The Surprising Math on Whole Life Insurance Returns

The math behind whole life insurance rate of return. We hear it constantly from the status quo financial planners out there and the quote unquote financial entertainers that whole life insurance is a horrible investment and it gets a terrible rate of return. And 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. That's just the way it is. 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. And another book to check out if you really want to nerd out and get into some great information about whole life insurance is Solomon Huebner's The Economics of Life Insurance. It's like a hundred year old book that pairs some of the timeless concepts of things like capitalization, depreciation, and liquidation to your human life value, which is, of course, the essence of life insurance. And I think this alone proves that life insurance and whole life insurance is really more than just a rate of return. It's a lot more. It allows us to take organizational and managerial principles that are universally accepted in corporate finance and apply those principles to our personal lives, like literally our lives. But now getting back to the rate of return of whole life insurance, what about that? Is it actually true that it gets a terrible rate of return? Here's my final book recommendation for this particular episode. There's a book out there called Confessions of a CPA, The Capital Equivalent Value of Life Insurance. The author of this book, Brian Bloom, implores the reader to take a look at whole life insurance and when you're comparing it to other assets and other asset classes, you really have to run a capital equivalent calculation and take into account some of the other costs that are included with other types of assets, like taxes and fees. And when you calculate things like that and when you take that into account, you find that whole life insurance has a much higher value than people are giving it just off the top of their head. Number one, the cash value of life insurance is not a rate of return or an interest rate. It's an actuarial calculation. Now you can back into an interest rate or a rate of return, but that's not actually how the growth is derived. The growth comes from the actuarial math and that's where some of the guarantees come from with a whole life insurance policy. Number two, one of the big things we have to look at getting back to capital equivalent cost or capital equivalent value is the fact that whole life insurance cash value is net of all costs, fees and commissions. And so when you're comparing it to other assets, you have to find out what those costs, fees and commissions and taxes are going to be for the other type of asset. And that's what we're going to do today. We're going to fire up the Truth Concepts calculator. This whole talk comes from Todd Langford, the founder of the Truth Concepts software. We're going to fire up the calculator and we're going to take a look at the capital equivalent value of the whole life insurance cash value. So buckle up and make sure you check out the video version of this. If you're listening in your car, make sure when you get home, head over to the website and you can check out the video version of this where you can follow along with me and look at the calculator. Okay, so here we have a 35 year old and we're going to illustrate this for 35 years when they turn 70. So we're kind of looking at the accumulation phase. We're not getting into the distribution phase just yet, but we're just going to look and see during the accumulation phases, this whole life insurance doesn't really get a terrible return. And so right on the face, $24,000 a year is going into this whole life insurance policy. And we can see right on its face, it's earning an internal rate of return calculated at 35 years of 4.6%. And if you're not familiar with what internal rate of return means, internal rate of return, when we calculate it at year 35, it's as if we had earned 4.6% every single year. And the reason I'm pointing this out is because we know that we have some negative years in the early years of the policy right here. But when you get out to year 35, you can see this annual return starts jumping up into the 5% range. And by the time you get to year 35, it's the equivalent of having earned 4.6% every single year from day one. So just an important little financial math piece right there. So a quick aside before we jump into more on the calculators, you know, something that's happened recently. There was an article, and Todd talks about this in his True Concepts training, where there was an article that came out 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%. So a question comes to mind, why is 4.35% exciting to anyone when we're told you can get 12% in the market? And I think what it's saying is it's proving that people actually do crave certainty. And so when the bonds jumped up to 4.35, that was a high enough return to raise some alarms with some of the analysts out there to say, hey, we better be on the lookout. The markets might be in trouble because people, bonds are now getting a high enough return that they're going to start shifting that money out of equities. 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. So we still haven't taken out taxes, fees, and other things like that. So the reason I'm bringing this up is because there's a weird disconnect out there with a lot of the typical financial planning advice where they're looking at 4.35% bonds like it's the next coming. And meanwhile, they're just writing whole life insurance off as just this terrible asset. So getting back to this calculator here, what if we were to take a look and we would start to take a look at what we'd have to earn in an alternate account just to match everything we get with this whole life insurance policy. So I'm going to click over here and select an alternate account. And why don't we just start and let's say we get the same return that we're getting in the whole life insurance policy, 4.6%. So we can see if we go to the whole life insurance down here, we have $2,000,000, $2,086. And if we switch over to the alternate account at 4.6, now this one is earning 4.6 from day one and we see that we have the same number, $2,086,000. So that's just proving the internal rate of return calculation. Okay, so we've got this. And when we're looking at life insurance, we're getting this 4.6% return. What kind of asset is it? It's an asset that's super safe. It's super liquid. And so what other kind of equivalents can we get out there? I mean, at that stage, we're really talking about your checking or savings account, maybe a money market account, but that's probably not really all that safe. Maybe a CD, but that's not all that liquid depending on how you have it set up. But those are the type of equivalent accounts that we're looking at. So if we have our money in that type of an account, do we have to pay some taxes on that? So if we put a 24% tax bracket on there, you can see up here in the top bar, this is doing an automatic calculation of the equivalent return you'd need to get after tax to match the whole life insurance. And we see up here that you need a 6.05% return just to match the after tax, the capital equivalent value of the whole life insurance. And so if I plug this into the fixed earnings rate over here to the left and I just copy that over, what we see is we're now back at the $2,086,000, but I needed a 6.05% rate of return on the alternate account to match the permanent life insurance. If I go back up to the life insurance piece here, what also comes along with this cash value? Don't I also get a death benefit that comes along with that? Do I have that with my alternate account? And the answer is no. If I want to really compare apples to apples, wouldn't I need to buy some term insurance, buy term and best the difference, right? To have that same protection for my family. So let's go up here and I've already got some term insurance values loaded in. Let's include that. This is going to be a 30-year term policy. And we see that when I add this in, I've got an $1,100 annual premium for 30 years. And when I add this in, I now need a 6.3% rate of return every single year in order to match the performance of the whole life insurance. So I'm now kind of in the realm of, I'm a little outside of savings accounts and CDs, right? I'm probably outside the realm of bonds too, but that's probably the thing that would get me closest. So if I start looking at bonds again, when we start looking at fees, commissions, custodianship, I could easily put a management fee of 1.5%. I think that'd be pretty conservative. And when I do that and I start adding in fees, so now I've got taxes, my term insurance and fees all calculated, I've created my capital equivalent, I need an 8.5% rate of return every single year just to match what I can do with the permanent life insurance. And so I think this is a pretty good demonstration to walk through this and really understand what's going on. So going back to that story, let's take a look at what this means in our life and we'll look at a little bit of a visualization of it. If I go back to that story about the bonds and the actual 4.35 that they were getting, let's just call it 4.5, four and a half, a four and a half percent bond, right? I include that. I plug that into my calculator. I've got a one and a half percent management fee. I've got my 24% tax bracket. The term insurance drops off it in 30 years. And if I just look at a graph of this, let's first start with the cash. Look at the difference between the cash value and the blue line and the bonds and the yellow line. We start off a little bit behind with the life insurance cash value because of the costs early on in the policy. We kind of hit parity here in year nine and then the life insurance cash value just really takes off. So if we just look at this as a bond alternative, I mean, this starts to look very good. And if we're looking at things like modern portfolio theory where most wealth management firms are going to tell you, you should have stocks and bonds, maybe like a 50, 50, 60, 40, 70, 30 to stocks. Whatever the split is, and if you're rebalancing that and your bonds are performing weaker than your life insurance on a net basis, wouldn't having permanent life insurance actually allow you to buy more stocks because the value of the life insurance is going up so you could have actually more in stocks if you use life insurance as a bond replacement. So just a thought there. Now let's look at the legacy though. Let's add this in. And of course, the yellow line, which is the term insurance plus the value of the bonds, we see that it's a little bit higher during the working years than the permanent life insurance because remember, you don't get the death benefit and the cash value. Cash value is the equity in the death benefit. Just like the equity in your house, when you sell the house, you don't get the sale price plus the equity. The equity is built into the sale price. It's the same concept. So we have a little bit more value when we add in that cheap term insurance, you know, the buy term invest the difference, but we see as we get out here in 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. And then we see at age 65, because that 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 that you have because the term insurance value is gone and the permanent life insurance death benefit. So what ends up happening is, you know, when people get to this stage and they do not have a permanent life insurance death benefit, this value now has to do a lot of jobs in retirement. It's got to, it's got to provide income for you. It's got to provide liquidity in case of any health issues or unexpected expenses. And it's got to provide a value to your heirs. Like if you want to pass something along, this is the money that it has to come out of. And then not only that, but we, you know, health insurance costs keep going up and up and up. And of course, as you get older, you're at risk of really needing some type of long-term care type of thing or disability protection. So all of those things have to come out of this pool. Now, of course, you probably have some stocks too, so this number would be a little bit higher. 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 this money? It gives it at least one less job. And actually it gives it two less jobs because this death benefit permanent life insurance comes along with accelerated death benefit riders that protect you for chronic and terminal illness. So you actually have two less jobs to do with your cash down here because you have this permanent death benefit. Here's another thing to think about though, you know, you've got this death benefit during your working years, the buy term invest the difference strategy. And don't get me wrong. This is good. I'm not, I'm not against term insurance, right? But I am pro permanent death benefit as well. And what happens is, so people look at this and they're like, okay, well, I've got all my protection and it's maybe even a little bit better protection during my working years. And when I get to retirement, I don't need this protection anymore because I've saved up all my money and I'm just going to be retired. But is that actually true? You have this protection during a time when it's statistically highly unlikely that you will die prematurely. And of course, that's why the premiums on the term insurance are so low because the risk of you dying during that period is very low. And the insurance companies of course know this, they have that data. So you're, you have the coverage when, during a time in your life when it's statistically highly unlikely you'll die and then it completely goes away during the period of your life where it's guaranteed you will die. And so how does this ever make any sense? The only valuable death benefit is the one that's enforced when you actually die. This is the value of this permanent death benefit and having it after you're done with your working years and you go into retirement, it gives you so many more options to not only protect yourself during this retirement phase, but actually get more to use and enjoy while you're still alive. So this is a huge, huge deal. But just going back to the rate of return conversation, I don't know, 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 you try to match that with some other type of asset? We can see, you know, 8.5%, that is not a terrible return. No one would say that that's a terrible return. And we have to look at the type of asset that it is. 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? So, you know, we really have to start being a little bit smarter with how we're comparing things and not really 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. Thanks, everyone. Talk soon.