By Jason Oshins, Financial Advisor, MBA
Imagine your favorite epic film of all time – Superman, Godfather, Star Wars, or, if you ask your teenage daughter, Hunger Games. Each film draws you into a journey that only can be appreciated as a sum of many crucial parts unveiled methodically. Now imagine kicking back with your overly-buttered popcorn, being told by some sensory overload graphic to silence your cell phone, and watching your film, only to have the reel break after twenty minutes. Would you leave the theater with a full appreciation and understanding of the film’s brilliance? Absolutely not. Similarly, people view life insurance in a vacuum as opposed to one component of a larger strategy.
Life insurance is one of the most misunderstood elements of planning. We’ve all heard advisors extol the virtues of buying term insurance and investing the difference, emphasizing the opportunity for superior return in the market. This doesn’t tell the whole story. It stops at, well, the part where baby Superman gets catapulted into space inside an egg-like craft while his planet Krypton self-destructs. At best, it demonstrates a flawed understanding of “macro” planning, which accounts for the various moving pieces along with the interaction among these pieces. In a future article, we will address how the death benefit can enable access to much greater cash flow during retirement. With term insurance, the death benefit goes away when the policy lapses; with whole life insurance, this isn’t the case. For now, however, we’ll focus on assessing the “buy term and invest the difference” argument, putting aside the power of the death benefit and instead focusing exclusively on the cash value and its reverberations. This article constructs an intellectually honest analysis of the life insurance’s true rate of return (ROR).
Traditionally, the assessment goes like this – money invested in the market will offer a larger return than life insurance’s cash value. Flawed out of the gate, this viewpoint refuses to sit through the whole film. Sit back, silence your cell phones, indulge in your overly-buttered popcorn, and allow us to offer a true assessment of life insurance’s return, without cheating you out of the ending. To do this, we’re going to apply a three-part framework, as follows:
- Part 1: Cash value… we begin with the internal build-up inside the life insurance policy; growth is unencumbered by annual taxes1, so long as the policy remains in force;
- Part 2: Cash value + term savings… we add the money saved by avoiding term premium payments, as these payments no longer are necessary given the acquisition of permanent insurance;
- Part 3: Cash value + term savings + tax savings… we add the money saved by reducing taxes, as properly-funded2 whole life3 insurance doesn’t trigger annual taxes; this is not the case with mutual funds4, for which investors receive a 1099 each year.
For the purposes of the analysis, our client is a healthy 35 year-old male who obtains a $1,000,000 life insurance policy. In the first scenario, he purchases a 30-year term policy for $1,000 per year. Additionally, he invests $13,000 in the stock market. We’ll assume a generous 8% annual rate of return, year in and year out, in which case our client significantly outperforms the average investor in equity funds, who earned an annual ROR of 3.69% over the last 30 years, according to the most recent study from Dalbar5. For the second scenario, our client will make just one different move. Rather than putting the $13,000 savings allocation into the market, he uses it to acquire a whole life policy6. He then takes the $1,000 otherwise allocated to purchasing term insurance – which no longer is necessary – and invests it in the stock market. For these recaptured dollars, we’ll assume a 6% ROR net of taxes. We’ll apply the same assumption for the taxes avoided in this scenario. While the numbers change depending on the insured’s age, the framework applies irrespective of the age.
PART 1: CASH VALUE
We’ll start with the cash value, the internal build-up of money unburdened by taxes. This is the film’s opening sequence; so much is missed if the viewing experience ends here. Many focus exclusively on the policy’s cash value, ignoring the other rippling saving components, which this analysis will address shortly. For the first part of our assessment, we’ll begin – where the other viewpoint ends – with this as the foundational component of the analysis, acknowledging that more, much more, is yet to come.
We’d be remiss to disregard another notable flaw in the standard analysis. Typically, the comparison ignores the difference in risk between a mutual fund and the cash value in a life insurance policy7. Cash value doesn’t decrease; it’s built on guarantees and augmented by annual dividends. This is fundamentally different from an investment, which swings wildly from positive to negative, depending on the year. As such, the return in the first scenario is significantly riskier than that in the second scenario. Nonetheless, the ROR of a whole life policy still is healthy, even when the assumptions are stacked against it by comparing it to this far riskier alternative.
Using our healthy 35 year old, the policy’s cash value alone results in:
PART 2: CASH VALUE + TERM SAVINGS
In the next part, we address the term insurance component. If our client purchases whole life insurance, does he still need to acquire temporary insurance to cover the $1,000,000 death benefit? Absolutely not. As such, we recapture the annual $1,000 term cost he now avoids, along with all its future growth. To reiterate, we’ll assume a rate of return of 6% net of taxes on this recaptured money. As you can see below, we are now settling into the growing plot and developing characters of our film. We nurse our supersized drink for fear of missing the coming scenes due to a necessary bathroom break. We are beginning to appreciate the developing sum of the parts.
After parts one and two, we’ve established that whole life insurance provides a long-term ROR competitive to that enjoyed by the average investor invested in mutual funds. Let’s see what part three reveals.
PART 3: CASH VALUE + TERM SAVINGS + TAX AVOIDANCE
Taxes – I’m yet to meet somebody who likes paying them. They certainly provoke strong feelings. It’s only fitting that our analysis concludes with this provocative subject. If our client allocates savings to whole life insurance, does he still trigger taxes on these dollars? Absolutely not. When money is in the market, what does the IRS expect to be paid at the end of the year? That’s right… taxes. Investors receive a 1099, and they pay taxes based on their investments’ activity and performance. A properly-funded whole life insurance policy grows unencumbered by taxes – not a penny goes to Uncle Sam.
