How Whole Life Insurance Can Protect Your Money, Your Family, and Your Future
Whole life insurance doesn't only protect your family after you're gone. It’s also a powerful financial tool that can enrich your life in numerous ways while you're still alive to enjoy it.
David Lewis is the founder and owner of Monegenix, an insurance agency based in Durham, North Carolina, as well as its lead insurance adviser and a registered financial consultant. I’ve been a client of David’s for two years, and, in that time, he’s shown me some incredible things about what whole life insurance can do for my financial plans. I recently had an enlightening conversation with him about whole life insurance—specifically, how you can use it to improve your life in ways many people don’t know about.
Tim White: How did you get into financial planning services, and what led you to specialize in life insurance?
David Lewis: Long story short, I started working in the industry because I drifted between many different careers, and this was the first one that really caught and held my attention. I read in a textbook how insurance is all about protecting the things that people value most. That really struck a chord with me, as did the prospect of being able to protect people from losing their savings to market crashes and government-induced crises.
One of my first bosses in the insurance industry told me that he invested some of his own money in the company 401(k) plan, but most of it went into our whole life insurance products. He was investing $60,000 per year in premiums because he knew exactly where his money was, knew that it was growing safely, and slept well at night as a result.
That’s when it really hit me. This guy who had been in the business for thirty years, a competent and successful investment adviser, chose to put the bulk of his own money into whole life insurance. That’s the moment when I decided I needed to investigate it more deeply.
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White: What, exactly, is whole life insurance? In what ways can it make our lives better?
Lewis: The inner workings of whole life insurance are complicated, but the basic premise is simple: When you buy a policy, the insurer takes your premium dollars and invests them in a number of places—in the stock market and in other types of investments, but mostly in investment-grade bonds (those that are believed to have a lower risk of default and receive higher ratings from credit rating agencies).1 As with other types of life insurance, a whole life policy pays designated beneficiaries when the policyholder dies. But it also provides loads of other benefits.
As you make premium payments, you build equity in your policy—an asset with cash value—just as you do in your home by paying your mortgage. The insurance company is able to generate enough return on those investments to make good on its future promises to policyholders, which are the contractual guarantees of the policy. Any gains over and above the guarantees are paid to policyholders as a dividend, which can be reinvested in the policy to further grow the death benefit and cash values. When you hold that policy for many years, the power of compounding interest turns it into a substantial source of income that you can draw from in retirement or use to finance major purchases at very low interest rates. Some people use their whole life policies to put their kids through college and even make a profit by doing so (more on that later).
The essence of whole life insurance boils down to the idea of human life value. Dr. Solomon Huebner coined the term and was the first one to talk explicitly about this idea, at the Wharton School back in the early 1900s. I’m paraphrasing here, but he defined it as the total monetary worth of an individual’s character, knowledge, initiative, and experience. He was the first professor to link life insurance to productivity in explicit terms. He pointed out that the total amount of money you’re likely to earn over your lifetime can be calculated and that this amount can be insured. Life insurance, he reasoned, shouldn’t only pay your beneficiaries if you die—it should protect you against the loss of your earning potential for as long as you remain productive.
I think whole life insurance has two primary benefits over other kinds of investments. First, it has the unique ability to take uncertainty about your future income and savings and replace it with a known financial outcome, regardless of whether you live or die. No matter what, you’ll have a certain guaranteed level of future income from the policy, and your savings are immune to almost all of the risks that other types of investments are exposed to. That may sound like a simple thing, but it’s an incredible feat that only the life insurance industry can pull off in today’s economy. Some policies also allow you to spend your death benefit while you’re alive if you suffer from a terminal or chronic illness.
Whole life insurance isn’t subject to as many burdensome regulations as traditional retirement and investment accounts are, which is largely why it’s able to do so much that they can’t do. For example, whole life policy earnings usually are exempt from taxation. You’re not taking on the additional expenses that come with many other types of assets, such as broker fees or early withdrawal penalties. And, at any given time, you know the bare minimum amount of money you can draw from your insurance policy in any given year, which means you can make a financial plan around that figure. Dividends then are added to that minimum amount, and although they’re never guaranteed, historically most whole life companies have exceeded their minimum projections almost every year, so dividends generally are very stable and reliable.
Another benefit of whole life insurance is that you can borrow money against the value of your policy at unusually low interest rates. The insurance companies I work with offer what are called secured, non-amortizing loans. This is a fancy way of saying that the insurer doesn’t require you to repay the loan on a set schedule, so you’re largely free to pay what you can, when you can. Interest is charged only on the outstanding principal balance, and a well-built plan can give you the option to repay some or all of the principal before paying any interest during the first year. This is the complete opposite of how a conventional loan works and is probably the lowest-risk, cheapest loan you’ll ever find in any marketplace.
Plus, when borrowing against your policy, its cash value continues to grow, so loans don’t compromise your long-term financial goals. That’s how parents pay for their kid’s college tuition, then use the same whole life policy to retire comfortably ten or twenty years later. They’re not withdrawing money from their policies—the insurance company is giving them a low-cost loan and holding part of the policy as collateral. Even if the parents take five or ten years to fully repay the loan, the policy itself still has been earning interest the whole time. No retirement account I’ve ever heard of enables you to do anything of the sort.
