Whole Life Insurance Question

[Mulligan]

Situation: My friend will be retiring in a couple years with 2 pensions between him and his wife. He believes through his budgeting that he will have about $3k a month left over after monthly expenses. Currently he has no assets, and will plan to buy a house in Florida. He is going to save up enough in the next 3 years to put a 20% downpayment and finance the rest.
He just starting paying into a whole life policy that has a premium of $2k a month with an initial death benefit of around a half million and in 24 years the policy will be paid off with a death benefit of around 1.5 million, and it will kick off dividends down the road, or payout will increase if reinvested. He asked me if this was the correct thing for him to do, and wanted my input. I was needing some help in presenting arguments against what he did, or verify what he is doing is correct. I am a little at loss of this, because I would never tie up that amount of my free cash flow into an insurance policy, and I have always been told to buy term insurance, and avoid whole life.

He wants to build up money for his children to inherit, and also protect his wife to a degree because her pension is significantly smaller. What are some of the negative counter arguments can I present to him? Remember he will be heading into retirement with no assets except for potential money saved in the short term for a house purchase. But, he will have over a 100k pension from a solid system, with 2% annual Cola. He wants to travel and enjoy life but it appears he will be putting himself on a tight leash with 2/3 of his free cash being dumped into an insurance policy. What are all the drawbacks to his strategy? He keeps saying he can always "take money" out of policy if he ever needs it, and cites the ability to let his children receive this money tax free when he retires. Any thoughts would be appreciated.

 

[Mulligan]

Correction: Last sentence should read, children receive the money tax free when they die, not retire.

 

[brewer12345]

You are wasting your time. He has already swallowed the marketing and bought the product, so you might as well tell him congratulations and to enjoy his retirement.

 

[Mulligan]

You are wasting your time. He has already swallowed the marketing and bought the product, so you might as well tell him congratulations and to enjoy his retirement.

Brewer, he was soliciting advice from me. I don't quite know what to say other than I wouldn't have done that.

 

[H2ODude]

Agree with Brewer. I've been told for so many years to avoid WL insurance that I never learned enough to have a clue as to how they work. If he still had an option, the only thing I'd suggest is to spreadsheet out the in and out of the WL policy vs a conservatively invested cash flow. But it sounds like it's done, and there's no juice in proving that a friend made an error.

I generally avoid financial advice to friends. It pains me to see them do (to me) dumb things, but I don't want to cloud the friendship with advice. Plus, as smart as I am my advice could turn out wrong under certain circumstances, and then there's the blame deal. Good luck.

 

[Mulligan]

Agree with Brewer. I've been told for so many years to avoid WL insurance that I never learned enough to have a clue as to how they work. If he still had an option, the only thing I'd suggest is to spreadsheet out the in and out of the WL policy vs a conservatively invested cash flow. But it sounds like it's done, and there's no juice in proving that a friend made an error.

I generally avoid financial advice to friends. It pains me to see them do (to me) dumb things, but I don't want to cloud the friendship with advice. Plus, as smart as I am my advice could turn out wrong under certain circumstances, and then there's the blame deal. Good luck.

So you think he is in effect "locked in" no matter what does? He didn't mention that.

 

[H2ODude]

So you think he is in effect "locked in" no matter what does? He didn't mention that.

Probably to a degree. As stated, I know little about WL but I thought it was like variable annuities, once you sign on there's a steep price to get out. I may be totally wrong though. Hey, I said I didn't know much about WL!

 

[pb4uski]

A common problem with these products is that they don't live up to the sales illustration so it is likely that your friend will be disappointed.

 

[heeyy_joe]

I'm not quite sure all the information to make a call on this in favor of the life policy is available. If he is purchasing this policy as a "pension max" plan, whereby he collects the maximum on his monthly pension (if he dies payments stop, she gets nothing) and then she can purchase her own annuity with the life insurance death benefit. The idea is that the increased pension payments fund the policy and provide cash value buildup as well as a death benefit.

