David H. Kinder, RFC®, ChFC, CLU
F.A.Q. #12 - Buy Term and Invest the Difference ALWAYS wins... (sort of)
Updated: Jan 18
Well, this headline and pic should get plenty of attention on my LinkedIn and Facebook channels! I decided to do a series of posts on the differences between these investment mantras and bring a higher level of thinking to the subject.
Why? The internet is full of "wisdom of the masses" (where the 'm' is often silent; yes, I said that). When a client wants to determine if what they did was a GOOD decision, I want to have MY VOICE out there (somewhere) to be added to the mix. One of my advantages of being an independent life insurance and annuity agent is I don't have an overbearing compliance department to scrutinize everything I write. As long as I don't put any company "under the bus" or make any outrageous claims about returns or quote rates, I'm just fine.
Let me start with the admitting that Investments will ALWAYS win... when comparing products with the same dollars to invest with the goal of building a net worth.
About 3 years ago (in 2015), I was on a closed internet discussion forum only for investment professionals. Finally, a prominent poster brought out "the big guns" and began to tell me how, well I'm well-meaning, that I'm costing my aggregate clients HUNDREDS of MILLIONS of future net worth.
And here's his argument and numbers:
OK, so here's the scenario. 35 year old male, standard health rating needs $500,000 death benefit. Should he BTID or get whole life? Lets assume he would invest the BTID funds in American Funds Balanced Fund. Let's pretend he bought the F1 shares, which are NTF funds at major custodians (basically load waived A-shares). The fund has averaged 10.9% since inception (which was 1975), and has averaged 7.22% over the last 10 years, which covers the crash of 2008. So lets just pretend he can only earn 7.2% on his money (mind you, that's less than the 3, 5, 10, or since inception numbers of this SIMPLE balanced fund, that is also too conservative given his age, but forget all of that). Alright, so he is deciding between a PENN MUTUAL Guaranteed Choice Whole Life policy at the annual premium of $5,935, or North American OR Transamerica 30 year term (both of which cost $895 per year, giving him $5,040 to invest each year, which we'll assume he invests in a Roth IRA or Roth 401K at work, making it also tax free). For WL he picked PUAs for dividends. Year 0 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $0 NON-GUARANTEED ASSUMPTION WL DB = $500,000 NON-GUARANTEED ASSUMPTION WL CSV = $0 TERM DB = $500,000 SIDE FUND = $5,402 WINNER = BTID
Year 10 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $49,250 NON-GUARANTEED ASSUMPTION WL DB = $525,076 NON-GUARANTEED ASSUMPTION WL CSV = $57,834 TERM DB = $500,000 SIDE FUND = $70,296 WINNER = BTID
Year 20 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $120,590 NON-GUARANTEED ASSUMPTION WL DB = $619,733 NON-GUARANTEED ASSUMPTION WL CSV = $171,713 TERM DB = $500,000 SIDE FUND = $211,186 WINNER = BTID
Year 30 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $207,125 NON-GUARANTEED ASSUMPTION WL DB = $619,733 NON-GUARANTEED ASSUMPTION WL CSV = $367,295 TERM DB = $500,000 SIDE FUND = $493,561 WINNER = BTID Year 40 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $300,350 NON-GUARANTEED ASSUMPTION WL DB = $1,045,993 NON-GUARANTEED ASSUMPTION WL CSV = $681,006 TERM DB = $0
SIDE FUND = $1,059,508 WINNER = BTID
Year 50 GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $384,670 NON-GUARANTEED ASSUMPTION WL DB = $1,427,213 NON-GUARANTEED ASSUMPTION WL CSV = $1,149,840 TERM DB = $0 SIDE FUND = $2,193,167 WINNER = BTID
Year 65 (age 100) GUARANTEED ASSUMPTION WL DB = $500,000 GUARANTEED ASSUMPTION WL CSV = $462,100 NON-GUARANTEED ASSUMPTION WL DB = $2,285,093 NON-GUARANTEED ASSUMPTION WL CSV = $1,427,213 TERM DB = $0 SIDE FUND = $6,353,313 WINNER = BTID So there are the REAL WORLD NUMBERS, using real products, apples to apples to compare. You can see that for ALL 30 YEARS while the term policy is in effect, BTID wins by a widening margin as you approach the 30 year mark. At the 40 year mark (when this person still isn't even to life expectancy), the DEATH BENEFIT numbers are a little closer than at any point in time because the BTID person only has the side fund (no term anymore), but the cash value numbers aren't even close. And the BTID person doesn't even need to take a "tax free loan in retirement."They just take their money because it's just that...their money. And from there, it just worse and worse, until it gets really ugly. It doesn't even matter if you use the Non-guaranteed assumptions, it's