Whole Life Insurance: Why Do the Extremely Rich Use It?

We continue our life insurance segment to talk about Whole Life Insurance. What is it? How does it work? There are several people that use it and they are usually especially wealthy, but why? Is it best for someone who is up and coming to get early or a late stage investor? What is the best way to approach it? 

Why am I writing so many questions? Who am I? Am I a sentient being?

But really, this is just about life insurance.

Transcript

Chris Holling: 0:00

This is the truth about investing back to basics podcast where we want to help you take control of your personal finance and long term investments. If you're looking for a way to learn the why and how investing, then you found the right place. Thank you for taking the time to learn how to better yourselves. So you're you've got a game plan. We've We've, I was gonna say we've got a game plan, but really, it's it's all if you've got a game plan, I don't even want to know what's happening. We'll slowly ease into it. Hey, actually, first. Did you did you hear about the Mexican train bomber? No, he had locomotives?

Sean Cooper: 0:54

I shouldn't have known I should have anticipated.

Chris Holling: 0:59

I decided to start looking up. Did you hear jokes because they? I like those. They make me go like, did you hear about the McDonald's that was trying to get into the high end of the steakhouse market. It was a big McStake.

Sean Cooper: 1:14

Yes, it would be.

Chris Holling: 1:20

Okay, this one is also okay, I got it. I got a different list here. Let me like dad jokes to make you cringe. That's my, that's my wheelhouse

Sean Cooper: 1:29

your specialty.

Chris Holling: 1:30

That's what I'm all about. That's funny, I've deleted I've deleted the numbers from all the Germans. I know from my mobile phone. Now it's Hans free. The welcome ladies and gentlemen, boys and girls to another episode of The Truth about investing back to basics. My name is Chris Holling.

Sean Cooper: 1:56

And I'm Sean Cooper.

Chris Holling: 1:57

And today we are going to talk about something that I told Sean did not tell me what it is that we're talking about. It's all genuine. It's all all organic responses happening today, which is totally different than every other time that I have no idea what we're talking about. So. So, Sean, what what are we talking about today?

Sean Cooper: 2:20

Whole Life Insurance?

Chris Holling: 2:23

Oooh that was that was the crowd going. They all seem to

Sean Cooper: 2:30

I'm going to go with the crowd went uhhhh.

Chris Holling: 2:34

well, yeah, with that attitude.

Sean Cooper: 2:37

Okay, I will say our first insurance conversation was far more enjoyable than most any other insurance conversation ever.

Chris Holling: 2:45

And as I said on the last one, oh, ye of little faith. Actually, I think that's what I said. I don't know. Yeah, we had a decent time with with term insurance. But this this is the the other the other side of the coin, right ish, that we're looking at term insurance versus whole life. That's how I've always known it is like the, the the big two of life insurance is term and whole. Is that true?

Sean Cooper: 3:09

Yeah, basically.

Chris Holling: 3:10

Okay, cool. Well, what I'm not I'm not having a guest this time, because I know

Sean Cooper: 3:16

you're not gonna humor everybody with that enjoyable.

Chris Holling: 3:22

So I think that whole life insurance is a an amount that you pay that you once you pay that amount, then you have coverage life insurance coverage for your whole life. And then and then that's it. Yep, that's what I got.

Sean Cooper: 3:52

Okay, if you're talking about paid up insurance and yeah whole life, then yes,

Chris Holling: 3:57

Dang it, there's different versions of this. I thought it was just like, you just you give me your life is worth this much. Pay me money. And, and that's, that's not it.

Sean Cooper: 4:10

No, most people will pay a monthly premium, like any other insurance as opposed to one lump sum.

Chris Holling: 4:15

Sure, maybe because you don't tend to have that lump sum available. But you're you're doing it to get to a goal of paying a certain amount in total, whether it's a payment plan or a lump sum. And and then and then once you hit it, then you're you're good. And if you don't hit it, then I imagine you have up to that amount available or something. Something goofy like that. But it's not a term. It's not a set term of time that you have the coverage is the goal. Right?

Sean Cooper: 4:47

Right. It covers you for your entire life.

Chris Holling: 4:50

Sweet. See, I know stuff. That's thanks. This has been the truth about investing back to basics. Well, okay, tell me, tell me What I like I have a super dumbed down version of that, but I'm positive, I'm missing stuff. So tell me what it is that I'm missing. Sean. I also just started drinking too, because why not? You know?

Sean Cooper: 5:16

What time is it there?

Chris Holling: 5:17

Noon. means it's not 11 In the morning, it's not morning anymore, so it's fine.

Sean Cooper: 5:24

Yeah, it's almost one there. So, you know? Yeah, no, I'm

Chris Holling: 5:28

like, 45 minutes late, is what I know, it just sounded good. Whatever, Sean, what am I missing?

Sean Cooper: 5:36

That's the biggest thing is whole life insurance covers you for your whole life your entire life. That is that is its primary purpose. The other big thing that people will note is that it has the ability to build up a cash value.

Chris Holling: 5:53

Well,

Sean Cooper: 5:54

go ahead.

Chris Holling: 5:54

I'm sorry, I was gonna let you expand on that. Ultimately, I just How do I put this? If if I was going to ask you a big question of the day, and you might already have plans to address this. But if I was going to ask you a big question, I would ask you why I've come across so many, I can't even say so many. Why have I come across people that are wealthy that swear by whole life insurance. And I imagine that's kind of what you were alluding to, and then I made a noise that made you stop, so I had to interrupt.

