Take the Money and Run

Let’s assume that Eli and his wife, Bracha, are actually not the right candidates for whole life insurance. Let’s see how this plays out: As Eli sees his cash value growing each year, he decides to finally start using it — his daughter Chavi just got engaged, and he and Bracha need to figure out a way to pay for the wedding. However, accessing the money, either by taking a withdrawal or a loan, can be complicated.

Eli and Bracha do a bit of research into the two options. With a loan, they are essentially taking a loan from the insurance company, with the policy’s cash value serving as the collateral. They can borrow up to a certain percentage of the cash value, and like other loans, interest is charged and it accrues over time. With a withdrawal, they would lose some of the eventual death benefit. Loath to lose even a portion of that money, they looked more into the first option, albeit warily.

“Hmm… we gotta be careful,” Bracha told Eli. However, they realized taking a loan from a bank would mean paying a higher interest rate than what the insurance company would charge them (the insurance companies typically charge lower rates than banks).

Eli and Bracha decided to go ahead with the loan. Worst comes to worst, they figured, if they would be unable to pay off the loan balance or Eli would pass away before they paid it off, the outstanding amount would be deducted from the death benefit paid out to his beneficiaries.

Eli and Bracha just made a big financial mistake: taking a loan without a clear plan to pay it back or an even clearer understanding of the implications.

Not terribly surprisingly, while Eli and Bracha certainly intended to pay back the loan, they were unable to do so right away. Consequently, their premium payments increased, and after a few years, they didn’t have the funds to continue paying the higher premiums. Next thing they knew, the policy lapsed.

Initially, they didn’t sweat it. “Oh, well, at least we had insurance for those few years and were able to pay for a chasunah.” However, what they didn’t realize was that eventually they would find themselves staring at a tax bill for the amount of the loan (including accrued interest) minus the cash value and premiums paid in. The loan became taxable income and one big headache.

Unfortunately, no one told Eli and Bracha that a whole life policy isn’t just an insurance policy with a piggy bank attached to it. It’s a complicated financial product that comes with significant consequences. If what the couple had really wanted was a permanent life insurance product that have lasted for Eli’s entire life, other types of permanent insurance would have been cheaper. And if they wanted to use the money they paid into the policy to use toward a future chasunah, there probably would have been better financial products and strategies to achieve this goal.

The Right Fit for Whole Life

Whole life insurance is not for everyone, by any stretch of the imagination, but it can be an option for people in the right circumstances. But the “right circumstances” are few and far between and typically involve high net worth individuals with an already large, diversified investment portfolio who fully understand how whole life insurance policies work.

Take our initial example of Dovid and Devora. They added an expensive kind of permanent insurance to their greater investment portfolio in order to add diversification to their already large portfolio. Furthermore, with the help of their financial advisor, they planned to use the policy as another potential income stream in retirement. All of these factors — the need for insurance, the already very diversified investment portfolio, the advice of a seasoned financial advisor, the ability to pay expensive premiums, and the financial planning and tax planning assessments — all contributed to Dovid and Devora’s decision. They also studied the illustration (the page that shows all the anticipated year-by-year policy values that are given to the prospective buyers before purchasing the policy) with their advisor and understood how all the guaranteed and non-guaranteed features worked.

And all this notwithstanding, while buying this policy seemingly wasn’t a mistake considering their circumstances, there were other products that they could have chosen from, such as universal life, that may have been cheaper.

Let’s look at another high-net-worth couple, Menachem and Esther. Menachem, a very healthy 50-year-old, bought a Whole Life 15 Pay policy, in which he only has to pay $50,050 per year for 15 years, without missing an annual premium payment. While this premium payment is expensive — and much higher than other insurance — he and Esther, with the help of their financial advisor, figured out a plan of how they would pay these premiums in a way that made sense, both from a tax perspective as well as a financial one.

When he initially bought the policy, it guaranteed him a growing cash value as well as a $1 million death benefit through age 120, as long as he paid the 15 years of scheduled annual premiums. However, they also planned that once Menachem turned 70, they would take $118,000 per year as income for ten years, in the form of a loan, to fund their retirement years, while allowing their other investments to continue growing.

In other words, they paid $750,000 in premiums and withdrew $1.18 million (which came with tax advantages). The ten-year income stream negatively affected his death benefit and cash value, but upon Menachem’s death at age 95, his beneficiary received a $250,000 death benefit.

