found this post on why the mutual structure doesn't count for much. But what about everything else? Why can't someone offer whole life insurance as an investment with no bells and whistles and low transparent fees? The only thing I can think of is that Vanguard offers variable annuities and they don't offer whole life insurance. The uniqueness of Vanguard might be the underlying issue here. But if whole life is repellent to Vanguard, why?

NotWhoYouThink
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Re: What are the structure problems with whole life insurance?

Post by NotWhoYouThink » Sun Feb 11, 2018 7:49 pm

What do you think the benefits are of whole life insurance? Are you really looking at it for the payout after you die, or are you looking at it as a retirement fund?

In any case, check out this thread from whitecoatinvestor, and see if you still have questions.

https://www.whitecoatinvestor.com/what- ... insurance/

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MichaelRpdx
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Re: What are the structure problems with whole life insurance?

Post by MichaelRpdx » Sun Feb 11, 2018 7:54 pm

Food for thought.

Early in my career I had to model returns from whole life products over the life of the investment. One huge drag on the investment value was the insurance broker being paid a first year commission equal to the first year premiums. Not in all cases, just most of them. The agent would then get a smaller residual commission each year the policy was in effect.

Can we say high fees?
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overthought
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Re: What are the structure problems with whole life insurance?

Post by overthought » Sun Feb 11, 2018 8:14 pm

jaro wrote:
Sun Feb 11, 2018 5:17 pm
Someone pitched me on whole life insurance... as a way to invest tax free. When I came to these boards to do some research I found that whole life gets such an icy reception that actively managed equity funds look beloved by comparison. Now I am wondering what the fatal flaw with whole life is.
Think of it as the world's worst Roth 401(k) plan:
  • 30 year or more time horizon
  • After-tax dollars go in, not taxed on growth
  • Matures at death instead of retirement
  • Severe early withdrawal penalties
  • You can take loans against the accumulated value... but Bad Things happen if you can't pay them back
  • Mandatory large contributions. Miss payments and the plan goes *poof* taking most of your assets with it.
  • The first year and a half of contributions go into the plan administrator's pocket (commission)
  • Completely opaque investment strategy. You don't get to pick funds, asset allocation or anything. No access to past performance, either.
  • Completely opaque fee structure. Front load? Expense ratio? Sales load? Most likely all of the above, and big too.
  • The advertised growth rate is perhaps 3% on a good day
  • Plan loses its tax-advantaged status if the growth rate is too high.
  • Can't roll it over to a different plan if you decide you dislike your administrator
Last edited by overthought on Sun Feb 11, 2018 8:30 pm, edited 2 times in total.

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Raymond
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Re: What are the structure problems with whole life insurance?

Post by Raymond » Sun Feb 11, 2018 8:19 pm

overthought wrote:
Sun Feb 11, 2018 8:14 pm
jaro wrote:
Sun Feb 11, 2018 5:17 pm
Someone pitched me on whole life insurance... as a way to invest tax free. When I came to these boards to do some research I found that whole life gets such an icy reception that actively managed equity funds look beloved by comparison. Now I am wondering what the fatal flaw with whole life is.
Think of it as the world's worst Roth 401(k) plan...
Thanks for the excellent analogy!
"Ritter, Tod und Teufel"

adamthesmythe
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Re: What are the structure problems with whole life insurance?

Post by adamthesmythe » Sun Feb 11, 2018 10:10 pm

Some products are just too hard- or too much work- to figure out. Look at it from the other side. You KNOW how to save for retirement- invest regularly in something sensible, ideally deferring taxes. You KNOW how to get the necessary insurance for your family- term life.

This reasoning- together with the suspicion that the agent is clearing a bunch of money- is a good reason to stick to the obvious.

bberris
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Re: What are the structure problems with whole life insurance?

Post by bberris » Sun Feb 11, 2018 10:25 pm

I think OP wants to know what, in principle, is wrong with WL. Yes there are high fees and commissions, but lots of otherwise good products have them too. And the product is complicated enough to make the fees obscure.

But couldn't some ethical provider make the product work well? I think not. The problem is the entanglement of two distinct objectives into one product. Would you buy a mutual fund that also had a term policy inextricably attached? That is whole life. But when you describe it that way, it just seems absurd.

jaro
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Re: What are the structure problems with whole life insurance?