Sean Cooper: 6:28

Yeah, it has to do with that cash value, it also has to do with the taxability of it, they're most likely using it for if they do want the money, they're they're taking loans out of the policy, which a loan is not going to be taxable. Although there's also no tax advantage paying it back for obvious reasons. The other side of it is insurance proceeds are not going to be taxable to the beneficiaries either. So it's a good way of transferring wealth, ultimately.

Chris Holling: 7:00

Okay.

Sean Cooper: 7:02

So it's really the combination of those two that cash value, and then the tax benefits of it that they are looking for, ultimately, whether or not it is more beneficial than many alternatives would require crunching the numbers

Chris Holling: 7:22

in regards to like transferring wealth or

Sean Cooper: 7:27

correct,

Chris Holling: 7:28

okay, yeah. And so I guess I imagine when when you're talking about transferring wealth, it's, it's from one generation to the next sort of the old money term. Is that, is that right? Okay.

Sean Cooper: 7:40

Correct. Yeah.

Chris Holling: 7:41

And that's because of the cash value of it.

Sean Cooper: 7:44

No, that that part has nothing to do with the cash value.

Chris Holling: 7:47

Okay,

Sean Cooper: 7:47

that has to do with the actual benefits. So the cash value will go into that, too. But ultimately, it's the the death benefit that really lends itself towards the transfer of wealth, but

Chris Holling: 8:04

and how does that transfer happen? Does that mean that the policy transfers or you're just saying that it's more likely to get paid out because it covers your whole life versus a term that you might lapse?

Sean Cooper: 8:15

Well, I mean, it's provided you don't the policy doesn't lapse can provided you continue to pay the premium, then by by definition home, his whole life is guaranteed to be paid out eventually. In fact, whole life insurance. I mean, I say covered for your whole life, but ultimately, most Whole Life policies have some kind of I can't remember the name of it. maturity date, in which they basically just pay out the benefit and call it a day.

Chris Holling: 8:55

Oh, right. I have heard of that. Okay.

Sean Cooper: 8:58

That's typically around age 100, though.

Chris Holling: 9:04

Okay. Geez, I was I was thinking they were just said like 80 or something. That's

Sean Cooper: 9:08

No, no, it's designed to be it's designed to be insurance as opposed to a benefit to you the insured. So, you know, it's not meant to pay out to the the insured but to the beneficiaries of the insured. So

Chris Holling: 9:25

How old is Warren Buffett? Now? He's not 100

Sean Cooper: 9:29

I don't know.

Chris Holling: 9:29

But he's old.

Sean Cooper: 9:30

I'm pretty sure he's not 100.

Chris Holling: 9:32

I'm calling you out Buffett. I think you're old. I just I just

Sean Cooper: 9:38

I don't know what he has to do with this conversation. But sure,

Chris Holling: 9:40

nothing. I just I just assume he has whole life insurance. I don't actually know he might swear against it. For all I know. I just

Sean Cooper: 9:47

It wouldn't surprise me if he does, but the bulk of his wealth is in investments directly.

Chris Holling: 9:53

91

Sean Cooper: 9:55

There you go a

Chris Holling: 9:57

net worth of 104 Point 9 billion good for you. Geez I digress. Sorry,

Sean Cooper: 10:06

I actually saw an article recently that his average annualized rate of return isn't really that much different than the market. But the reason his wealth has grown so much is because he's started so much earlier than the average person and has continued investing so much longer than the average person.

Chris Holling: 10:23

When you when you say earlier, you saying like, he started in the market when he was like, 12.

Sean Cooper: 10:28

No he was like, I think 15

Chris Holling: 10:31

I was not that smart at 15. Okay, fair enough. So then it's, it's guaranteed to pay out at some point, which is the point of whole life, but you are still paying a premium, you have to keep up with the premium. And if you don't keep up the premium, then you don't get the benefit. And if I remember correctly, from some conversation we've had the whole life is also usually more expensive. Premium wise, like,

Sean Cooper: 10:58

correct.

Chris Holling: 11:00

Is it significantly like yes, double, triple quadruple, sept Sep. Septuple. Is that it's seven? I think.

Sean Cooper: 11:08

I don't know the exact amount, but it is significant for it is similar levels of coverage is going to be significantly different. More than double or triple I'm pretty sure.

Chris Holling: 11:20

Oh, wow. Okay,

Sean Cooper: 11:20

yeah. Because a you're, you're covering your entire life, not a set period in which you're most likely not actually going to make the claim. So it's guaranteed to be paid out at some point, as opposed to the, you know, less than 3%, possibly point 5% claims on the Term Life policies,

Chris Holling: 11:41

right.

Sean Cooper: 11:43

Additionally, you have the cash value, so a chunk of your premium is going into that. So you're going to be paying more for that. And then it has so many other additional features, potentially, the just the administrative costs are going to be higher as well. So yeah, you're talking about quite a bit more expensive.

Chris Holling: 12:03

Okay. Um, so how do I work? If you are looking at that, let's just let's just take me as an example, because we're because we can. So for me, when I know that I have life insurance because of my job, and we talked about that in term life insurance. Right? I unavoidably have some form of life insurance, because of the the risks that that are part of my job. And I?

Sean Cooper: 12:33

Well, because the company provides it

Chris Holling: 12:35

right, and the company provides it, if given the option, would it be who've me to get more involved in a whole life Avenue? Because there might be more of a cash value to it? Or would it not? Because then I like let's say I work for 20 years, and then I decide it's time to retire. But then I'm not as worried about whole life or, you know, I've had the term this whole time or something like that, does that cash value not carry over? If I stopped paying the premium? Is there any reason why I should prefer the whole life during this arguably more risky time of my life and career? Was that too many words?

