In a post from his blog, Dave Ramsey states, “Cash value life insurance is one of the worst financial products available.” This is simply wrong. It is wrong because Dave Ramsey either doesn’t understand what a good whole life insurance policy looks like or else he is ignorant. Of course, he doesn’t show any examples from real illustrations when he says, “Your insurance person will show you wonderful projections, but none of these policies perform as projected.”
He goes on to give his reasons why whole life insurance is such a bad investment. He narrows these to:
Cash value versus term life insurance costs.
Cash value policy rips you off and you really don’t get any death benefits later in life.
His arguments are off base in both the math as well as the concept. First, I’ll note a couple of things about Dave Ramsey generally, then a few things about why I think you should consider whole life insurance, then I’ll get into Ramsey’s two points in detail and show you an actual whole life insurance illustration today.
As far as Mr. Ramsey is concerned, I have nothing against him. I have often enjoyed his radio program and have read some of his books. I enjoy his down home style and his straightforward approach to telling people to save and invest and not spend. I also admire his approach to giving back. You may have heard his famous line that you “live like no one else, so later you can give like no one else.” I believe in Ramsey’s admonitions to both live within your means as well as to give back generously when you can.
Whole life insurance is not what Ramsey says. Whole life insurance is not necessarily for everyone, but it has its benefits. However, there are huge differences between policies and there are only a handful of whole life insurance companies that I would recommend. It is also best for those in higher tax brackets. As a savings plan, it is best for those who use it as part of their conservative portfolio, not as a comparison to the stock market. However, if you are comparing tax advantaged whole life insurance to a non-tax advantaged stock market investment, there are still some benefits to the whole life insurance approach.
What does it take to have a good whole life policy? I suggest three things.
Buy only from a mutually owned whole life insurance company that pays dividends and compare between at least two or three of the major companies.
Always maximize paid up additions or additional payments to your policy. Insurers have different names for this. Many agents don’t even know this option exists. If your agent doesn’t, then run to an agent who does.
Buy a whole life policy because the numbers make sense, not because it’s a whole life policy and don’t buy it for the insurance.
So, why is Dave Ramsey wrong about whole life insurance?
First, let’s look at his cash comparison. There is no doubt that a term policy is cheaper than a whole life policy. No one has ever debated that. What is the truth about a term life policy?
A term life policy will almost never be used. A 30-year-old man as in Ramsey’s example, will almost certainly not die before age 50 (using the 20 year level term policy example from Ramsey). The odds are less than 2% probability of that man dying. That’s why the premium is so low. Then how much more insurance does that man need when he reaches age 50? Let’s say that he needs insurance until age 65 when he plans to retire. This would cost over double the original policy, if the man is still in excellent health. Standard rates would be approximately $10 a month more than that. Still not bad, but what if the man has gained excessive weight or developed a heart condition or some other medical issue that disqualifies him from life insurance completely? What then?
The other point is that $125,000 of life insurance may be enough when the man is 30 years old, but what about when he is 40, 50, or even 60 years old? Most people will need between $250,000 and as much as $500,000.
The other problem with Ramsey’s analysis is that any good whole life agent will tell you that the value of a whole life policy is over time. Ramsey’s analysis is all about what happens in the first three years. Yes, he is absolutely right that the first three years a permanent life policy will not have a positive return, but how many 30-year-old men are worried about a three-year return? No whole life insurance agent with any credibility would sell a whole life insurance policy to a person with a three-year time horizon.
Ramsey further clouds things by comparing a whole life policy to stock mutual funds without considering taxes or the possibility that those same stock funds in any given three-year period could have lost money. In addition, his use of 12% as a return rate is simply malpractice. From March of 2007 to March of 2010, the S&P 500 index lost almost 19%. A whole life policy over the same period earning about 2.6% would look pretty good. The market is not guaranteed, nor is 12% a reasonable long term expectation.
Here is my personal example. Back in about 2000, I had my plan set so that I could retire at 55 using a strategy very similar to Dave Ramsey’s investment advice. Of course, what has happened over the past seventeen years has not been a 12% or even a 9% gain in the stock market, and I sit having to work and invest for another five to ten years depending on how things go.
As I said above, it's irresponsible to argue that a stock market investment will return 12% over time. Some have even suggested that the market will be pressed to return a 5% average over the next five years. Investing and insurance are both all about risk and how much you are willing to take in order to make a given return. One analysis available on the internet by an engineering student suggested that a good whole life policy was about the same as investing in a corporate bond fund, which certainly isn’t a waste of money.
Another personal example is my college savings experience. I began saving for college like a good parent when my first child was about five years old. From that time until the time she started college, the S&P 500 gained about 3.4% per year. I would have been much better invested in a whole life insurance policy. Mr. Ramsey compares apples to oranges and comes out with the conclusion that he wants rather than giving you the real story and the risks behind his approach.
Ramsey then says that you lose the insurance benefit over time and so this is a rip off. He says, “You would be better off to get the $7 term policy and put the extra $93 in a cookie jar!” I believe that Ramsey knows this is hyperbole, but that’s the way he talks because he isn’t an investment advisor. He’s an entertainer. He may be right that someone who follows his advice won’t need life insurance by age 57, but he can't guarantee that. He also leaves his 30-year-old man with a seven-year gap to fill. I’ll give Ramsey enough credit to say that he believes that the premium cost of that gap insurance will be inexpensive given the level of savings the person will have attained. However, he doesn’t explain what happens during those seven years if the client cannot obtain a new policy at all. That’s a big assumption, but still misunderstands the point of whole life insurance.
