All types of insurance policies including auto, home, disability, and life are designed to protect against a loss and make the insured ‘whole’ again. A loss of transportation, loss of shelter, or loss of income are common examples of a loss, and the insurance coverages associated with these are designed to replace your car, repair your home, or replace your income.
Life insurance is a unique insurance in that it doesn’t benefit you, but rather your family in the event of a premature death. There are a lot of emotions tied to life insurance, which in many cases can lead to consumers obtaining insurance policies that may be ‘suitable’ but not in their best interest. We’ll explore the difference between a suitability standard of care and fiduciary standard of care later in this article, but first let’s define what is whole life insurance.
Whole Life Insurance
Whole life insurance is a type of policy that covers you for your whole life, hence the name. This is in contrast to term life insurance, which provides coverage for a specified term (typically 10-30 years).
Whole life consists of two components: death benefit and cash value.
A portion of your monthly premium for a whole life policy goes toward paying for the death benefit. The death benefit is what would be paid to your beneficiaries in the event you unexpectedly pass away. Term life insurance only has a death benefit component.
Another portion of your monthly premium goes toward funding your cash value, which is basically an investment component added to the insurance policy. The portion of your premium designated toward your cash value is invested by the insurance company to earn interest while the policy is in place.
How does whole life insurance work?
Whole life insurance typically comes with level premiums, meaning the premium amount you pay should remain the same for the life of the policy, which remember continues for your whole life, or age 100 in many cases. As long as premiums are paid, the death benefit will be paid to your beneficiaries at your passing. If you stop paying premiums, your policy may lapse and you will no longer be insured.
While the policy is in place, your cash value component continues to grow as well. The portion of the premium designated for the cash value is added, and the investment returns contribute to the growth of the cash value too. Investment returns for whole life policies are guaranteed, but often are low around 3-5% (compared to the S&P 500 which has earned 9-10% average annually since its inception).
The selling point for most insurance agents is the ability to borrow against the cash value tax-free. Whether you need money for college, a child’s wedding, or home repairs you can access the cash value of an insurance policy quickly and tax-free. This may sound like a great option, but this is still considered a loan. The loan you take is borrowed against the policy itself and accrues interest. Failure to pay the loan back could result in the loan exceeding the cash value and causing the policy to lapse. Any unpaid loans would also be deducted from the death benefit should the insured pass away before the loan is paid back.
Issues with whole life policies
For starters, insurance salespeople typically lead their sales pitch by highlighting the investment features of a whole life policy. But as mentioned above, life insurance should be designed to protect against a loss, not be an investment account.
Secondly, because of the cash value component, premiums are often 2-3x higher for whole life policies than they are for term policies. The insurance company is charging a fee to ‘manage’ your investments, which erodes the expected returns of the cash value over time.
Thirdly, after the cost of insurance and cash value, a portion of the monthly premium goes toward sales and administrative expenses. These costs are typically very high in the beginning years of the policy which prevents the cash value from accumulating but also imposes what are referred to as surrender changes. Surrender charges are fees paid when trying to cancel a life insurance policy before the insurance company has recouped the costs of sales, advertising, and commissions to the insurance agent. These surrender charges can last 10-15 years meaning if you try and cancel the policy before this time, you will get back less than what you put in.
Lastly, the majority of veterinarians are better off investing their savings in other tax advantaged accounts, such as a 401k or Roth IRA, than they are paying higher premiums for a whole life policy.
For example, assume you have $200 to spend on life insurance each month and can choose to purchase a $1 million term policy for $100 a month or purchase a $1 million whole life policy for $200 a month. You choose the term option and invest the remaining $100 a month into a target date fund within a Roth IRA with an average 7% annual return adjusted for inflation.
After 30 years, you would have $119,260. By choosing the whole life policy instead and earning 4%, your cash value would only equal $69,510.
Why are whole life policies sold to veterinarians?