Sean Cooper: 13:14

Well, you're asking a lot of different questions there. And we haven't really fully covered whole life insurance yet. So you're getting into when it makes sense versus when it doesn't, for generally speaking, whole life tends to make the most sense for people who have already capped out their other tax advantaged investing accounts. And are looking for an additional tax advantage means of investment while I say investing, but really, for transferring wealth, it it tends to make the most sense, but for people who have

Chris Holling: 13:57

okay already capped those other avenues out and have very large

Sean Cooper: 14:08

for individuals for what you're talking about? No, cash flows, and I can explain why that is later The one other time that it tends to make sense is like we talked about, which is also an option with term insurance is for key employee or what's the word for it? Like a Buy Sell agreement that those sorts of things. So So business for business partners, typically not.

Chris Holling: 14:33

Okay, so

Sean Cooper: 14:34

that's not always the case. But typically no.

Chris Holling: 14:37

So just so I have like a visual in my head kind of a, I don't know, a diagram an example. Who would be I don't know that ideal is the right word, but the most likely candidate to try and utilize those tax advantages like you're talking about some someone that has exhausted those things is likely to be a person that Blank,

Sean Cooper: 15:01

yeah, you've already capped out all of your retirement accounts.

Chris Holling: 15:04

Okay? Like, you're like you've maxed out the contribution to your Roth IRAs. And like those, those

Sean Cooper: 15:12

401ks, 403bs whatever options you have available to you, yes, you've already capped all of those out, and you have a significant cash flow available to you on top of that.

Chris Holling: 15:23

Okay. Okay. And then this is just a new avenue to start to exercise at that point.

Sean Cooper: 15:30

Correct.

Chris Holling: 15:30

Whereas you're saying that that, you know, we can't say that it's wrong. But to somebody that's newer into getting involved in investing, going down a whole life route would not, you is not something that you should necessarily consider to be your first avenue. Is that fair to say?

Sean Cooper: 15:54

Yeah, not typically.

Chris Holling: 15:57

Okay, that's what I was getting at, I guess. I actually don't know what I was getting at. I'm trying to sort through sort through the weeds in my head.

Sean Cooper: 16:05

Well, why don't we back up a little bit and cover the cover whole life in a more complete manner?

Chris Holling: 16:10

Sure.

Sean Cooper: 16:10

And then

Chris Holling: 16:10

sorry,

Sean Cooper: 16:10

to jump into, you know, why, why that might be. So you know, we talked about the benefits some of the benefits? Well, first off, the biggest disadvantage is the cost. That is the biggest disadvantage to whole life insurance, it's expensive.

Chris Holling: 16:24

Yeah.

Sean Cooper: 16:26

The advantages number one, lifetime coverage, pretty straightforward. As an end, as opposed to term insurance, that only covers a specific term, this covers your entire life. The number two is that cash value, so a portion of your premiums that you're paying goes into a cash value that can then either participate in the growth of the company or is invested in the market, so it can grow. And then you have some flexibility with what you can do with that down the road. Typically, people use it as a kind of a usable fund, they, you can take a loan from the policy. So you accumulate a certain cash value, you take a loan from the policy, say to buy, put it put a down payment on a house or pay for kids college, and then you pay it back over time. The advantage being is you take that money out, and there's no tax consequence for doing so provided you eventually pay the loan back,

Chris Holling: 17:25

which also to touch on just just a piggyback on you for a second, for those that are listening and paying attention to it. This is not the only avenue, I think this is kind of what you're alluding to that this is not the only tax advantageous option to do something like that, because I utilize that for my 457 as well, my my 457 B is a deferred comp, tax type retirement account that I was also able to loan against myself and not have taxes. work against me here. I just wanted to point that out that like that, that sounds like a good option to have. But there are also other accounts that also offer this option.

Sean Cooper: 18:07

Right? Yeah, so loans in general, you're not going to have any tax consequences for taking out a loan. Now in the two examples we've talked about, you're technically paying the interest back to yourself, either your retirement account or your insurance policy as opposed to paying a bank. Either way, you have to evaluate the benefits, the tax benefits relative to the cost of actually going any of these routes. So you know, when you pay back the if you actually take a loan from a bank, for example, there may be tax advantages as you're paying that back. Whereas there's no tax advantage when you're paying yourself back per se. Just the tax advantage of not having a tax on the loan for taking your own money out.

Chris Holling: 19:04

Right. Yeah. And I mean, that's just just for like, personal examples, because I think that it helps me retain stuff when I have a personal example, that's something that's been happening with me is that I took out a loan against myself on this 457. And then the way that they've utilized it, and I don't know if I've told you this, actually, but the way that they're utilizing it is that the same amount that was in my account, they're treating it as though I still have that amount. And so that amount that is being utilized in the market to continue to grow, still exists. I'm just paying back to that amount at that point. I didn't, I didn't drop it in value at that point where, you know, it went down to about half I took about half of what was in my account, but they're still using it as if I had the full amount in my account in the market to continue to let compound interest grow at that point.

Sean Cooper: 19:55

Gotcha.