This could be the scheme, and it would take some scrutiny to ascertain whether or not this is a good deal or a bad one.

 

[Independent]

The first thing is to ask about the guaranteed values vs. the "projected" values. Plenty of insurance companies have failed to make their projected numbers. Also, ask about guaranteed cash surrender values if he needs his money at the end of the first or second policy year.

I can imagine that buying insurance may make sense if his wife couldn't live on just her pension plus (probably his) SS. But, in that case, he should look at a much smaller policy, and consider term-and-invest-the-difference.

The tax situation is complicated. If he invests in equity mutual funds where he gets the lower dividend and cap gain tax rates, he may discover that the lower fees in the mutual fund (I'm assuming you'd recommend low load indexed funds) outrun the tax advantage of a life insurance death benefits.

Like you, I'd be more concerned about making sure I have enough money to handle the unexpected slings and arrows in retirement, rather than trying to build an estate for the kids. What will they do with the money when he dies? How old will they be? Will they just enjoy a retirement that's nicer than his? I'd look at saving the $2k/mo in an emergency fund, knowing that the kids will get the proceeds if I never use it.

Maybe thinking about his goals, rather than getting $$ in his eyes from some tax strategy, would be your best advice.

 

[2B]

Many, many years ago I bought a whole life policy. After two years and some more information about term, I compared the policy value with the original sales material. It wasn't even close. The sales info said I'd have more than my total premiums. Reality was about 20% less. I priced a term policy, bought it and cancelled the whole life.

He can get the insurance coverage for what his wife would need at a lower cost if his health is good enough to qualify. It might be hard to get a policy that covered him too long but saving the extra would create a big fund for her to draw on.

Financially, he would probably come out way ahead if he plowed the cash into a balanced fund and never looked at it again. The downside is that dying quickly would make the whole life policy a better choice.

I have never been able to talk anyone out of buying a whole life product or getting them to cancel one. I have planted the seeds that have caused a couple of people to "discover" the downside of the whole life a year or more later.

In your situation I'd suggest looking at term and investing the difference. Then I'd ask him to compare his policy value with the advertized returns. I doubt you'll get him to change.

 

[heeyy_joe]

The problem with buying term insurance and investing the difference is:

PEOPLE DON'T.

 

[FinanceDude]

Whole life is not all that complex. You pay for your "whole life", hence the name. Most people do not need it. However, I have seen it used as a wealth transfer tool by estate planning attorneys to lower taxes at death. Sounds like Mulligan's friend was sold this policy as a retirement acculating policy rather than pure life coverage.

You can always cancel a WL policy at any time, but the surrender charges in the early years is oppressive. Also, the cash value (CV) does not grow much those early years, as the insurance company had to pay the selling agent about 60% of the 1st year's premiums as a commission.

People are often sold the ability to take money out of a WL policy. While it can be done, it is done with what's called a "policy loan". The insurance company "borrows" you a portion of your CV, and charges you an interest rate on it. Some insurance companies "credit back" a portion of the interest charge, lowering it from let's say 7% to 3%. However, a corresponding amount of CV is "tied up" with the loan, in effect guaranteeing it. And, on that portion "tied up", you get NO dividends, and it reduces the death benefit by the same amount.

 

[Mulligan]

Some good points mentioned as I told him I would talk to him tommorrow. A few points to clarify. Their pensions are very imbalanced. His a little over a 100k and hers about 20k. So with no real assets, she would need the life protection, and he told me he is a year into this, so canceling would be a helluva hit to about 20k he has in it. I won't suggest him to stop it, as he doesn't understand investing and may as a previous poster mentioned...not do it. But, based on what Ive read and was posted, I am going to quit telling him to use it as a piggy bank to borrow from. He has already done it a few times and paid back. The agent left him the impression that basically he could do this all the time. So he was thinking I will not worry about saving a separate pool of dollars because that money is there already anytime he needs it. All this will do is decrease the value of his policy which contradicts what he is trying to do. I don't think he really understood that.

