The Math on Whole Life Insurance Returns
We hear it constantly from the status quo financial planners out there and the "financial entertainers" that whole life insurance is a horrible investment and it gets a terrible rate of return.
What I've found is most people's opinions about whole life insurance are completely based on somebody else's opinion. Rarely have I seen someone who has a negative opinion about whole life insurance who has also actually looked into how it works.
Source Material
That's why Nelson Nash's book, "Becoming Your Own Banker," which is the source material for The Infinite Banking Concept, was such an important book. It was such a positive force out there in the financial world because it really forced people to rethink what they knew about whole life insurance and why they should have it as a tool in part of their financial life.
For those wanting to go deeper, I recommend:
"The Economics of Life Insurance" by Solomon Huebner - A hundred-year-old book that pairs timeless concepts like capitalization, depreciation, and liquidation to your human life value
"Confessions of a CPA, the Capital Equivalent Value of Life Insurance" by Brian Bloom - Shows how to run capital equivalent calculations that account for all the costs of different assets
These books demonstrate that life insurance is really more than just a rate of return. It allows us to take organizational and managerial principles that are universally accepted in corporate finance and apply those principles to our personal lives.
Understanding Cash Value Growth: Two Key Points
The cash value of life insurance is not an interest rate - It's an actuarial calculation. You can back into a rate of return, but that's not actually how the growth is derived. The growth comes from the actuarial math, which is where some of the guarantees come from.
Whole life insurance cash value is net of all costs, fees, and commissions - When comparing to other assets, you have to find out what those costs, fees, commissions and taxes are going to be for the other type of asset.
Breaking Out The Financial Calculators
Let's look at a real example using the TruthConcepts calculator (created by Todd Langford).
For our example, we'll look at a 35-year-old funding a whole life policy with $24,000 a year, projected out to age 70 (35 years). Right on its face, this policy is earning an internal rate of return (IRR) of 4.6% at year 35.
If you're not familiar with IRR, it means that at year 35, it's as if you had earned 4.6% every single year - even though the early years have lower returns and later years have higher returns (in the 5% range).
A Real-World Comparison
A quick aside: there was an article recently that essentially said, "look out, the market is in trouble because bonds just hit 4.35%." Meaning that people will probably start shifting money from equities like stocks into bonds to get that 4.35%.
A question comes to mind: Why is 4.35% exciting to anyone when we're told you can get 12% in the market? I think it's proving that people crave certainty.
But here we are with bonds at 4.35%, meanwhile, we're told life insurance gets a "terrible rate of return." We see right here that we can get a 4.6% rate of return. And again, this is a net rate of return on the whole life insurance. The 4.35% on the bonds is gross - we still haven't taken out taxes, fees, and other costs.
Creating A True Comparison
What if we look at what we'd have to earn in an alternate account just to match everything we get with this whole life insurance policy?
When we run the numbers, to match the whole life insurance performance, you would need:
6.05% return after accounting for a 24% tax bracket
6.3% return if you also buy term insurance (to replace the death benefit)
8.5% return when you add in management fees of around 1.5%
That's a huge difference from the surface-level comparison most people make!
Visualizing The Difference
If I graph this comparison between a 4.5% bond (with fees and taxes) and the whole life policy, we start off a little bit behind with the life insurance cash value because of the costs early on in the policy. But we hit parity around year nine, and then the life insurance cash value really takes off.
If we just look at this as a bond alternative, it starts to look very good. And if we're looking at modern portfolio theory, where most wealth management firms tell you you should have stocks and bonds, wouldn't having permanent life insurance actually allow you to buy more stocks? The value of the life insurance is going up, so you could actually have more in stocks if you use life insurance as a bond replacement.
The Legacy Value Comparison
When we add in the legacy value (death benefit), the term insurance plus the value of the bonds is a little bit higher during the working years than the permanent life insurance. This makes sense because with life insurance, you don't get both the death benefit and the cash value - the cash value is the equity in the death benefit, just like the equity in your house.
But as we get into our late fifties, the value to our heirs from the permanent life insurance starts to exceed the value of the bonds and the term insurance. Then at age 65, because the term insurance completely drops off, we're looking at almost a two and a half million dollar difference in terms of value to our heirs between just the bond value and the permanent life insurance death benefit.
A "Permission Slip" to Spend
When people get to retirement without permanent life insurance, their savings has to do a lot of jobs:
Provide income for daily living
Provide liquidity for health issues or unexpected expenses
Provide a legacy value to heirs
Cover potential long-term care or chronic illness costs
But if you have the permanent life insurance death benefit, doesn't that kind of give you a permission slip to use and enjoy more of your other assets? It gives your other assets at least two less jobs, because this permanent life insurance comes along with accelerated death benefit riders that protect you for chronic and terminal illness.
The Irony of Term Insurance
The most ironic part about the "buy term invest the difference" strategy is that it provides protection when you statistically don't need it (during working years when premature death is unlikely) and vanishes precisely when you're guaranteed to need it (as you age and mortality becomes certain).
The only valuable death benefit is the one in force when you die.
Whole Life is Not An Investment, But It Ain't No Slouch Either
Going back to the rate of return conversation - decide for yourself. Is it true that whole life insurance gets a terrible return when we actually take into account all of the things that you get from it and try to match that with some other type of asset? We can see you need an 8.5% equivalent return. No one would say that's a terrible return.
We have to look at the type of asset that whole life insurance is - a cash equivalent asset. So really, when we're comparing, we have to compare to other similar asset classes. What other asset can you have the guarantees and liquidity that you get with whole life insurance and get an equivalent 8.5% on it?
We really have to start being a little bit smarter with how we're comparing things and not take the "if you have a hammer, everything's a nail" approach to just comparing rates of return with no context, like some of the typical financial planning advice people do.