Chris Holling: 19:56

So yeah, yep. There's there's the personal example for you

Sean Cooper: 20:00

Yeah. So, you know, we talked about one of the other advantage, the ability to withdraw that cash value, and then the Another would be flexible premiums. So with term insurance, typically your premiums are set, there's really no flexibility in terms of increasing those or decreasing those, depending on the type of whole life insurance you have, you may be able to change your premiums over time, you know, I term does have some riders that you can tack on that would make certain circumstances where you wouldn't have to have to pay a premium. But with whole life insurance, you have typically have a lot more flexibility in terms of changing that value, which could impact or change your your death benefits, or your cash value. Or once your cash value reaches a certain level, it can essentially be self sustaining and actually pay itself, which is kind of what people, many people strive for what the is thrown out there as the sales pitch. So you actually use the cash value to pay the premiums, obviously, that doesn't help the cash value continue to grow as much as it otherwise would. But it makes it so that you are no longer having to dump into the policy it's covering itself essentially, is the idea.

Chris Holling: 21:21

Yeah, okay, that makes sense. When when you're adjusting that premium, or you choose to adjust that premium, does that also adjust your your ultimate payout? Are you saying, Hey, I'd like to pay more to get to that point or pay less to have a lower end result? Or?

Sean Cooper: 21:38

Potentially, yes, yeah. So as you're, if you're actually changing your premium, like the total amount being paid to the insurance company, typically, that is going to change your death benefit. Now, if you're actually using the cash value to pay the premium, the premium that's being paid to the company hasn't really changed, it's just changed where it's coming from. So that's probably not going to impact your death benefit. With that said, the cash value of the policy will as it grows or shrinks, potentially change your death benefit, because if it reaches certain thresholds, it can actually cause the policy to mec, which also can happen based on the payments that you're making. So and we can talk about that here in a little bit. Okay.

Chris Holling: 22:21

That makes sense.

Sean Cooper: 22:22

So those are the big advantages. So lifetime coverage, a growth of cash value, ability to withdraw the cash value, and flexible premiums with term insurance, there is no cash value, there's no there's nothing there that you can take out, you can say, hey, I want to just close out my policy and take this money, or I want to take a loan from it anything like that. It's just if you died, then your beneficiaries get something, whereas whole life insurance there is actually a value that builds up over time.

Chris Holling: 22:54

Gotcha. Okay.

Sean Cooper: 22:56

So those are the advantages. Now, some of the things to look out for, aside from the whole cut the high cost, you definitely want to look at that. The other thing is, you really want to be skeptical if the presentation is painting too pretty a picture of the cash value benefits.

Chris Holling: 23:15

Okay,

Sean Cooper: 23:16

and what I mean by that is a couple of things. First off, just from a practical perspective, if you have a whole life insurance policy, and this goes back to your idea of, you know, someone just starting out and starting with whole life, as opposed to starting with investing or term insurance or

Chris Holling: 23:36

Dang. Okay, something like that, if you're paying the minimum premium on a whole life insurance policy, because that premium is flexible, you can typically actually put more in than is required of you. If you're paying the minimum that's required, then, in the early stages, around 90% of your payment is just covering premiums, and only about 10% is going to cash value.

Sean Cooper: 24:02

yeah, so and early stages, it's even worse than that. But it does gradually shift very gradually over time, the other way so that more and more of your payment is going into cash value as opposed to just paying premium. But early stages, you're putting pennies into that cash value relative to the money you're actually putting in.

Chris Holling: 24:24

Right. Okay, that maes sense

Sean Cooper: 24:25

Yeah. So if for someone who's just like a, I need X amount of coverage, and they're just going to pay the minimum premium, that cash value is going to be absolute minimum. And essentially what they're doing is just creating very, very expensive permanent term insurance for themselves.

Chris Holling: 24:47

Okay.

Sean Cooper: 24:49

So like I said that that that ratio does improve over time, but is slow. But for that reason, and this kind of sounds counterintuitive. That's what You actually want to fund the policy with as much as you basically can relative to the the premium without causing it to mec, now mec is a modified endowment contract, if you cause your policy to mec it loses all of it's all of the tax benefits of life insurance. So you really want to avoid that. Put it Put another way, you basically want to purchase the smallest death benefit that you can afford relative to the premium you're going to be paying

Chris Holling: 25:35

to whole life specifically.

Sean Cooper: 25:37

Correct,

Chris Holling: 25:38

right? Okay.

Sean Cooper: 25:39

Because you want as much of what you're paying to go to cash value as possible, you want that ratio to be skewed towards the cash value, not skewed towards the insurance premium.

Chris Holling: 25:52

And that smaller amount that you're referring to that would be the contribution is because the amount is so high, the the amount that does not go to essentially the principle of it is so high is why you want to do that. And then and then get to that point later where you fund it. Is that what you're saying?

Sean Cooper: 26:10

I'm not sure I follow you there.

Chris Holling: 26:11

Okay, well, then maybe I'm just completely lost. So what? I guess, I guess, touch on it a little bit? What, why? Why do you do that smaller amount, instead

Sean Cooper: 26:27

You don't want to do the smaller amount?

Chris Holling: 26:28

Oh, okay, that's where I got confused. Okay, I'm sorry,

Sean Cooper: 26:30

you want to quit, you want a small, you want the smallest death benefit that you can afford

Chris Holling: 26:35

smallest death benefit.

Sean Cooper: 26:37

So if you know how much you can put into this policy on a month monthly basis, you want the smallest death benefit that you can afford without the without causing the policy to mec, because your payment, the split of your payment, a larger percentage of it is going to go into the cash value instead of just paying insurance premiums. So lining the pocket of the insurance company. Okay.