still awful. It's reasonable to expect to live to age 85. And if you did, and you made the mistake of choosing whole life instead of BTID, you would have one million less dollars in "cash value" and $750,000 less in "death benefit" by choosing whole life. And god forbid you live to age 100, where you actually stop paying for your pig of a whole life policy (and stop "investing the difference" in your BTID plan), you would have FIVE MILLION DOLLARS LESS IN "CASH VALUE" and FOUR MILLION DOLLARS LESS IN "DEATH BENEFIT" because of that choice. Is that enough of a "real world" illustration using real products? Is that enough "facts and figures" to debunk the whole life myth? I used a SIMPLE balanced allocation fund that includes 12b-1 fees that any idiot could buy. The allocation fund was more conservative than it should be for 35+ years of the example. I choose the 10 year return number for the fund, and then rounded it down, even though the 3, 5, and inception numbers are FAR more favorable. I used a whole life policy from a respected mutual insurer. I used a term policy offered at the same price by two different insurers. I used PUAs (Note: dividend option, not cash dump-ins) AND obliged the "non-guaranteed assumptions" in the illustration (which rarely work out the way they are shown). The results are this... If the person dies the day he signs up for Medicare, his family would get 50% more "death benefit" using BTID, amounting to over $300,000. If the person lives to age 85, his heirs would get $750,000 LESS if he chooses whole life, and that is their BEST CASE (i.e. non-guaranteed scenario). And if the person lives to illustrated age 100, his family will get a legacy that is $4,000,000...FOUR MILLION DOLLARS LESS than if he would have simply bought a term policy, from any number of carriers, and invested the difference in a stupidly simple balanced fund in his Roth IRA. FOUR MILLION DOLLARS LESS in net worth DHK... THAT is why we think your idea is bull****. It's not a personal judgement on you (you seem like a nice guy that wants to do what is best for people). Your math skills are just bad. PS: And at ANY point in time, this person can access his SUPERIOR cash value in his Roth IRA side fund, with the click of a button. No tax-free loan. No payback. No interest. No hoops. It's simply his money...and he doesn't need to die to get it.
Pretty convincing, isn't it? Pretty brutal against me too, isn't it? (I copied everything word for word, and only made a minor insert regarding Paid Up Additions (PUA riders vs dividend options) and bleeped out his one curse word.) Here's the problem: he's comparing PRODUCTS and not investments vs insurance planning! Insurance planning has FAR more factored into this.
How can I tell? 1. Look at Year 0. He shows there's $0 cash values for earning anything. That means he didn't properly structure the policy from the beginning! No wonder it's not performing well. "Investment grade" life insurance policies are maximum funded up to the MEC guidelines without making the plan a taxable account. They have FAR higher cash values when policies are structured this way! The death benefit should've been MINIMIZED as much as possible and the difference bought with term life insurance. I just did a quick calculation for a MINIMUM funded whole life policy for $500,000 for a 35 year old male, standard underwriting: The premium (for 2018) would be $7,080 - about $1,100 MORE than the earlier premium quoted of $5,935.
A properly max-funded $500,000 WL policy for age 35, standard, non-smoking would be $17,900 to secure $500,389.90 of GUARANTEED permanent life insurance death benefit and GUARANTEED cash values of $10,904 to earn compound interest!
You reduce the death benefit to $166,790 (instead of $500,000) for the same $5,935 annual premium to over-fund the policy up to the MEC guidelines. Doing it this way would've had a guaranteed $3,559 of 1st year cash values... not zero as previously posted.
The REAL question will be: Why would anyone voluntarily CHOOSE to "over-pay" for their life insurance coverage? We'll cover this in future blog posts!
How about non-guaranteed? The numbers were slightly higher at $11,053 of cash values ($100 of difference) and $501,093 of non-guaranteed death benefit (about $700 difference) due to dividend performance.
Those numbers are FAR more attractive... IF we can "find the money" to make it work AND you understand WHY one would WANT to do it.
Now, three (3) years have passed since this interaction... but rates didn't change THAT much. He simply uses a MINIMUM-FUNDED policy rather than the properly funded and structured MAXIMUM-FUNDED to the MEC guidelines policy.
