Yes, Virginia, Whole Life Insurance Is Worth It

And, that is the enduring story of whole life insurance. It is inescapably intertwined with advanced mathematics — an eternal story, promising an unbreakable guarantee of the future. The guaranteed cash value, guaranteed death benefit, and guaranteed level premiums of whole life insurance ensure policyholders never have to guess about their financial future. Whole life insurance’s big and not-so-secret promise is to make the uncertain, certain. It protects individuals against financial loss while simultaneously providing financial security for an entire lifetime.

That this simple fact of whole life insurance is often left unsaid or unacknowledged is unfortunate.

Contrast this with the empty promises of speculation. For years, investors were promised 12% average returns from the stock market. In hindsight, they earned far less — in many cases, less than 6% after taxes. In some cases, even less than that.

In 2017, Fidelity analyzed 22,400 retirement plans, monitoring the performance of 15.3 million investors and published its results in a special report. Fidelity’s investor database is one of the largest known databases of its kind. At the end of 2017, it reported the 10-year median annual return for investors was just 5.80%, before taxes. These investors were committed to remaining invested for the long-term — only a small percentage of these investors took hardship withdrawals or 401(k) plan loans. Despite their loyalty to the markets, these investors were rewarded with risk and lost capital. Even so, they remained faithful, which speaks to the idea that committed investors tend to “stick with it” and some even believe they have earned more than they actually have from their investments.

The published trailing returns of many equity mutual funds foster this belief by suggest investors are earning double-digit returns. Often, the sobering reality is investors are earning far less than advertised. This was highlighted more recently by the latest DALBAR study, which found the average equity mutual fund investor earned just 3.88% annual return over the last 20 years. Investors who placed their money in more diversified mutual funds, where money is spread out across multiple asset classes, fared worse — just 1.87% per year over the last 20 years.

A promise of high rates of return causes investors to save less. If investors expect to earn 12% returns from their investments, they don’t need to save nearly as much as if they earn 4%. But, planning on a 12% (or even 8%) rate of return, and receiving 3% to 4% returns instead, destroys an investor’s financial plan, making it impossible to retire with any sort of financial security.

And, despite the widespread belief by investors that they will be in a lower tax bracket when they retire, the Center for Retirement Research at Boston College found that taxes on income drawn from retirement accounts can eat up 25% to 33% of a typical investor’s retirement savings, assuming income taxes never increase from today’s relatively low rates.

Risk Tolerance V. Risk Capacity

Part of the problem investors face today isn’t financial. It’s emotional. It’s the faulty notion that risk tolerance matters. Risk tolerance is how an investor feels about risk. And yet, feelings do not necessarily jive with facts. Investors are routinely asked to assess their own risk tolerance, often through subjective risk tolerance questionnaires. They are asked, for example, how they would feel if they experienced a 40% decline in their portfolio value. They answer while sipping a latte in a plush office, in a leather chair, in a comfortable room with relaxing music. What they experience “in the moment” of a market crash almost never corresponds with their initial feelings about said crash beforehand.

This raises an obvious question: do subjective risk tolerance questionnaires matter? A risky investment may not feel risky to the investor, and yet it may be risky, nonetheless. This phenomenon has plagued investors for decades.

Contrast this with risk capacity — the amount of risk an investor must take to meet his or her investment goals. Or, said another, perhaps more useful way, the amount of risk an investor can afford to take to meet their investment goals. When reframed this way, risk capacity becomes an objective calculation of how much money investors can risk to meet future goals.

Meaning, if the guaranteed future value of an investor’s savings is insufficient to pay all future expected expenses, an investor likely cannot afford to take any risks. Investors can reasonably take risks when they have guaranteed savings sufficient to cover necessary future expenses. Of course, implied in this view is the idea that investors need insurance for financial security and independence.

Putting Whole Life Insurance Front and Center Would Fundamentally Change the Financial Planning Industry Forever, and Restore Trust in the Financial Services Industry

To achieve this sort of financial security, an investor would benefit from putting a high premium participating whole life insurance policy front and center in a financial plan. High premiums, and high guaranteed cash values, allow investors to pass financial risk onto a life insurance company. Each dollar of guaranteed premium, and the resulting guaranteed cash value, frees up riskable money which can be invested in speculative investments (if he so desires). The client has put enough money into life insurance when he is fully insured for his human life value — the present value of all his future income.

But, this extensive use of whole life insurance to guarantee a future savings and death benefit would require a complete overhaul in how financial advice and financial planning is delivered to clients. That change, which overturns decades of financial planning dogma, can seem potentially threatening. But, what is the alternative? Investors today are retiring in waves, wholly unprepared for what awaits them. Subsequent generations need not share in their fate.

For today’s investors, the choice is simple: Do you want certainty about your future or do you want to speculate and gamble with it?

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David Lewis is the founder and owner of Monegenix. He designs insurance-based financial plans, financial calculators and apps for business owners and professionals.