A lot of people have asked me if they could do the same thing using a 401(k) plan loan, but those work very differently. In that case, you would be withdrawing funds from the account, which halts the growth on that savings. The loan terms tend to be strict. Principal and interest are calculated like a conventional loan, and you’re often forced to pay steep fees or penalties if you deviate from the repayment plan. Retirement plan loans also have a number of other quirks that can affect your long-term finances negatively. That’s why most financial planners advise against such loans. Many of those advisers simply don’t know that whole life insurance can outperform retirement plans in terms of plan loans—and in many other ways, too.
I have a client in his sixties who has lost the bulk of his life savings three times over through various market crashes. This person had never heard of whole life insurance before coming to me, and to my mind, that’s unbelievable. The loss of decades worth of income and savings is exactly what whole life insurance is designed to prevent—more people should know about all of the different ways it can protect their savings, enhance their lives, and provide peace of mind.
White: How do insurers and independent advisers make money doing this?
Lewis: When the insurer’s investments make money, they set aside enough to pay the guarantees of the policy and use any extra money to pay their own operating expenses. Whatever money is left is returned to policyholders as a dividend. In a mutual company, the policyholders are the owners of the company, so all of that money belongs to them. The company’s regular employees get paid a salary, and independent agents and brokers generally get paid a commission on the sale of each policy.
For life insurance policies, commissions are usually “heaped,” meaning the commission payout is high the first year, then dramatically reduced in subsequent years until it eventually disappears. Critics are quick to claim that commissioned products incentivize sales over service. It’s true that some agents try this route. However, being reckless with policy sales creates enormous problems for an agent and can quickly kill his reputation. If clients cancel their policies in the first twelve to twenty-four months, insurers take back all of the commissions previously paid to the agent. Insurers also check an agent’s cancellation record and may refuse to work with agents who frequently sell policies that get canceled. Selling purely for the sake of commissions—without thinking about what’s best for the client—is a huge risk and a bad idea for the agent.
As an independent agent, I am paid either a commission or a combination of a commission and an asset-based fee. I take a significantly smaller commission than many agents do, meaning that more of my clients’ money goes into the policy, which allows their cash values to build up rapidly. A lot of agents don’t do that because it cuts into their pay. For me, it’s proven to be a great business practice. Many of my clients end up buying multiple policies from me because they quickly see the value in what they’re receiving and want more of it.
When I sell a policy with asset-based fees, I get paid by the insurance companies according to the policy’s performance. If the client does well, I do well. It’s a brilliant strategy because insurers and advisers both are incentivized to design and sell the best policies they can. I wish more insurers and agents would adopt that model, because if an adviser’s policies do well over time, he’s rewarded accordingly, and if they perform poorly, his paycheck is small or nonexistent. So the incentives of all parties are aligned. It’s a win-win relationship all around.
White: What are some of the other pros and cons of whole life insurance compared to more traditional investments, such as 401(k)s, IRAs, or brokerage accounts?
Lewis: Life insurance and retirement plans perform two totally different functions, at least in terms of how they work today. Retirement plans are subject to thousands of pages of regulations, and they severely restrict how and when you can access your own money. Many people can and do realize decent gains from them, but the projected returns often are overstated, and many people end up losing money in the long run. Broadly speaking, these plans are unstable, unpredictable, and inflexible.
Whole life insurance, on the other hand, is a private contract with a life insurance company designed to shift financial and mortality risk away from you and onto them and to guarantee you specific outcomes. Its guaranteed value is not dependent on stock markets. However, when the insurer’s stock and other investments perform well, policyholders receive larger dividend payments, which can add a significant amount to the guaranteed value of their policies.
Perhaps the most significant benefit of whole life insurance is the incredible stability and reliability of the product and the companies backing it. Generally speaking, you’d choose whole life insurance over traditional retirement accounts when you want a guarantee about your future savings—either savings to pass on after you die, the amount of money you can save (and spend) before then, or both. Almost every life insurance company in existence today is fully solvent, so it’s extremely unlikely that they’d ever default on their obligations.
Whole life insurance is undeniably safer than traditional retirement accounts, and I’d argue that it’s even safer than keeping your money in a savings account or bank CD (certificate of deposit). In fact, more and more banks nowadays are putting a significant percentage of their capital into life insurance—that’s how safe it is. In the 1980s, banks owned virtually no life insurance, but today, something like 70 percent of banks own either whole life or universal life insurance on their employees. Banks also use life insurance earnings to help offset the cost of employee benefit plans, and the big banks buy billions of dollars worth. Banks tend to be very skittish investors, so the fact that they lean so heavily on life insurance says a lot about its stability.
That said, whole life insurance has a few drawbacks. First of all, it has a long required holding time, so a person whose goal is to make money quickly likely won’t benefit from it. You really need to be willing and able to hold onto your whole life policy for at least ten years, with twenty to thirty years (or longer) being ideal.