I also found out his "first year review" with agent is soon. Well he told me he has already talked to him about starting another one! He needs to know this 60% commission thing. It all makes since now....agent is wanting him to put every extra penny he has into whole life to increase his fat commission. All while telling him it is fine to do this because you can borrow the money anytime he needs it. The agent appears to be trying to convince him that the policy can essentially be his bank! So I think the best I should do is just get him to not start another policy, and quit using his current policy as a bank, and start saving additional money for other needs without hitting up the life policy. Sound like reasonable advise?

 

[timo2]

Some good points mentioned as I told him I would talk to him tommorrow. A few points to clarify. Their pensions are very imbalanced. His a little over a 100k and hers about 20k.

The pension imbalance is a concern. What is the survivor benefit on his? That gap of income for his spouse might be big if he passes first. That would be a good reason for the WL insurance, and also provide peace of mind that his wife will not be broke after he is gone. And if his spouse passes first, he can get the cash value out, or change beneficiaries, or whatever. So he shouldn't kick himself over getting a policy to deal with the income gap if he passes first.

But he should stop there. no more life insurance policies for him. That death benefit from the one policy is plenty (and maybe too much, but too late now).

Also, is the wife's pension adjusted for inflation?

 

[Mulligan]

The pension imbalance is a concern. What is the survivor benefit on his? That gap of income for his spouse might be big if he passes first. That would be a good reason for the WL insurance, and also provide peace of mind that his wife will not be broke after he is gone. And if his spouse passes first, he can get the cash value out, or change beneficiaries, or whatever. So he shouldn't kick himself over getting a policy to deal with the income gap if he passes first.

But he should stop there. no more life insurance policies for him. That death benefit from the one policy is plenty (and maybe too much, but too late now).

Also, is the wife's pension adjusted for inflation?

His goal, I believe is dual in purpose. Ultimately they would like to live a long life, then have the policy pass on to their children. But it is there also in case he would die early. He is taking his pension option 1 meaning, when he dies, the pension dies. The only real hole I was worried about for him was if he died shortly after retirement thus causing spouse to draw down the policy while in her 50s. No social security, btw. So I think I have him convinced to take option 6 which is 10 year term benefit. If he died 3 years into retirement, she would get his pension for 7 more years. It only costs $25 a month. This would allow her to save money and not tap the policy until late 60s at the earliest on a worst case scenario. Pensions both have 2% annual colas.

 

[heeyy_joe]

His goal, I believe is dual in purpose. Ultimately they would like to live a long life, then have the policy pass on to their children. But it is there also in case he would die early. He is taking his pension option 1 meaning, when he dies, the pension dies. The only real hole I was worried about for him was if he died shortly after retirement thus causing spouse to draw down the policy while in her 50s. No social security, btw. So I think I have him convinced to take option 6 which is 10 year term benefit. If he died 3 years into retirement, she would get his pension for 7 more years. It only costs $25 a month. This would allow her to save money and not tap the policy until late 60s at the earliest on a worst case scenario. Pensions both have 2% annual colas.

I think the WL in place is reasonable given the specific condtions. He should not buy another policy, and your idea on 10 year certain pension is a bargain at $25 reduction.

 

[timo2]

His goal, I believe is dual in purpose. Ultimately they would like to live a long life, then have the policy pass on to their children. But it is there also in case he would die early. He is taking his pension option 1 meaning, when he dies, the pension dies. The only real hole I was worried about for him was if he died shortly after retirement thus causing spouse to draw down the policy while in her 50s. No social security, btw. So I think I have him convinced to take option 6 which is 10 year term benefit. If he died 3 years into retirement, she would get his pension for 7 more years. It only costs $25 a month. This would allow her to save money and not tap the policy until late 60s at the earliest on a worst case scenario. Pensions both have 2% annual colas.

and the wife is OK with option 1? That was a good catch you made with the early retirement hole. How many options are there?

 

[Mulligan]

He said she was good with it... I guess the policy was good enough for her. I think there are 6 options. Max, full spouse benefits, 3/4 benefit, 1/2 benefit, 5 yr. term, and 10 year term.