Chris Holling: 27:03

Sorry, I understood it as the smallest contribution.

Sean Cooper: 27:09

No,

Chris Holling: 27:10

right? Okay, I'm with you

Sean Cooper: 27:13

no, you, you want the smallest percentage of your monthly payment in this scenario to be going as premium insurance, yeah, actual payment to the insurance company. Because if you're. So if you try to get a larger death benefit, the largest death benefit you can afford, then a very, very tiny percentage of your monthly contribution is going to cash value and the bulk of it is going towards insurance premium and basically lingning the pocket of the insurance company.

Chris Holling: 27:45

Wow, okay. I can see that.

Sean Cooper: 27:48

Right. And now we're all we're also assuming here that your goal in purchasing whole life insurance is not just the insurance itself. Now, if your goal is the insurance itself, and you want to target whatever insurance level you want, but again, that, you know, you may also want to consider term insurance in that scenario, as opposed to whole life insurance. And that's where, why I was saying earlier, it tends to be whole life insurance tends to be more favorable if you have large cash flows, and you're trying to create a tax advantaged place to put those cash flows.

Chris Holling: 28:27

Okay. Yeah, I could see that,

Sean Cooper: 28:29

again, this is these are very, very broad strokes, each individual needs to evaluate what they're trying to achieve. And then compare your various options. Because when when we're talking about this from an investment standpoint, so you always want to compare and contrast all of your options. So if you're looking at Whole Life Insurance from an investment standpoint, obviously your some of your alternatives are going to be your retirement accounts, non qualified investment accounts, any number of different things, so you're not just looking at it from an insurance standpoint, if you're looking at it from an investment standpoint, you have to compare your alternatives. And that actually brings me too, but that's why we were talking about this from the standpoint of trying to maximize that the portion of your contribution that goes towards cash value as opposed to just premium, so you basically want as much extra funds, much of the extra funds that you put in above and beyond the minimum premium premium you want it to fund the cash value of the policy as opposed to just covering the premium Right, yeah, cuz basically whatever your death benefit, however, your death whatever death benefit you choose, that's going to ultimately determine what your premium is what the portion is, that's going to go to the in just paying the insurance. So if you pick a larger death benefit, then you have to buy by definition, you're going to have to pay a larger amount into the insurance premium itself, that is not going to go to your cash value. Which is why you actually, the smaller death benefit is going to increase the amount of your contribution that goes to cash value instead of just print insurance premium.

Chris Holling: 30:39

Okay.

Sean Cooper: 30:40

Okay. So,

Chris Holling: 30:43

I think that makes sense.

Sean Cooper: 30:45

Cool. But that also brings me to the second point in which you want to be a little bit skeptical and really think through this process. Because as you're comparing your various options, you know, other types of investment vehicles. A lot of the insurance quotes that I've seen show returns in the neighborhood of eight to 12% on the cash value,

Chris Holling: 31:12

right?

Sean Cooper: 31:13

So if you're looking at returns of eight to 12%, first off, you got to keep in mind that, that, that eight to 12% is only on the cash value. So it's only on that that percentage of your payment that is actually going towards cash value.

Chris Holling: 31:29

Oh, and not the total contribution?

Sean Cooper: 31:30

Correct.

Chris Holling: 31:31

Right. Okay.

Sean Cooper: 31:32

Yeah, the total contribution is irrelevant. It's only what the portion that went into cash value that actually is going to grow.

Chris Holling: 31:39

Wow. Okay.

Sean Cooper: 31:40

The rest just went towards insurance premium. That's what I was talking about that division.

Chris Holling: 31:45

Yeah, I wouldn't have expected that I'm sure I would have, I would have been another sucker.

Sean Cooper: 31:50

Okay, yeah. But the other side of that is, if they're showing you an illustration that showing returns of eight to 12%, you've got to two different types of whole life insurance companies. First off, one is the company pays dividends on the cash value. The other is so that I can't remember the phrase, I think that's a participating company, where you are

Chris Holling: 32:20

a penny saved is worth two in the bush is that there

Sean Cooper: 32:23

is no no, basically, at you as an insurance holder, or technically an owner of the company. So you participate in dividends of the company, and that's how your cash value grows, the other you actually participate in the market. So your your, your money is actually invested in the market,

Chris Holling: 32:38

okay,

Sean Cooper: 32:38

so that that eight to 12% return that we're talking

Chris Holling: 32:42

right? about has to be derived from one of those, either the dividends from the company or the growth of the market. So if that is

Sean Cooper: 32:48

If they're assuming that the company itself can coming from the dividends of the company, you would need to basically, the company would have to be growing at a rate to sustain those dividends. So if you look back at just the s&p 500, to represent the the broad domestic market, you're looking at roughly 9%. So depending on the time period that you evaluate, average annualized rate of return, I think over the last, like 74 years is like 9.16%, or something like that, if you take out the last few years that have been really strong growth, then you're it drops down to like 8.91, either way, right around 9%. So if the illustration is showing eight to 12%, then unless they're at that 8% mark, you know, if they're over 9%, they're assuming that either A, the company itself can outpace the market, or B, somehow their investments can outpace the market, we're talking about the company being outpace the market, the general market, able to outpace the market for an extended period of time. If we're talking about about a whole life insurance policy, we're talking about your lifetime, however long that may be, that's a very potentially a very long time for a an individual company to out outpace the market. So if we look at it from the standpoint of, you know, if they're, if they're showing you a 12% annualized rate of return, they're gonna out percent out pace the market by 3%, for say, the next 50 years, then they would have to increase their total market share their their total percentage of the market that their company represents, by 300%.