By making a single move, putting the $13,000 savings allocation into whole life insurance instead of the stock market, our client significantly flattens his taxes. Over time, as we see, these taxes are of great consequence. Moreover, in addition to the extensive year one tax savings, our client benefits from the annual growth of this additional money. When we add these tax savings to the cash value and the term savings, we see that the life insurance has no reason to apologize.
Superman, Godfather, Star Wars, and the like are favorites from generation to generation. For each film, every scene builds on the prior to unveil a powerful story, and only when viewed in its entirety can the film’s true brilliance be appreciated. The same is true for life insurance. Typically, the “term and invest the difference” analysis disregards key components, essentially telling an incomplete story. This article remedies that flaw, presenting a more appropriate framework. By including the term savings and tax avoidance, the ending is dramatically different. The resulting rate of return is competitive with a far lower risk profile. But the true power is in the death benefit. In the first scenario, it goes away when the insured is 66. In the second scenario, however, this isn’t the case. Stay tuned for a future article in which we’ll focus on how a guaranteed wealth replacement mechanism – the death benefit – can unleash the ability to enjoy significantly more wealth during retirement.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. The information provided here is believed to be reliable but should not be assumed to be accurate or complete. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. All investments involve risk and may lose value. Past performance is not a guarantee of future results.
 Guardian, its subsidiaries, agents, and employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.
“Properly funded” means the policy is funded below MEC limits.
 Whole life insurance is intended to provide death benefit protection for an individual’s entire life. With payment of the required guaranteed premiums, you will receive a guaranteed death benefit and guaranteed cash values inside the policy. Guarantees are also based on the claims paying ability of the issuing insurance company. Dividends are not guaranteed and are declared annually by the issuing insurance company’s board of directors. Guardian has paid a dividend every year since 1868. Any loans or withdrawals reduce the policy’s death benefits and cash values, and affect the policy’s dividend and guarantees. Whole life insurance should be considered for its long term value. Early cash value accumulation and early payment of dividends depend upon policy type and/or policy design, and cash value accumulation is offset by insurance and company expenses. Consult with your Guardian representative and refer to your whole life insurance illustration for more information about your particular whole life insurance policy.
 Non-qualified investments generate taxes each year; qualified investments result in deferred taxes. The analysis assumes a non-qualified investment.
 Dalbar, Inc. is “the financial community’s leading independent expert for evaluation, auditing, and rating business practices, customer performance, produce quality, and service”. Published in 2014, its most recent Quantitative Analysis of Investor Behavior” shows that investors’ average annual return in equity funds is 3.69% for the past 30 years and 5.02% for the past 20 years, substantially underperforming the market.
 This is a hypothetical whole life illustration and is not representative of an actual Guardian whole life insurance policy. This hypothetical illustration is intended to show, in general terms, how a typical participating whole life insurance policy might work. The values are based on Guardian’s current annual dividend, which is not guaranteed and declared annually by Guardian’s Board of Directors. If purchase of a Guardian whole life insurance policy is being considered, a full illustration with guaranteed values and other important information must be provided.
 Risk is measured by standard deviation. For context, the standard deviation of the S&P 500 from 1973 to 2012 is 18.13. The standard deviation of US Treasury Bills, a proxy for life insurance’s cash value, is 3.35 over this same period. Source: Matson Money, Inc.
ABOUT THE AUTHOR
Jason Oshins is a Financial Advisor with Wealth Strategies Group. He works closely with clients throughout the country to increase wealth during lifetime, improve income during retirement, and provide a greater legacy upon passing, while also protecting their estate from taxes, inflation, and market volatility. He specializes in the areas of estate planning, investments, retirement planning, insurance planning and design, disability protection, long-term care, wealth transfer, and business planning. Jason obtained his MBA from the University of Michigan in Ann Arbor. He can be reached at (702) 735-4355 x218 or at [email protected].
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS) 6455 S. Yosemite Street, Suite 300, Greenwood Village CO 80111, securities products/services and advisory services are offered through PAS (303-770-9020). Financial Representative, The Guardian Life Insurance Company of America (Guardian), New York, NY. PAS is an indirect, wholly owned subsidiary of Guardian. Wealth Strategies Group is not an affiliate or subsidiary of PAS or Guardian.
PAS is a member FINRA, SIPC
2014-8938 Exp. 7/16.
OTHER ARTICLES IN THIS ISSUE
- MARKETING: “More Clients, Better Clients” by Joseph J. Strazzeri, J.D.
- LIFE INSURANCE: “Some Magical Aspects of Life Insurance” by Jonathan G. Blattmachr & Matthew D. Blattmachr
- TAX PLANNING: “Tax Alpha®: What Sophisticated Counselors & Advisors Needs to Know” By Robert S. Keebler, CPA, MST, AEP (Distinguished), CGMA
- PRACTICE-BUILDING: “A Monthly Meeting You’re Not Allowed to Miss” by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
- ASSET PROTECTION: “Why Offshore Trusts Do Make Sense (A Brief Story)” by Jeffrey M. Verdon, J.D.
Image courtesy of Stuart Miles / FreeDigitalPhotos.net