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Following up on the Ernst & Young piece about incorporating whole life insurance and annuities into a retirement plan, we noted that we generally agreed with the observation EY made about whole life insurance and annuities being good substitutes for bonds. We’ve held this belief for a long time. But we should quantify what makes us think this way.
Looking at Vanguard’s Total Bond Market Index Fund VBMFX, I used the Portfolio Visualizer to calculate results for a $10,000 per year investment taking place over the past 20 years (ending at EOY 2020). Here are the results:
Of particular interest here is the calculated Money Weighted Rate of Return (MWRR). This is the same as the internal rate of return. It comes out to 4.25%, which is well within the neighborhood of possibilities for whole life insurance at the end of the same time period.
But also consider that this time frame (2001 to 2020) would have involved whole life insurance with dramatically higher dividend scales than we see today. This means those illustrations that forecast a 4.5% IRR today, were forecasting something much higher back then. In fact, we showed in our real historical whole life results that one company projected and actually achieved an IRR north of 5% in just 10 years.
So, we can plainly see here that whole life insurance can rival the expected rate of return one achieves from the broader bond market during a period of significant interest rate reduction, which bolstered the returns achieved by the bond fund during this time period.
What’s more, if interest rates rise, that could be a net negative for bond investors, while not necessarily being a net negative for whole life insurance policyholders. Whole life holders should expect higher returns versus expectations of today. Bond investors will lose money on book value, but if they hold to maturity they’ll receive the promised income. This assumes that these bond investors are actually holding the bonds they “invest in.” Since the majority of retail investors are not in this boat, they will likely see losses from declines in the bond fund values that they hold.
Notice also that in some years, the account value of the bond investment went down. We see it around 2009, 2013, 2017, and 2019. (there was also a decline that takes place in 2020 when the overall market sold off big time early in the year) The decline wasn’t much and the overall trend is up. But whole life insurance will never experience this decline however modest it may be.
And whole life insurance offers several other benefits:
- Very tax preferential treatment with significantly higher contribution allowances that permitted if buying bonds in a retirement account wrapper
- Liquidity that is far superior to owning individual bonds
- No valuation headache in trying to figure out if the price one pays for a bond is good (what is a fair price for GE debt today? Pick any maturity date you wish)
- No recognized capital gains when a fund manager takes profits
- No income tax liability from the income produced by the bond
- The Infinite Banking Stuff
- A counterparty with one of the healthiest balance sheets in the country
- An asset that banks will take as collateral at nearly 100% of its current value
- A Death Benefit (novel idea)
So with a similar to a better rate of return than bonds and at least nine additional benefits to boot, it’s hard to explain why people opt for bonds over whole life insurance. In fact, when people understand this, they generally hold whole life insurance in high regard against bonds.
There is underwriting, so not everyone can buy in. And other impediments that make whole life less attractive in this case. But if you don’t fall into those unique circumstances, whole life insurance is a wonderful option.