Chris Holling: 34:39

Geez, okay.

Sean Cooper: 34:41

Right. So it's just statistically speaking, I'm pretty sure the odds are that the insurance companies more likely to go bankrupt than they are to achieve that rate of growth over that period of time.

Chris Holling: 34:55

That's, that's a that's a bad statistic. Okay. Yeah, I get that.

Sean Cooper: 34:59

So Just on the face of it, you want to think critically about what you're being shown. So a 12% rate of return over an extended period of time. From a historical standpoint, the general returns on the market doesn't make sense. Additionally, we're only talking about a portion of what you're contributing, contributing, that is actually going to see that rate of growth, whatever it is, so even if we, you know, go back and say, you know, insurance companies had some great growth over, you know, in the 1980s 90s, early 2000s, what have you, is strictly from a demographic standpoint, they're eventually going to face some issues. So we haven't talked about Social Security yet, but we will in the future. And essentially, the same issues that Social Security is facing now that started in 2018. And are only going to get worse over the next couple decades. Life insurance is going to face those exact same demographic issues in the next decade or so.

Chris Holling: 36:14

Okay, I can see that,

Sean Cooper: 36:16

basically, you have the the baby boomer generation, a very large generation that has thrown the whole concept of social security for a loop. Basically, they relied on an expanding work workforce, an ever increasing population of people paying into the system to cover the people that are getting paid from the system.

Chris Holling: 36:40

Okay,

Sean Cooper: 36:41

insurance is going to see the same thing, premiums versus benefits paid out, especially on whole life, because eventually they're all going to pay out because you have a smaller pool, smaller generations that are paying in over time versus the pool that is going to be paid out, relatively speaking.

Chris Holling: 37:02

Right.

Sean Cooper: 37:03

So just from that's just from a demographic standpoint, additionally, the younger generations have shown a propensity for being less keen on buying insurance than some of the older generations. So not only are they a smaller demographic, relatively speaking, but they're less prone to buying insurance in the first place. And you see this when you look at insurance company's income statements, the the profit margins, you know, premiums paid versus benefits paid out, is shrinking.

Chris Holling: 37:39

Why do you think that is? Is that? I mean

Sean Cooper: 37:43

oh, why they aren't? Why they're less likely to buy insurance or the demographics.

Chris Holling: 37:49

Why why do you think the demographic the the younger generation so to speak is less interested in insurance in the first place?

Sean Cooper: 37:58

That is a great question. I'm not, I'm not sure I actually have a good answer for that. I mean,

Chris Holling: 38:07

that's fair, I just I have no idea.

Sean Cooper: 38:08

So I'll take a shot in the dark. But I'd say a portion of it is the many of the younger generation tends to be slower to take on many of the roles. You know, they're they've, they're getting married later, they're buying houses later. So any of these facts factors are just kind of delayed, if you will.

Chris Holling: 38:40

Okay, yeah, I can see that.

Sean Cooper: 38:42

So I would probably put whole, like life insurance in general in a similar pool with that. So but the My point of this is that even if these insurance companies could have generated 12%, annualized rates of return over the last over, you know, two decades span, the odds of them being able to do it in the future and are not good, in my opinion. So just be skeptical if you're shown really rosy return figures, whether they're having you participate in the market or dividends of the company. Either way, it just, it doesn't make a lot of sense to me, in my opinion, your best case scenario is market like returns. And that's only on the percentage, the portion of the your payments that are actually going to cash value. The other is going just to cover your insurance premium. And is not money that you get to keep it's not money that's invested. It's not money you'll ever see again, except your beneficiaries eventually will get a chunk of it when you pass away.

Chris Holling: 39:48

Yeah.

Sean Cooper: 39:48

Does that make sense?

Chris Holling: 39:49

Yeah, I think so.

Sean Cooper: 39:52

A lot of these insurance quotes, they'll show basically your cash value reaching a point that equals the premiums you've paid in, in seven to 15 years. And that seven years timeframe is assuming those really high rates of return. So

Chris Holling: 40:14

okay.

Sean Cooper: 40:16

You know, fifth

Chris Holling: 40:17

Long time,

Sean Cooper: 40:17

yes, 15, probably more likely. But that gives you an idea of, you know, that's your your breakeven point, at that point, everything you've paid in, is now sitting back in your, your cash value. So from strictly from that standpoint, anything shorter than that your, you know, in investment itself, not accounting for taxes, it is most likely to be ahead, but that's not guaranteed, because, you know, the market could have lost value in that time, all sorts of different factors to take in, but that your your breakeven point in terms of just money in versus money out, not counting interest, or rather, they're assuming you've earned interest, but you would have just gotten out what you put in, so you would have earned nothing.

Chris Holling: 41:12

Gotcha.

Sean Cooper: 41:13

Makes sense. Yeah. So those, those are the big drawbacks, in my opinion, the cost, and just illustrations and sales pitches that are misleading, in my opinion.

Chris Holling: 41:29

Sure.

Sean Cooper: 41:31

Things to watch out for. And I'm not saying that you shouldn't purchase insurance by any means. It's simply to say proceed with caution.

Chris Holling: 41:40

Right. It's it's no different than anything we say on here, where it's just no know what you're getting into know what your know what it's about know what's important to you. Make a choice.

Sean Cooper: 41:51

Exactly.

Chris Holling: 41:52

This is no different.