2. The net worth argument commonly doesn't include the future taxation on whatever is being invested into. The poster above DID by putting the money into a Roth IRA, so there's no large tax burden on the horizon, unlike with a 401(k) or traditional IRA plan. But not all accounts work the same way. 3. Comparing a "safe money" equivalent to a market-risk equivalent using HISTORICAL returns really is also an "apples to oranges" comparison. That's an economic conversation for another time, but even Fixed Equity Indexed Universal Life Insurance shouldn't be compared on an asset-level to equities. However, since the comparison is make so often anyway, we'll include it. Keep in mind that I don't believe the same bull markets will be returning any time soon. I believe that the markets will be doing a lot of "yo-yoing" over time as people retire and begin taking distributions rather than contributions to their stock market accounts. Let me ask you a question: Which account has more money? $1,000,000 in a Roth IRA?
$1,000,000 in a 401(k) plan? The answer is the Roth IRA, because it's tax-free! How much taxes are in the 401(k) plan? It's unknown because we don't know how much will be pulled out at any given year, nor will we know what the future tax calculations may be. But NET WORTH planning... doesn't take that into account! It shows up on your balance sheet for the FULL amount in the account, but not necessarily the future taxes that are owed! Remember this: IRS Regulated 401(k) and Traditional IRA plans POSTPONE the taxes... and the tax calculations until accessed in retirement. You might not be paying much in taxes now... but even in the same bracket, you'll pay more in net taxes. How? Families most often have 3 common tax deductions: 1) Child tax credit (increased to $2,000 per child as of 2018 tax year) 2) Mortgage Interest Tax Deduction (maximizes in the early years of a mortgage) 3) IRS Regulated Retirement Plan contributions But in retirement: 1) Your children are grown (but they'll still ask for money) 2) Your home may be nearly paid off and not be paying much in mortgage interest - assuming you didn't refinance. 3) You're taking money OUT of your IRS Regulated Retirement Plan, rather than putting the money in. So even in the same tax bracket... you'll probably pay more in net taxes. Would you prefer to manage your taxes NOW? Or wait until your the majority of your retirement resources may be "held captive" by the tax system? However, if you want to get an idea of where taxes might be headed... you'll want to check out this documentary preview:
Most common Whole Life insurance rebuttals are rather weak. They often say "Who ACTUALLY invests the difference?" That's a dumb rebuttal and that's because it takes the same financial discipline and behavior to save in an investment account as it does in a permanent life insurance policy. (Whether the money STAYS there or not long term... is another story and a good discussion for a future blog post.) The phrase is actually INCOMPLETE! The full phrase is "Buy term and invest the difference... with me." It's a REPLACEMENT strategy, NOT a planning strategy. It also assumes that the person was QUOTED whole life insurance, can afford it, and actually decided to invest in securities instead. (Keep in mind that in the 60's and 70's... most captive career agents were selling affordable whole life, rather than doing the full job of insuring for human life value at proper levels.) Over the next few weeks, I'll be writing a far more comprehensive analysis of articles examining the "Buy term and invest the difference" with proper cash value life insurance planning. I want MY voice out there to combat all the negative stereotypes and assumptions. Just keep this in mind: This is about proper PLANNING using permanent cash value life insurance as a foundational product for economic security... NOT a product comparison. Here's a sneak preview of how proper life insurance planning works: Having more money saved, instead of wasting it needlessly and unnecessarily... may help to have more money earning uninterrupted compound interest:
Which earns more? (Rates are for illustrative purposes only) - $5,000 a year earning 12%?
- $15,000 a year earning 4%?
They earn exactly the same! $600! But this isn't an "apples to apples" comparison. This is an investing vs life insurance planning comparison. If you have MORE money in the life insurance policy, it EQUALS OUT the difference (and with no market volatility I might add).
Which of those two plans would have inherently more investment or market risk?
Which of those two plans has more liquidity with the LEAST consequences? (You may be surprised in a later post.)
THAT is the difference between investing and proper planning using life insurance with a properly structured policy.
So, if you start wondering "should I buy term and invest the difference" or "buy permanent life insurance?"... those are actually the improper questions to ask. Ask yourself: Should I just invest what I think I have? Or should I do life insurance planning with a skilled life insurance agent who can help me do a better job of spending, saving, investing, insuring, and planning?
Or maybe... we all got the saying wrong? Maybe it was really meant to be "buy term and sue for the difference"? https://www.reuters.com/article/us-citigroup-williams-lawsuit/citigroup-beats-800-million-appeal-by-onetime-billionaire-idUSKCN10G1QW