Other perceived cons of whole life insurance include higher premiums compared to term life insurance and lower returns on its cash surrender value (the lump-sum payout you can expect if you cancel and relinquish your policy) compared to, say, mutual funds. A lot of critics are very vocal about what they see as low returns on whole life insurance.
But here’s the thing: The Federal Trade Commission did a cost analysis study a while back and found that most dividend-paying whole life policies have a tax-free annual return of between 4 and 5 percent after at least ten years.2 Internal studies done at some of the major mutual life insurers (those owned by their policyholders) confirmed those findings. If you’re comparing this to hypothetical 12 percent returns in the significantly more volatile stock market, then whole life looks paltry—but who gets 12 percent in the stock market even somewhat consistently, much less every year, especially after taxes? Almost nobody.
When I say whole life insurance is a good product, I don’t mean that literally every policy in the marketplace is good. It’s like anything else you buy. Most of the contracts you’ll come across are mediocre, especially if you’re shopping “off-the-shelf” policies. Most people need to have a skilled insurance agent comb the marketplace for them, find a policy to serve as a starting point, and then work with the insurance company to customize the policy to suit their specific needs. If you do that, you can end up with a product that vastly outperforms traditional retirement accounts in a great many respects.
White: How does whole life insurance compare to other investments in terms of its track record and the financial strength of the companies that sell it?
Lewis: For the most part, whole life insurance is sold by mutual life insurance companies that have been in existence for more than 150 years. All of them have paid dividends to their policyholders every year since their inception or shortly thereafter.
Think about that for a moment. The first dividends these companies ever paid to their policyholders were paid before the modern U.S. dollar existed. These companies remained profitable and paid dividends through the Civil War, the Great Depression, both World Wars, 9/11, and the 2008 financial crisis. They never missed a beat. They paid all death claims and still remained profitable. Many of them even managed to grow their profits during those times. Most of them also buy insurance from companies that insure insurance companies, creating a cooperative net that makes it extremely unlikely for any one of them to fail.
These companies are from a different era, transported through time by brilliant businessmen who employed incredibly savvy business practices. In a certain sense, they aren’t just companies; they’re a commercial representation of immortality. It is almost unfathomable how financially strong these companies are, and it’s not by accident. They were built to last forever.
White: Most people tend to think of life insurance as a product that’s only relevant (or at least most relevant) to older people. Why should young people consider it?
Lewis: Because young people have a lot to lose. The primary purpose of whole life insurance is to shift financial risks (such as some of those associated with the stock market or with starting a new business) away from the individual and onto the life insurance company. By using whole life insurance, a young person can mitigate those risks and even afford to take more and bigger risks elsewhere in his life. I think the few people who know about life insurance’s potential as an investment asset tend to think of it as a product for very risk-averse people, but it actually opens the door for more risk-taking, especially if you start a policy when you’re young, because it gives you a safety net that can save you from total ruin.
For example, let’s say you’re in your early twenties, making $24,000 or so per year, and you want to start a business. If you set up a whole life policy beforehand—and if you’re sure that you’ll have at least enough money to pay the premiums for the first few years—then you needn’t worry about being ruined if your first business fails. If you give the policy a few years to grow, you could even take out a loan against it to get some start-up money for the business and not have to worry about paying it back on a set schedule.
For older people in their thirties or forties who are ready to start diversifying their portfolios and saving more of their income, knowing that effectively they have an invulnerable nest egg in life insurance makes the prospect of risking some money on bigger potential returns in the stock market a lot less scary.
The cash values also can act as a hedge against unemployment. Provided the policy has had some time to grow, the premiums can be lowered and, in some cases, stopped entirely while you get back on your feet. During this time, you also can withdraw money from the policy or borrow against it to stay afloat.
Young people have their whole lives ahead of them. That’s a lot of potential money to be made, which means there’s a lot at stake and a lot to protect. With life insurance serving as the backbone of your portfolio, you’re free to take risks elsewhere—risks that can enrich your life even further if you win but won’t totally wipe you out if you lose.
White: Where can readers go to learn more about life insurance and the many different ways to take advantage of it?
Lewis: Dr. Solomon Huebner’s original text, The Economics of Life Insurance, is something everyone who is interested in learning more about the tremendous value of life insurance should read, but it’s out of print and hard to find. The Wikipedia page on whole life insurance is a great starting point for basic information. Bobby Samuelson is definitely one to follow. He’s an independent consultant who advises life insurers on product design and a former VP of product development at MetLife. A lot of his content is paywalled, but he has a few good interviews on YouTube.
Other excellent resources include Life Happens and the National Association of Insurance Commissioners insurance guide. Also, Peter Neuwith is a well-known actuary who has some solid intro-level life insurance content on his blog.
Finally, my own life insurance buyer’s guide contains in-depth information on the pricing of term, whole life, and universal life insurance, dividend calculations for whole life, underwriting (i.e., risk assessment), what to look for in an insurance company, and how to properly name beneficiaries for your policy. It also contains practical recommendations on what kinds of insurance to buy, when, and why.
In addition to the guide, I publish client case studies demonstrating how these policies are used in real-world applications and the types of financial problems they can solve.
White: Awesome! Thanks so much for your time, David. It’s been great chatting with you.
Lewis: My pleasure!