Sean Cooper: 41:53

Yeah, we've talked about alternative investments, there are risks associated with those, those are there lockup periods, there are all sorts of things to be aware of, with, like hedge funds and things of that nature. So you want to know what you're getting into.

Chris Holling: 42:07

Right? Oh, absolutely. Yeah. getting back to what Chris was asking about earlier, when, when

Sean Cooper: 42:09

So

Chris Holling: 42:09

Okay, I can see that. does it make sense. And one of those places tends to be for

Sean Cooper: 42:18

And then the last tends to be people who have business partners, and key employees buy sell agreements, things of that nature. So with a key employee insurance, you're basically saying, Okay, if we lose this employee, it's going to have a negative impact on our overall profitability our bottom line, our ability to continue to function, so we're going to have insurance on them so that if they were to pass away, then we get a big pay payout to try to offset some of the losses that we're likely to experience from an operational standpoint, a Buy Sell agreement, that's more or less just to cover the cost of buying out a partner that would pass away so that there's not a need to generate a lump sum cash from the surviving partners. already maxed out contributions to retirement accounts. So they've already taken advantage of their their tax favorable investment options out there. And then they still have large cash flows, that they can use to more effectively take advantage of the cash value of a whole life insurance policy, and really take advantage of the tax benefits of the cash value and the death benefit proceeds.

Chris Holling: 43:41

Okay, so.

Sean Cooper: 43:44

And, like I said, that's just because you want that ratio, that the percentage of your monthly payment or whatever payment frequency you're making, you want, as large a percentage of it to be going to cash value as possible. If you're looking at this from an investment standpoint,

Chris Holling: 44:04

which to reiterate, is to hit on it at the lower end of the death benefit first, and then to ease back further into the principle down the road, if that's the route, you're going to go. Right.

Sean Cooper: 44:17

And well, I don't know what you're in terms of

Chris Holling: 44:20

when you were talking about earlier, you were principle saying the the lower end of the the smaller death benefit approach initially, and then easing into a, a larger amount, whatever you think is appropriate, further down, when you have a little bit more contribution into the principle at that point you wouldn't necessarily be choosing to increase your

Sean Cooper: 44:36

Well, contribution down the road and change the death benefit from that standpoint. I mean, yes, you could, depending on the type of insurance policy you're talking about, but the real point is you want for the most part you're shooting for if you're looking at it from an investment standpoint, you're shooting for the smallest death benefit You can afford,

Chris Holling: 45:01

right?

Sean Cooper: 45:02

So that the the larger percentage of your your contribution is going towards cash value. Now your death as your cash value increases your death benefit may also change as a function of the policy intentionally trying to avoid it becoming a Mec a modified endowment contract. But whether you choose to increase premiums or not, you know, or payments or not is not necessarily a function of that.

Chris Holling: 45:32

Okay, I guess I was more just alluding to changing changing the approach down the road as opposed to the the lighter end of the death benefit early on. If you choose to

Sean Cooper: 45:44

Yeah, if you choose to change it down the road, you certainly can, you know, if you do have, you know, greater cash flow. But again, the whole policy is going to have to modify overtime with you if that's the case, because otherwise you will cause it to mec, because what we're talking about is already basically maxing out what it's capable of without causing it to mec.

Chris Holling: 46:07

Gotcha. Okay.

Sean Cooper: 46:10

So increasing premiums down the road, without you'd basically have to increase the death benefit in order to do that.

Chris Holling: 46:17

Okay. Sure. I can see that.

Sean Cooper: 46:20

Yeah. Um, the other thing is, you may not hear this referred to as whole life insurance. They might, you know, your insurance agent might call it something else, they might call it something more specific, because whole life insurance actually encompasses Universal Life, variable life and Variable universal life. So UL, VL, and VUL. Okay, Universal Life

Chris Holling: 46:50

I don't think I've ever heard of those?

Sean Cooper: 46:52

Okay. That's fair. Universal Life insurance is a version of whole life insurance that allows additional flexibility. So you can modify it, that's where you can actually modify the death benefit and the premiums over the course of the policy.

Chris Holling: 47:08

Okay.

Sean Cooper: 47:09

So that's some

Chris Holling: 47:10

fluidly Is that what you're saying?

Sean Cooper: 47:12

Yeah, yeah. So basically, you can say, Okay, I need to, I mean, I'll reduce my premiums for a while, Death Benefits automatically just kind of going to adjust to account for that, or I want to increase it, it's going to account for that as well.

Chris Holling: 47:24

Gotcha.

Sean Cooper: 47:25

So it allows that flexibility. Okay, okay. My cash flow has changed. And that's what you were kind of talking about before.

Chris Holling: 47:33

Yeah, okay. Yep, that totally makes sense. It's just a little bit more movement, a little more fluid in it.

Sean Cooper: 47:39

Correct? Yeah. So that's specifically referred to as universal life. Within the whole life, spectrum. Variable life is the version of whole life that allows the cash value to be invested in various funds, rather than receiving a rate from the insurance company. So like a fixed rate from the insurance company, or even a variable rate from the insurance company. So that's actually a variable life. So the variable stems from the fact that the, the cash value is variable, it varies with the value of the underlying funds that it's invested in, much like a variable annuity, which we'll talk about in an upcoming episode. And then lastly. So I should add the variable feature can cause that cash value, and therefore the death benefit to fluctuate over time. And then lastly, variable universal life is basically a combination of the two. So you can not only vary the death benefit based on the premiums you're paying, so you can adjust your premiums, but the underlying cash value is going to change based on the market. So both of those factors can impact the death benefit. So VUL is technically where you're going to see the most fluctuation potentially in your death benefit, but you also have the most flexibility in terms of what you're paying in and what you're investing your cash value in.