One reason primarily. Insurance agents are paid on commissions, meaning their pay is tied directly to what they sell. Whole life policies and other types of permanent life insurance policies pay much larger commissions than term policies, so it is in the insurance agent’s best interest to sell you a product that earns them higher commissions. Commissions are typically tied to premiums, so the higher the annual premium the higher the commission. Veterinarians graduate from vet school with higher average incomes than most college graduates and the ability for increasing income potential, making veterinarians a target for insurance salespeople.
This is where it is important to discuss the suitability standard of care vs. a fiduciary standard of care. The suitability standard of care states that as long as a product is suitable for one’s needs, an insurance salesperson can recommend an investment that is more costly and generates a higher commission than a similar low-priced option. A fiduciary standard of care legally obligates a professional to act in the best interest of the client.
Consider this scenario. You need $500,000 in life insurance. You approach a life insurance agent who recommends a whole life policy with a $500,000 death benefit and the cash value feature. This policy, while suitable for your needs, may not be in your best interest as the higher premiums require you to sacrifice other savings. A professional who follows the suitable standard of care is allowed to recommend and sell this product, earning a higher commission in the process.
A professional who follows the fiduciary standard may review your entire situation and recommend it is in your best interest to obtain a $500,000 term life policy, using the savings in premium you would have paid in a whole life policy to bolster your emergency fund or max out your retirement plans. Basically, there is a much lower conflict of interest with the fiduciary standard of care.
Why Veterinarians Don’t Need Whole Life Insurance
Life insurance is a necessity for most individuals, particularly those who have loved ones that depend on their income. But the need for a life insurance policy that lasts for an individual’s whole life is often unnecessary. Life insurance only really needs to be in place as long as there are significant financial obligations the remaining spouse or dependents couldn’t handle by themselves. Odds are, as a financially responsible veterinarian, you most likely won’t have a need for life insurance when you are 75. Your home may be paid for, your children are self-sufficient, and your savings should be enough to sustain your surviving spouse even if you pass away unexpectedly. You won’t have any income that needs to be replaced, which is the primary reason for obtaining life insurance in the first place.
Purchase term policies to protect your family and invest the rest in other tax advantaged ways.
When A Whole Life Policy Makes Sense
There are a few instances where a whole life or permanent life insurance policy can make sense.
Dependent with Special Needs
If you have a dependent with special needs and you want to ensure their care for when you pass, a permanent policy can make sense. It is advised to speak with a qualified estate attorney who can work with you to have the proceeds go for the care of the dependent without disqualifying them for government benefits
In 2021, the current estate exemption is $11.7M per person, and $23.4M per couple. If you anticipate your estate exceeding this amount, a permanent policy can help with providing liquidity at death to help pay for estate taxes, which can exceed 40%. This is popularized by the Irrevocable Life Insurance Trust (ILIT) and you should consult a qualified estate attorney when considering this option. The estate exemption is also subject to fluctuation (it was only $5.45M/person in 2017) so it would be wise to continually re-evaluate your need for estate liquidity.
If you own a business with other partners, a buy/sell agreement funded with permanent insurance can help ensure the transfer of assets in the event of the passing of a partner and assist with business continuity.
Loss of Pension
Pensions are no longer as common as they once were, but many retirees still rely on pension income to fund their retirement. If a pension does not offer survivor benefits, when the pension holder were to pass away so does the guaranteed income stream. This can affect the surviving spouses retirement, and thus a permanent policy can help mitigate this loss.
Maxed Out Other Accounts
If you are able to max out your employer retirement plan, IRA or Roth IRA, fully fund your emergency reserves, college savings, and future goals (home down payment, practice purchase, etc.), then considering a permanent policy could help add an additional investment vehicle for you. This would need to be factored into your overall financial plan.
Veterinarians are a popular target for insurance salespeople. Before signing on the dotted line, consult with a fiduciary financial planner who can discuss all of your options and make recommendations based on your entire financial picture while acting in your best interest.
Andrew Langdon is a CERTIFIED FINANCIAL PLANNER™ and the founder of VetWorth, a fiduciary fee-only financial planning firm dedicated to serving the unique needs of veterinarians and their families.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Andrew Langdon, and all rights are reserved. Read the full Disclaimer.