 

[FinanceDude]

Why not take full spouse benefit option? That way she would not be in a bind. The amount would be lower, but she would also get hers, and both together might equal choosing a 10 year option?

Also to clarify, the agent "only" gets 60% the first year, on each policy year after, typically they will get 11% commission on new monies, and a 5% or so retention bonus on the entire policy. Lots of folks on here rip on FAs for compensation, but there is REAL MONEY to be made in life insurance..........

 

[Mulligan]

Why not take full spouse benefit option? That way she would not be in a bind. The amount would be lower, but she would also get hers, and both together might equal choosing a 10 year option?

Also to clarify, the agent "only" gets 60% the first year, on each policy year after, typically they will get 11% commission on new monies, and a 5% or so retention bonus on the entire policy. Lots of folks on here rip on FAs for compensation, but there is REAL MONEY to be made in life insurance..........

That is what I would have done, and left it at that. But he is trying to leave assets for his children, and didn't think they could save as much on their own as a life insurance would give them. The full option would have dropped his pension close to $1000 a month, coupled with the fact he is paying 2k a month into policy, would have left them with little extra money to enjoy retirement on a monthly basis. I don't think he is familiar with the power of compounding interest. As, I showed him if he took the same $2k and invested it in stocks assuming just 4% return, he would have more money than the base guarantee death benefit, plus being in control of his money. Then I showed him how much more that was compared to the "surrender value". The difference is that was almost double! Very shocking to him... I don't think he realizes the guy is a salesmen, not a financial advisor. I think if he walked in their to the agent saying he wanted every extra penny put in that policy plus money he borrowed, the agent would have set him right up without question!

 

[FinanceDude]

That is what I would have done, and left it at that. But he is trying to leave assets for his children, and didn't think they could save as much on their own as a life insurance would give them. The full option would have dropped his pension close to $1000 a month, coupled with the fact he is paying 2k a month into policy, would have left them with little extra money to enjoy retirement on a monthly basis. I don't think he is familiar with the power of compounding interest. As, I showed him if he took the same $2k and invested it in stocks assuming just 4% return, he would have more money than the base guarantee death benefit, plus being in control of his money. Then I showed him how much more that was compared to the "surrender value". The difference is that was almost double! Very shocking to him... I don't think he realizes the guy is a salesmen, not a financial advisor. I think if he walked in their to the agent saying he wanted every extra penny put in that policy plus money he borrowed, the agent would have set him right up without question!

I guess I am not sure why he is so adamant about leaving assets to his kids, WHAT about his WIFE?

 

[Mulligan]

I guess I am not sure why he is so adamant about leaving assets to his kids, WHAT about his WIFE?

I don't really think he has given serious consideration to either one dying relatively young since both their parents are still alive. He is thinking the million dollar policy would take care of her needs, because she will still have her 2k a month COLA'd pension, also. I imagine it will suffice, though I don't know if she would know what to do with it. I am sure that insurance guy would try to convince her to buy another whole life policy with it. Those fees agents receive from that kind of policy just astounds me.. That yearly check up meeting by the agent now makes sense...he wants to make sure he keeps things on track to get that retention bonus!

 

[Mulligan]

Btw- Financedude, maybe ignorance is bliss, since the process was done....I lifted your response concerning agents fees and sent it to him. His response was only about the hockey game he was watching and I didn't even mention the game in my email...Well at least it will keep him from buying more of something he doesn't need when agent tries to sell more of the product. He mentioned something earlier about the agent was wanting him to not pay income taxes out of his pension, put it in another whole life policy, and then pay the taxes quarterly by withdrawing it back out of the policy to pay them and it will generate another X amount of whole life insurance with of course, some up front money. He said the agent was doing that himself. Well now I get it, of course he is going to make money off it. He is going to get a 60% commission and retention bonus on his own money!

 

[Original Wally]

My understanding is that in California, being a Community Properrty State, when I took my CalPERS, anything other than full spousal protection would have required her sign off. Just my understanding.