Chris Holling: 49:11

And when it's adjusting with the market like that, do you have any say in the adjusting or they just notify you or where where does that fluctuation happen?

Sean Cooper: 49:19

What do you mean,

Chris Holling: 49:21

you were saying that like it, it varies the the amount that you would receive from a death benefit, or the amount that you're contributing? And it's kind of due to the market does that? Does it just happen the market adjusts and so then the payments and the benefits adjust automatically? Or is that a like a discussion that you have so to speak?

Sean Cooper: 49:40

Well, so your premium your your premium payments are irrelevant to the the mark underlying market in that scenario, so there's not a tie between the two. So if the market fluctuates, that changes your death benefit that doesn't necessarily change what you have to pay in.

Chris Holling: 49:57

Okay, I gotcha. I gotcha.

Sean Cooper: 49:59

In terms of the market fluctuation, you have no say in the market fluctuation if we did, we'd all tell the market just to do what we want it to. You have a say in what you're invested in, potentially, but in terms of how those investments do, it's based on whatever the market does.

Chris Holling: 50:15

Okay. Yeah, that makes sense.

Sean Cooper: 50:17

That was that was the bulk of it. I mean, to sum up, if we tie in last week, in this week, and you know, term insurance is mean insurance in general as a means of transferring risk, typically, that used on the term insurance side of it, basically, limit your liabilities for your, that your survivors might face if you pass prematurely. Typically, that speaking on the term insurance side, your goal is to buy the minimum that you need. There's, it's not often that you have cause to buy more than what you would need. Whole Life Insurance, on the other hand, is more often viewed as an investment as a tax planning tool, provided you understand all the features of the policy. And think critically about the assumptions being made in the illustrations that you're being provided, and understand how the cash value works, and how your premiums work. And you know, what all the benefits are to

Chris Holling: 51:25

Yeah, absolutely. Because that's, you know, just you? like we were saying earlier, you know, when you're able to measure all those things, and look at all that, that's, that's what's important, you know, figuring out what's what's important to you.

Sean Cooper: 51:38

Absolutely.

Chris Holling: 51:39

Just unfolding, approaching as you need to, and I don't know, that's, yeah, that's pretty straightforward to me.

Sean Cooper: 51:45

Always evaluate all of your options and think critically about how your options relate to one another. If you know, any of the options look, too good to be true. They probably are.

Chris Holling: 51:59

Yeah, like many things, understood.

Sean Cooper: 52:04

Yep. Absolutely.

Chris Holling: 52:06

what else what else we got?

Sean Cooper: 52:08

That was it, man. That was? I think that was I'm not even sure we're on the short end of our, our goal here. So

Chris Holling: 52:18

we did not meet the short end of this goal here. That's okay. We'll sort it out. We'll Yeah, fair enough. Okay, well, that was that was very whole lifee. And then I think that's a that's a decent description, we've touched on our whole life stuff that attaches into the term life thing, you're going to extend out into some further understanding insurance that we're going to be going over, I believe annuities is what's going to be happening next. And we it's it's just, you know, more of a stack of stuff that I still don't know anything about. Which is, we should probably just rename the podcasts like stuff Chris doesn't know, would probably probably be a more apt way to name this. Because it makes sense.

Sean Cooper: 53:04

You know, the basics of all the insurance stuff we've talked about. So far.

Chris Holling: 53:08

Only only because I'm, I'm learning with you, the my, my guided, knowledgeable, mathematic one. Whatever. Anyways, I'm gonna close this before I keep saying stupid stuff. Thank you again, for joining us on the truth about investing back to basics. My name is Chris Holling.

Sean Cooper: 53:28

And I'm Sean Cooper,

Chris Holling: 53:29

and we will catch you next time. Podcast disclaimer disclaimer. The disclaimer following this disclaimer, is the disclaimer that is required for this podcast to be up and running and fully functioning and moving forward. This is going to be the same disclaimer that you will hear in each one of our episodes. We hope you enjoy it just as much as we enjoyed making it.

Sean Cooper: 53:56

All content on this podcast and accompanying transcript is for information purposes only. Opinions expressed herein by Sean Cooper are solely those of fit financial consulting, LLC unless otherwise specifically cited. Chris Holling is not affiliated with fit financial consulting, LLC nor do the views expressed by Chris Holling represent the views of Fit financial consulting LLC. This podcast is intended to be used in its entirety. Any other use beyond its author's intent, distribution or copying of the contents of this podcast is strictly prohibited. Nothing in this podcast is intended as legal accounting or tax advice, and is for informational purposes only. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. This podcast may reference links to websites for the convenience of our users. Our firm has no control over the accuracy or content of these other websites. advisory services are offered through Fit financial consulting LLC, an investment advisor firm registered in the states of Washington and Colorado. The presence of this podcast on the internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute, follow up or individualized responses to consumers in a particular state by our firm in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant to an applicable state exemption for information concerning the status or disciplinary history of a broker dealer, investment advisor or their representatives. The consumer should contact their state securities administrator

Chris Holling: 55:37

they go Why do crabs never give to charity? Because they're shellfish

Sean Cooper: 55:51

We're on track? That was the determining factor

Chris Holling: 55:58

I didn't say was the right track. It's just a track