Fiduciary Standard vs Suitability: Getting the Most Optimal Advice

Though Asher and Miriam’s kids are still quite young, they decide to be proactive and start saving for their children’s simchahs. One day, Asher’s friend told him that he’d just purchased insurance that he could also use as an investment or savings account in order to fund future chasunahs. He encouraged Asher to meet with his insurance agent to find out more. But is meeting with an insurance agent the best course of action? Or should he and Miriam meet with a financial advisor or RIA (registered investment advisor)?

These two financial professionals may have different approaches to helping Asher and Miriam, because of the different regulatory standards the financial advisor and insurance agent must comply with. Typically, a registered investment advisor, or advisors at investment companies such as Merrill Lynch, have to comply with the fiduciary standard, while insurance agents have to comply with a suitability standard, which is a lower level.

Fiduciary standard is a legal and ethical obligation that requires a person to act in the best interest of another party, typically a client or beneficiary. Meanwhile, a suitability standard means that a financial professional is obligated to recommend investments that are suitable for the client based on factors such as the client’s financial objectives, risk tolerance, investment experience, and financial situation.

In practice, the suitability standard means that as long as an investment product meets the client’s stated investment objectives and risk tolerance, it can be recommended, even if there may be other products available that are better suited to the client’s needs.

Whole life insurance agents are usually licensed insurance producers who are required to adhere to a suitability standard, which isn’t as comprehensive as the fiduciary standard in the investment advisory industry. Insurance agents are generally required to recommend insurance products that are suitable for the client’s needs and financial situation. This means that agents must have a reasonable basis for believing that the recommended product meets the client’s objectives and tolerance for risk, or ability to deal with risk.

However, the insurance agent is not explicitly required to act in the client’s best interest or recommend the very best option that has the lowest fees and highest returns. Rather, they must simply recommend a product that aligns with the client’s needs and financial situation.

Here’s an example of how the two different financial professionals might work with Asher and Miriam. Were Asher and Miriam to meet with a registered investment advisor, he/she would conduct a thorough analysis of Asher’s financial situation, including (but not limited to) income, expenses, existing investments, and risk tolerance. The advisor would develop a plan including a combination of investment strategies designed to grow Asher’s savings over time while minimizing risk.

After giving his recommendations and implementing them, the advisor would provide ongoing monitoring and management of the couple’s investment accounts, regularly reviewing investment performance and making adjustments as needed to stay on track toward the savings goal. As a fiduciary, the advisor is legally obligated to act in Asher’s best interest and prioritize his savings goals above his own, along with fully disclosing any conflicts of interests and providing ongoing support. The advisor needs to provide the very best option for Asher, not simply an option that fits the requirements.

How does it look were Asher and Miriam to meet with an insurance agent? While the agent is not held to the same fiduciary standard as the registered investment advisor, he/she is still required to recommend insurance products that are suitable for the client’s needs and objectives. Likely, he would offer savings solutions through life insurance products. The agent would provide the couple with several options, including (perhaps) a whole life insurance policy with cash value accumulation features. The agent would emphasize the whole life policy’s ability to provide tax-deferred growth of cash value, which can serve as a savings vehicle for future big ticket expenses such as chasunahs. The agent would disclose information about the policy’s premiums, fees, surrender charges, and potential risks to ensure that Asher and Miriam have a clear understanding of the product.

In contrast though, the investment advisor might have reservations about recommending a whole life insurance policy for future big ticket expenses, as it may not be considered the most optimal strategy for meeting Asher’s and Miriam’s goals due to the higher costs of whole life insurance, tax considerations, lack of flexibility, and the restrictions involved with accessing the cash value. Unfortunately, the complexity of the product (the interaction between premiums, cash value growth, dividends, and policy loans) can make it difficult for clients to fully understand the product and its implications, which is why people sometimes invest in it instead of other, more suitable options.

10 Pay And Done?

Some people purchase whole life insurance policies in which, instead of paying premiums every year, they can create a policy in which they only pay premiums for a specific amount of years. In other words, even though the policyholder stopped paying annual premiums after a specific amount of time, the insurance policy can stay active through age 100, with cash value continuing to grow even after the premium payments stop. These whole life products typically have “10 Pay” or “15 Pay” in their product names, indicating the amount of time the scheduled annual premiums must be paid for. However, are you truly done paying after 10 or 15 years, as the name claims? An illustration of your policy can give you some clues.

Look at the guaranteed side of the illustration — do premiums truly stop after a certain amount of time and never start again? Sometimes an insurance agent will add a rider onto the policy to make the death benefit much higher than it’s supposed to be. Due to the high cost of these riders, premiums on these “10 Pay” or “15 Pay” policies may stop, but then start again 20 years later, at much, much higher amounts.