First, the policy does gain value, so it’s far better to put your money into a whole life insurance policy than to put it under a rock. His claim is again simply silly and irresponsible. The decision for the consumer is whether the return and advantages of a whole life policy are sufficient compared to other uses of that same money. I don’t know any insurance agent telling people that they should never invest money in mutual funds or to put all their money into a life insurance policy. This is Ramsey’s other mistake, he sets up a false choice that it’s either one or the other.
Second, the insurance portion of the policy does disappear and the policy becomes essentially a savings account. Why? Because that’s the way the policy is designed from an actuarial perspective. A whole life insurance policy sets a client up with a means of saving money at a reasonable tax free rate of return that adds a death benefit component that exists for most a person’s life.
The other thing that Ramsey doesn't tell his readers is that the death benefit does not completely disappear until age 100 to 120 depending on the policy, so for the clear majority of people, there will be a death benefit in addition to the cash accumulation.
Other advantages of a good whole life insurance policy include policy Loans with dividends continuing at normal rates as if the money is still in the policy.
Imagine a case in which you could put $10,000 in a stock mutual fund, borrow $9,000, pay it back three years later at 5% and have the stock mutual fund still be worth what it would have been if the money had been in the account the whole time. So, let’s use something that approximates Ramsey’s case. To make the math easy, let’s say that if you had left the money in the account for the three years it would have earned $4,000. Wouldn’t it be nice to have the use of $9,000 and still have $14,000 when you put it back? However, that world doesn't exist and you would have $10,400, not $14,000 plus you would have paid 5% interest on the loan. A big difference.
Let’s say your whole life policy earned 10% over the past three years. Let’s also say that you paid interest, but that interest goes to your account, so the net effect is that you have $11,000. So, you end up ahead of the game. compared to a stock investment in the mutual fund. What if you were able to do this several times over a twenty to thirty year time horizon?
Of course, I can’t guarantee that your situation will be exactly that, but what if you could take out that money as often as you want because it’s your money and you can use it for anything you want, such as business activity or another investment opportunity?
Let’s also remember that the life insurance portion of your whole life policy stays in place. You haven’t lost it. So, even in year 20 of the policy, you can loan yourself 90% of the cash value and not lose the life insurance portion.
A permanent life insurance policy is also tax advantaged because it’s not an investment. It’s life insurance. This is especially important for those in very high income categories or those who might have to pay inheritance taxes.
I realize that most people aren’t in a situation where they plan to pay inheritance taxes, but what if the tax code changes? Is congress more likely to increase or decrease estate taxes and the exclusion over time? That’s anyone’s guess.
I recently presented the Infinite Banking/Bank on Yourself/Be Your Own Banker concept to a friend of mine who is an investment banker and one of the smartest people I know. His take on using whole life insurance, especially purchased on your children (because the cash grows faster and the life insurance benefit is greater) is one of the only ways for the “average Joe” to create a legacy of wealth.
Because a parent can buy large amounts of whole life insurance as a savings plan for his or her children and retain ownership of the cash value and be the beneficiary of the policy, it puts the owner in a good position. If the child dies young (not a good probability or desired outcome, but possible), the parent receives the cash benefit and can either use it for all sorts of expenses or use it to assist expenses for grandchildren. If the child doesn’t die young (the more likely case), the parent has a better return over a longer horizon and can pass the policy to the child without the policy going through probate.
While I am not a proponent that this strategy is for everyone, I am convinced that it is effective for far more people than currently consider it. The challenge is that you don’t know until you see actual illustrations for your case and then examine them considering all of the risk and tax factors out there. Dave Ramsey’s analysis is overly simplistic and in some ways simply wrong. Unlike Ramsey, I'm willing to provide evidence of my claims. See the illustration attached to view a real example of a policy purchased on behalf of an 18-year-old male for yourself.
There may be people for whole this strategy doesn’t work, but there are plenty of testimonials from wise individuals who have used this strategy of purchasing cash value life insurance in order to produce wealth for themselves as well as create a legacy for their children and grand children.
You can see that in year 3 of the first screen shot that the cash value, even in the non-guaranteed illustration is below what was put into the policy, but Ramsey's claim that none of it exists is simply wrong. You can see that the break even period for this policy is about eleven years. This is not a short term savings plan.
Note also that the life insurance value grows over time in this illustration. While the life insurance does disappear over time due to the actuarial calculations embedded in the policy, the life insurance value increases in the first ten years of the policy.
Near the end of the policy, you can see that by age 98, the consumer has put $51,200 into the policy over time and the cash value is 415,657 in the non-guaranteed section of the policy. There is only an additional (approximately) $38,000 in life insurance, but there still is that benefit to the insureds family. Of course, given current statistics, the odds of living to age 98 is very small.
One other claim by Ramsey is that these non-guaranteed dividends never happen. Of course, he gives no evidence, so it's difficult to say much other than he is just plain wrong. Good companies almost always achieve those dividend rates or even higher. The key factor is usually what are interest rates at the time the illustration is given. In the current interest rate environment, the dividends projected might actually be lower than those the client will experience because as interest rates and other returns improve, the dividends of a good insurance company will improve.
The facts are that a good whole life insurance policy properly designed can be a more than reasonable product to assist a client in achieving a variety of financial goals. It's a strategy that is worth considering for many people.
NOTE: For a further look at Ramsey and his saving advice versus his investing advice see the article from Forbes "Save Like Dave Ramsey, Just Don't Invest Like Him."