Are whole life insurance annuities a scam? In one word . . . yes, but also a little bit of no, and a little bit of maybe.
Good Morning and welcome to the Steven Carlson, of course it may not be morning for you when you are watching this, but it is “very” morning for me. 5:27am on a Saturday morning to be exact, yes, I am one of weird people that loves mornings. Anyways, like I was saying, welcome to the Steven Carlson Show, I’m Steven Carlson.
I’m sure you have heard it before, Wall Street is like a Casino, and only the wealthy make money, normal people like you and me just get slaughtered.
The problem with this mindset is throughout the past 100 years every significant drop in the stock market has fully recovered all loses and turned profitable in less than five years. So as long as your investment strategy is for longer than five years, you can make an average of 7% annually.
More importantly who is the person giving you the advice to stay out of stocks and instead purchase a life insurance annuity policy? Are you being told that by your insurance broker?
What alterative motives, if any, do they have? Or are they only trying to sell you on the “safe investment strategy” of life insurance annuities so they can make their hefty sales commission?
If you listen to their sales pitch it sounds amazing: “guaranteed payments for life, no matter what happens in that risky stock market.” On the surface that sounds great, but once you dig into the numbers you quickly see how bad of a deal annuities are for almost all people.
There are a few very unique situations where annuities may be helpful, such as parents providing for a special needs child that will require medical care for the remainder of their life, etc. But for most people, annuities are a bad idea and I’ll explain why.
But first, please smash the like button and subscribe to this channel. Doing so really helps with the YouTube algorithm. Also, I’d love to hear from you if you already have an annuity, comment down below.
If you’re unfamiliar with whole life annuities, the basic concept is: you give an insurance company your money and in return they pay you an income stream, for the rest of your life. In some annuities, if you die before you’ve received all of your money back, sucks to be you. The insurance company keeps the money.
I’m not making it up, for many policies that is how it works. Of course, there are also plenty of annuities where that’s not the case. Family members can receive cash back or even continued monthly income after your death — but you pay extra for that.
The stupid thing is annuities are sold to you by using “fear” that the stock market is a gamble. Yet, in reality an annuity is basically a gamble as well. You’re making a bet with the insurance company that you’re going to live longer than they think you will.
They take your money, invest it in the stock market themselves, and they give you a very small portion of the profit they make off your investment.
Yes, you heard me right. They take your money, they invest it, and they give you a small percentage of the profit, while they keep the rest of the profit.
Of course, they are guaranteeing a specific return to you, so if the stock market has a bad year, you still get paid. Like for example how the fears about the Coronavirus dropped all of the major indices nearly 13% in three days this week.
But they know statistically, while there may be a year or two that is bad, over your entire lifespan the market will be up and the insurance company will profit.
Annuities are such terrible investments that just after the US Government passed a law in 2016, specifying that financial professionals had to act in their client’s best interest, sales of annuities fell 8%. They slid an additional 18% in the first quarter of 2017, and have continued to fall since.
A $500,000 benefit policy, your broker usually makes between 2-7% of the total up front, so in this case he could have made up to $35,000 as his fee for convincing you to sign on the dotted line.
So how exactly does an annuity work? In the most basic form, you pay a monthly premium to your insurance company, for example: $500 per month.
Part of that is allocated to the “costs of providing your insurance” and some of it is allocated to the “Cash Value”, this is where the insurance company invests part of your money tax-deferred.
This Cash Value account pays you a dividend around 4-6% per year.
The purpose of the Cash Value account is to offset the cost of providing you insurance as you get older without changing the monthly premium cost you are required to pay.
How about we break these numbers down with an example:
Let me introduce you to two sisters, Suzy and Stephanie. Like most siblings sometimes they are best of friends and other times they are at each other’s throats.
This is one of the times where the sisters cannot agree, they each want an insurance policy with a $500k death benefit, but they cannot agree on which one to get, term or whole life?
Suzy purchases a whole life insurance annuity and pays approximately $563/month, but part of her monthly premium goes towards her Cash Value and she expects to get paid a dividend of 5.5% per year. Not bad right? Well . . . the problem is you are not paid 5.5% on the whole $563/month, only on her Cash Value. Based upon a recent study the average annuity paid out closer to 2% of the total premium amount.
Thirty years later Suzy would have paid in $202,680 in total premiums, but her Cash Value account will have a balance of almost $250k. So, she “made $50k” . . . right?
Well let’s take a look at her sister Stephanie. Once again, she also has a life insurance policy with a death benefit of $500,000, but her policy was a 30-year term life policy and her monthly premium is only about $52/month. After 30 years, Stephanie has only paid in $18,720 towards her insurance.
The 30 year term is up, so she gets nothing, and the insurance company kept the $18k. Wait, that sounds like a crappy deal for Stephanie!
Suzy must have been better off right? Heck, she MADE money, didn’t she?
Not exactly, and here is why:
Stephanie was a little bit smarter than her sister Suzy, and she invested the difference between her insurance policy cost and that of her sister’s annuity policy. In this case about $511/month and she invested that into an fund that tracks the S&P, which averages about 7% return per year.
Now her investment is worth nearly $580,000, when Suzy only has $250,000. This is an over 2x better return.
But that is only part of the story. Remember how I said the Cash Value investments are “Tax- deferred” that is a fancy way of saying, you are not paying the taxes now, but you will pay them when you retire and oh boy will you pay.
The crappy part is annuities are taxed as ordinary income, not long-term capital gains, like any other normal stock investment that you have held for 30 years. Additionally, if you had invested your $511/month in a ROTH IRA, all of your investment is now tax-free. Check out my video on ROTH IRA investments, a link is in the description below.
So, in summary is a whole life annuity policy a scam or bad idea?
For most people, especially those in their 20s, 30s, or 40s, yes it is most likely a waste of money. You would be far better served by investing your money in a wide-ranging index fund that follows the S&P as that will average slightly better than 7% per year growth, even after calculating for inflation if you invest for longer than 10-years.
If you are older or have a unique health situation an annuity may be right for you, but you will need to carefully consider the options to determine if it is right for you.
What should you do if you are already in a poor-preforming annuity term? Well, I am not a lawyer, nor a certified financial advisor, so I cannot provide you advice, but I would suggest you sit down with a qualified financial advisor that you can trust to go over your options.
You may be stuck in a bad deal, as many of these policies have horrible early termination clauses that penalize you 15-25%, plus there may also be tax ramifications of cashing out your tax-deferred benefits early. It is very possible you will have to pay all the taxes now PLUS a 10% tax penalty.
I really hope this video has helped you. Please like & subscribe.