The White Coat Investor by James M. Dahle, MD

Posted by Mark Pugsley.

NOTE: This article is adapted from an article that was written by my friend Jim Dahle, MD and posted on his very popular website The White Coat Investor. This article is re-posted here with his permission. Because his website is geared toward doctors and other medical professionals I have modified the article somewhat to be read by a wider audience, but the core advice is his.

You should have a solid insurance plan and a solid investing plan – but you shouldn’t mix the two.

Remember the combination TV/VCRs? Seemed like a great idea initially. But then you ended up with the worst of both worlds, and when one of them broke, the other became useless. It’s the same with investing. Instead of providing some kind of synergy by mixing the two, you end up with the worst of both worlds.

Insurance products that are most frequently pitched as investments go by different names—cash value life insurance, whole life insurance, universal life insurance, variable life insurance, variable universal life insurance, variable annuities, equity-indexed annuities, deferred fixed annuities…the list goes on and on.

A large percentage of insurance buyers have been suckered into one or more of these at one point or another. Why does that happen? I think there are a number of reasons:

#1 These Policies are Very Complex

Most people are novices when it comes to investing and knowledge of the financial world. This knowledge gap handicaps us when we make financial decisions. We are too trusting, too naive, too worried about things that don’t matter, and not worried enough about things that do.

Even simple financial cliches that sophisticated investors know (such as “Don’t Mix Insurance and Investing” and “Buy Term and Invest the Difference“) can be profound revelations others.

These products are purposely made to be very complex. They are NOT simple to understand, and when an investor points out issues with it, the salesman will quickly move on to another feature of the product. The complexity always favors the issuer, not the buyer.

#2 Insurance Salespeople are Usually Not Licensed to give Investment Advice

Everyone markets themselves as a “retirement specialist” or a “financial planner” these days, no matter what their licensure or qualifications. Insurance salesmen, stockbrokers, and mutual fund salesmen like to take advantage of the fact that they know just a little more than you.  If you are wondering whether someone is licensed to give investment advice or to sell securities, FINRA’s BrokerCheck website is a good place to start.

But unfortunately, most of their training is in sales, which means they can make whatever product they happen to profit the most from look extremely attractive to you.  

#3 Insurance Products Do Not Provide Better Asset Protection Than your 401(K)

Insurance salespeople are quick to point out that in some states the cash value of a life insurance policy or the value of an annuity may be protected from your creditors in the unlikely event of an above policy limits judgement from malpractice and other litigation.

What they usually fail to point out is that so is your 401(k), IRA, and sometimes a great deal of your home equity. Also, it is not universally true that funds in these products are protected from creditors; it varies from state to state. Life insurance cash value protection is limited in many states and annuity protection is limited in most states, but 401(k)s receive lots of protection in all states and IRAs receive protection in most states. So the bottom line is that your existing 401K is probably a better place to protect your money than the complicated and expensive insurance products they are trying to sell to you.

#4 Insurance Products Do Not Provide Better Estate Planning Benefits

Insurance salespeople also love to tell you how life insurance proceeds are estate tax-free. But hardly any Americans pay estate taxes at all. A typical married person has to leave behind more than $23 million at their death to pay ANY estate tax. Most of us will never have assets like that.

Estate tax law can change at any time, of course. It wasn’t that long ago that the exemption amount was only $1 Million. But through gifting and trusts, there are ways to eliminate or minimize that burden without paying for an overly expensive insurance policy or annuity.

#5  Insurance Products Do Not Provide Better Tax Benefits

I am appalled at how many physicians don’t max out retirement accounts such as 401(k)s and IRAs before “investing” in life insurance. The tax benefits of a 401(k) exceed those of cash value life insurance. Not only do you get the tax-free growth over the years, but you also get an upfront tax deduction.

Cash value life insurance doesn’t offer that. Don’t expect to learn that from someone who sells it though. Even fully taxable investment accounts provide some tax benefits not available in an insurance product, including lower qualified dividend and long term capital gains tax rates, tax loss harvesting, and the step-up in basis at death.

#6 What is the Value of a Guarantee?

Most of these insurance products come with some kind of guarantee. It might be a certain amount of guaranteed value at some point down the road, some kind of guaranteed minimum growth rate, or a guaranteed amount payable at death, but I can assure you there will be some kind of guaranteed benefit.

Is there a value to that guarantee? Of course, and it seems especially valuable in times of high market volatility or political uncertainty. However, in nearly every case the buyer is overpaying for that guarantee. The complexity favors the seller, not the buyer.

#7 It’s Difficult to See the Cost of the Insurance

As these products become more and more complex, they become less and less like commodities. Commodities are all the same and are sold based on price. If a company sells a variable annuity that is different from every other variable annuity on the market, it becomes very difficult, bordering on impossible, to compare competing products – its never apples to apples. Customers usually end up with the one that pays the biggest commission to the salesman.

Also, these products usually have some type of insurance component. The insurance company can charge whatever it wants for that. If you have no way of determining what the insurance cost should be, how will you know if you’re being ripped off? You won’t, and you are.

#8 The Investment Component is Extremely Expensive

To make matters worse, the investment component is also often overpriced. Variable life insurance and variable annuities, in particular, place your money into the equivalent of mutual funds, except they are managed by the insurance company. The company not only doesn’t hire very good managers (why would it, no one buying the fund is looking very closely at them), but it also overcharges for them.

The expense ratios on these variable annuity “funds” are some of the highest I’ve seen. They can range from 1.5% to 3% or even higher. That’s 10 or even 100 times what you’d pay for a mutual fund at Vanguard, even an actively-managed one.

#9 The Value of Liquidity

One of the biggest downsides of these insurance products is the lack of liquidity, meaning you have to pay a “surrender charge” to get your money out early. Some investment advisors recommend you never buy something that you can’t look up the price of in the Wall Street Journal every day. Stocks, bonds, and mutual funds can generally be sold any day the market is open. Liquidity means you can “go to cash” any time you want. This allows you access to your money to invest it elsewhere, spend it, or give it away.

Insurance products always limit your liquidity. In fact, the only way you can access your cash in most of these products is to “borrow” from your policy (which has its downsides, including paying interest and sometimes causing the policy to fail) or to surrender it, which means you pay a huge fee and the amount you receive often much less than what the “cash value” is supposed to be. Liquidity has a value, and far too often insurance product investors give it away for nothing.

The bottom line is that there is no synergy that comes from mixing investing and insurance. Don’t get me wrong; I’m a big fan of insurance. I think you should insure very well against financial catastrophes. But any time agents start combining insurance policies with investments (or other insurance policies), you should step back and consider whether you would be better off buying your needed financial products a la carte.

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