Post by jaro » Sun Feb 11, 2018 11:44 pm

bberris wrote:
Sun Feb 11, 2018 10:25 pm
I think OP wants to know what, in principle, is wrong with WL. Yes there are high fees and commissions, but lots of otherwise good products have them too. And the product is complicated enough to make the fees obscure.

But couldn't some ethical provider make the product work well?
Yeah, this is what I was wondering.
The problem is the entanglement of two distinct objectives into one product. Would you buy a mutual fund that also had a term policy inextricably attached? That is whole life. But when you describe it that way, it just seems absurd.
It does seem absurd, and I accept that must be a big part of the answer. The fact that this entanglement is driven by a very complicated tax system does nothing to mitigate its impact. However, what you say is equally true of variable annuities which seem to be regarded as tolerable investment vehicles in some cases. Is there a structural reason for whole life to be "worse" (more complicated, more hidden fees and restrictions) when the tax advantages are seemingly larger?

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Top99%
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Re: What are the structure problems with whole life insurance?

Post by Top99% » Mon Feb 12, 2018 9:04 am

Personally I view insurance as most useful for protecting one from low probability but high impact events like house fires, lawsuits or, in the case of life insurance, dying before one has accumulated enough assets to support their dependent(s).
Dying is high impact but also high probability over one's entire lifetime.
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NotWhoYouThink
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Re: What are the structure problems with whole life insurance?

Post by NotWhoYouThink » Mon Feb 12, 2018 9:35 am

However, what you say is equally true of variable annuities which seem to be regarded as tolerable investment vehicles in some cases. Is there a structural reason for whole life to be "worse" (more complicated, more hidden fees and restrictions) when the tax advantages are seemingly larger?
OP, when "someone pitched you whole life", can you explain what "someone" told you was the way you would access the money in the whole life policy? Maybe if you explain how you think you would use it your questions would be easier to answer.

Jack FFR1846
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Re: What are the structure problems with whole life insurance?

Post by Jack FFR1846 » Mon Feb 12, 2018 9:46 am

Combining investment with insurance is like buying a tire inflator with an attached bar-b-que spatula.

Whole life has fees for everything.
When the insurance company invests in low risk assets, you get the low return minus the fees.
The commissions are paid by you.
The pitch by the insurance agent may have nothing to do with the contract for the policy you buy. He might pitch that you're buying the fastest electric assisted car ever built and what's in the actual policy is a washing machine.
Tax free can be a lie. I cashed in a policy started by my dad in the 80's last year. Guess what.....I'm paying taxes on the gains this year.

In general, the actual policy winds and twists and turns in ways you can't follow. The goal is that you believe the lies the salesman tells you so he can make his boat payment. By the time you figure out you're being screwed, it's cost you 10's of thousands of dollars and you have zero cash value.

The insurance salesman doesn't call this insurance because you can easily compare term insurance, find out that it's significantly cheaper and he doesn't get his big commission. But if he throws the word "investment" out there then, well, that must be good, right?

I was pitched a whole life policy to "Hide" our assets from FAFSA. This is a common ploy. Money tied up in a whole life policy isn't seen by FAFSA. But if your income is high enough to have all these assets to hide, your income likely disqualifies you from everything but loans. Better still....if your kid goes to a private college who adds CSS to FAFSA, they ask specifically about insurance cash value, so you're screwed by the whole life policy and get zip benefit.
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BogleMelon
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Re: What are the structure problems with whole life insurance?

Post by BogleMelon » Mon Feb 12, 2018 9:55 am

One word: Middleman

When you buy a product, any consumable product, you don't just pay for the manufacturing price, you also pay its transportation cost to the store, storing cost, marketing expenses paid so that you get aware of the product...etc.

The financial product is not a consumable product. You don't buy rental home for example to live in it and enjoy it, you buy a rental home to rent it out to a tenant and hoping you make more money than you paid. So the formula is more money earned or less money paid to buy the home or both turns out to be profitable and vise versa.

Now with WL, there is an insurance company which is specialized mainly in insurance, not -for example- index funds. The company invest the money in a safe way, because again they make profits from insurance products not investing. So the insurance company here as a whole is considered a middleman for a customer who is buying WL policy to invest. If the company investing my money in something, why wouldn't I go directly to that "thing" and buy it? Also, on the company side, the company won't be able to be profitable if it sold you that investing product at a low profit margin, because again they are not specialized mainly in that product, they are an insurance company afterall.