Forced Savings or Forced Spending?

Many people are sold whole life insurance as a way to be forced into saving for the future. “You get a life insurance policy and you’re forced to save for the future!” is a common sales pitch. However, whether it’s the most suitable option for saving for the future depends on individual financial goals, preferences, and circumstances.

While there are advantages to whole life insurance, including being forced to save and accumulate cash value, there are other vehicles that could be more suitable for saving for the future, including ones that offer better returns, more flexibility, and lower fees.

For those contemplating purchasing whole life insurance primarily for the forced savings aspect, it’s crucial to carefully weigh the pros and cons in order to understand if this product is truly right for you. Strong consideration should be given to alternatives such as combining a brokerage account with term life insurance to achieve similar objectives with potentially greater flexibility, access to cash that’s not tied up with an insurance company, and cost-effectiveness.

What to Do with Dividends

If a whole life insurance policy is considered to be “participating,” then the policyholder can “participate” in receiving a portion of the insurance company’s surplus earnings, also called “dividends.” These dividends are not guaranteed and are typically based on the financial performance of the insurance company’s investments (assets such as bonds, mortgages, and other fixed income securities); its overall financial health; and the overall experience of its policyholder pool (such as mortality, policy lapses, claims, etc.).

In other words, just as stock shareholders of Coca-Cola may receive dividends based on the company’s profitability and performance, policyholders of participating whole life insurance policies may receive dividends based on the insurance company’s financial success and investment performance.

What are dividends used for? Policyholders have the option to receive dividends in cash, use them to purchase additional paid-up insurance, offset premiums or make them smaller, or leave them to increase the cash value.

While dividends offer valuable benefits, it’s crucial to recognize that historical data, such as Mass Mutual’s 40-year dividend history, indicates a downward trend. For instance, dividends have decreased from 12% in 1984 to approximately 6.1% presently. New York Life also has a downward trending dividend record from 10.25% in 1989 to 6% in 2024.

Real Estate Riches: Leveraging Insurance

Real estate investors have also been known to use permanent insurance, like whole life policies, to provide themselves quick access to cash, explains Dimitry Farberov, CFA, CFP, Director at Miracle Mile Advisors in Los Angeles, California.

“Ultra-high-net-worth real estate investors leverage their permanent insurance policies for liquidity when traditional lending sources offer less favorable terms,” he explains. “The cash value in these policies can provide a quick and efficient source for a down payment.”

For example, says Farberov, look at 2008. The lending environment was cut off by banks, but real estate prices were cheap and rapidly creating a lot of opportunities for investors. These properties were being sold at pennies on the dollar. Many people were asset-rich but didn’t have liquid cash at the time. The real estate investors with policies that contained a large cash value were able to pull out the cash to buy a property and then once there was a rebound, they refinanced and put the money back into their policy.

“Investors were able to access the money overnight,” he says. “Loan rates from insurance companies were and are typically the lowest in the industry. Also, the interest on the loan is tax deductible. Ultimately, you’re just paying yourself back.”

Estate Tax Strategies

Permanent insurance can also be used as a part of a strategic tax and estate planning strategy for ultra-high-net-worth individuals, especially those with large illiquid estates. Illiquid assets refer to assets that are difficult to quickly convert to cash without significant loss. This includes real estate, ownership stakes in privately held companies or partnerships, collectibles, and even trusts that have restrictions for distributions.

The estate tax is currently above $26 million per couple. This means that every dollar above that exemption amount is taxed at 40 percent. “This is very challenging for ultra high net worth families in which their wealth is tied up in real estate or business,” comments Farberov. He gives an example of a couple, a 73-year-old husband and 65-year-old wife. They have an illiquid estate valued at $60 million. If they both pass away today, every dollar above $26 million will be taxed at a massive tax rate. What if it’s a bad economic environment and the family doesn’t want to sell these assets at such a discount to pay the estate tax?

The couple can plan for this event by using the high revenue from their business to fund a permanent life insurance policy owned by an irrevocable life insurance trust (which is outside their estate). They can pay $305,000 per year in annual premiums. When the second spouse dies, the estate gets a $15 million death benefit to pay for the estate taxes. This policy was designed for the permanent, guaranteed death benefit.

“Insurance is one of the few, if only, vehicles that you can buy that create immediate leverage and liquidity outside of the estate,” Farberov says, adding that while the estate is $60 million now, if the couple lives another 20 years, it can grow up to $80 million. Further, by paying the premiums during the lifetimes, they can also reduce the estate each year by $305,000.

(Originally featured in Mishpacha, Issue 1011)