That reminds me of a common scam that stores used to run in my home country. Every time I went to buy a jeans, there were that street who is full of stores selling jeans. Mostly unbranded jeans which you never heard about it their brands and they are claimed to be imported from (Jeans Island!) or whatever fancy country they come up with!
here is how the scam is run, you go in the store, you like the color, and materials but size doesn't fit. No size fits you of this exact brand this exact color in the store. The store worker tells you "That's fine, I will go and get your size from our nearby storage warehouse in 2 minutes". The guy gets out of the store, coming back with a similar jeans, that fits you well, but a different another unknown brand. The piece he got you now cost about 3X any jeans in his own store! You ask why is that? both are unknown brands, why the one in your "warehouse" costs as much triple as any other jeans in your store? He then explains: "Well sir, that brand is so famous in USA and so high end quality that we don't even keep it in stores! it is for special customers like you!"
What the guy just did? He went to a nearby affiliate store, asked them about a jeans in your size and your desired color, and then paid the full retail price as a normal customer (or may be got a slight discount as a returning customer!) and now he is marking the retail price up according to his own markup policy!

The store is not specialized, and buy it with the price you the real customer should have paid, but the store needs to make money off of it. So.. you pay the high expensive price then!
"One of the funny things about stock market, every time one is buying another is selling, and both think they are astute" - William Feather

Nate79
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Re: What are the structure problems with whole life insurance?

Post by Nate79 » Mon Feb 12, 2018 10:54 am

I have yet to see a problem WL solves that other products can not solve, and those product are cheaper, better performing, and more transparent. There is nothing special about the structure of WL - this is an insurance industry lie that they continue to push to trick the financially illiterate into believing.

The point of any financial product is to solve a certain set of problems. Once you know what that problem is you need to define which financial product best solves that problem at as low of a cost as possible.

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HomerJ
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Re: What are the structure problems with whole life insurance?

Post by HomerJ » Mon Feb 12, 2018 11:08 am

jaro wrote:
Sun Feb 11, 2018 5:17 pm
Someone pitched me on whole life insurance, not as life insurance per se (since I do not have any dependents) but as a way to invest tax free.
The plain old vanilla Total Stock Market Index Fund is very tax-efficient. Zero capital gains year-to-year; you only pay taxes on dividends.

20% tax (assuming you are in the highest bracket - it's 15% for most people) on 2% dividends is 0.4% tax each year.

Meanwhile whole life charges 2%-3% in fees. Hidden fees of course. But your "returns" will indeed be 2%-3% lower than if you just invested the money yourself.

Paying 2%-3% in fees to avoid 0.4% in taxes is not a very smart move.
Last edited by HomerJ on Mon Feb 12, 2018 11:34 am, edited 2 times in total.

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HomerJ
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Re: What are the structure problems with whole life insurance?

Post by HomerJ » Mon Feb 12, 2018 11:24 am

jaro wrote:
Sun Feb 11, 2018 11:44 pm
However, what you say is equally true of variable annuities which seem to be regarded as tolerable investment vehicles in some cases.
Variable annuities, in general, are mostly all junk too.

You need to read that thread again. Bogleheads like SPIAs, but that's NOT a variable annuity.

SPIA stands for Single Premium, Immediate annuity. You give the insurance company $100,000, and they give you $6000 a year (or whatever) for life. Note that's NOT a 6% return. The $100,000 is gone forever. They are just paying you your own money for the first 15+ years. But it's longevity insurance. If you live a long time, the money keeps coming in.

Those are extremely simple, and are a way to generate income in retirement. A SPIA is NOT a tax-deferred investment vehicle like you are asking about.

Variable annuities are sold just like whole life insurance. The insurance salesman stresses the tax advantages, but doesn't mention the enormous fees.

Avoid both.

Caduceus
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Re: What are the structure problems with whole life insurance?

Post by Caduceus » Mon Feb 12, 2018 4:19 pm

Well, if the fees for WL were low and transparent, insurance companies would stop offering them because there would be no profit advantage to offering something like term life insurance instead.

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