Six years ago, when one of my clients sent me a video of Suze Orman’s opinions on using whole life insurance for college planning, I realized Suze was quite passionate and made several fervent claims and accusations. The two that struck me the hardest were:
“That person is not an advisor, he is a salesperson, never talk to him again!”
“Did you ask him about all the fees and historical returns in that life insurance policy?”
She concluded with her regular coined statement in which she vehemently states to never, ever buy life insurance for investment planning and especially not for college planning purposes. To be honest, that was not the first time nor the last time I have had a client send me a video or an article questioning my recommendation on using life insurance for college planning.
Truth be told, I don’t blame clients for questioning my advice or recommendations. In many situations my strategies are a new concept for them, and if I were in their shoes I would be doing my own research as well.
Dave Ramsey is another popular financial planner I have often received articles and opinion pieces on. He is often quoted regarding why owning a 529 while buying term and investing the difference is better for college planning.
At first I felt personally attacked and offended by Suze’s opinions. My initial strategy was to explain to my clients how Suze and Dave are trying to appeal to the general masses so they can sell more of their books, be hired for future speaking appearances, and have an increase in TV ratings so more advertisements will be hosted on their shows. While all of this is true, the more I thought about Suze’s statements on fees and returns in regard to whole life insurance, I began second-guessing myself and considering the fact that Suze could be right. Then, out of the blue one day, my wife looked me in the eye and asked me what the fees and returns on a whole life policy over the past 20 years would actually have been. I froze—she had asked me the dreaded question. I remember mumbling “I think around 2 percent in fees and 6 percent returns?” She said, “Okay, can you show me?” When I told her I couldn’t, she asked, “Why?” Without thinking I muttered something resembling “guarantees good, market bad.” She walked out of the room unimpressed. It was then that I started actually believing that Suze and Dave could be right.
It finally dawned on me that after all this time I have been asking my clients to trust both the insurance carrier and me based on a handshake, without any proof of how returns are calculated or fees assessed to the policyholder. I have to be honest. I love investing in the market, all my clients, my friends, my family and colleagues all invest part of their portfolios in the market; but I can’t imagine investing in a fund or portfolio that did not disclose all the fees or past historical returns. Even though the information can be difficult to find, it is still obtainable by law. Unfortunately, that’s not the case for many types of permanent life insurance. For example, I’ve tried asking several of the whole life insurance carriers that I work with for their policy fee schedule, how dividends are actually calculated, and most importantly, how the dividend returns are assessed to the policyholder. I have spent close to eight years trying to get such a report without any success.
After attending numerous conferences I am able to recite various catchy mantras like “Guarantees good, market bad,” “Suze and Dave are owned by the banks, banks are bad,” “Dividends have paid for the past 100 years.” I would often come home after such conventions and find myself repeating the same mantras out loud and around my home. My wife would often question if I had really attended a financial planning workshop or a brainwashing.
The irony is that during those conferences, nobody ever talked about the actual rates of return or how dividends are calculated or assessed to the policyholder. If during the training any audience member ever asked such a question about the fees or how dividends are calculated, the presenter would simply repeat one of his many mantras. Fortunately, I learned early in my career about the benefits of full disclosure regarding permanent life insurance, and thus when an educated client is in a position to relegate a large sum of money to a college funding plan and asks, “How are the rates of return calculated into this plan?” answering that “guarantees good, market bad” often does not hold much water and ultimately will not lead to the sale.
One of the major advantages of using a permanent life policy over a 529 is the expected family contribution (EFC) implications. I truly believe that Suze nor Dave have never helped a client fill out a free application for federal student aid (FAFSA) form or helped select colleges for their clients. If they had, they would have realized that all colleges will require 529s to be used first before any financial aid will be awarded. Also, what happens if the college-bound student changes his mind and decides to take a different path rather than attending college? Liquidating the gains in the 529 becomes a fully taxable and penalized event.
Although the life insurance funding strategy can be applied to most families that can qualify for EFC aid, what about high income families with high assets that can pay for college with cash flow and do not qualify for any financial aid? Unfortunately, many insurance agents marketing college planning services only focus on sheltering assets for the EFC instead of looking beyond and becoming a true planner. In many cases the agents are not truly college planners and are only designing the policies for the benefit of their own checkbooks, not for what is in the best interest of their clients. Again, this is why Suze and Dave are not entirely wrong. Buying term and investing the difference is better. About six years ago I made the switch in my college planning practice to using full disclosure index universal life insurance products. I learned that if I designed the IUL based on the seven pay guidelines and up to the modified endowment contract (MEC) limitations as defined in section 7702 and 72e of the Internal Revenue Code, the overall cost was nearly insignificant over a 15-20 year period, particularly when compared to other, more popular investment vehicles. I then started making a big change and decided to start all my initial college planning funding appointments by addressing the fees first.
I compared my college funding plan to a traditional asset portfolio charging a 2 percent annual management fee. When I show the numbers I explain how the expenses for my funding plan are front loaded and, to be frank, my funding plan fees are going to be higher for the first 10 years. Then I show the client the break-even point. This is where my funding plan and the traditional asset portfolio cost have leveled out, typically around the 12th to 15th year, depending on the client’s age and health. Around the 20th year, on average, my college funding plan is about half the cost of the traditional asset portfolio, and by the 30th year my college funding plan is about 40 percent of the average cost of a traditional asset portfolio approach at a 2 percent annual fee. I then show the clients a report that compares other popular financial vehicles to my college funding plan. I show the same money coming out to pay for college and then I show money coming out during their retirement years. All of the financial products and options will be able to pay for college. The big difference is that during the retirement years the other financial products and options run out of income, while my college funding plan sustains well past life expectancy and even past age 100. I always give a full disclosure that my college funding plan is truly only beneficial if the client is planning to keep it for the long haul. If for any reason the clients think they might want to surrender the college funding plan after 8-10 years, mine is not a good option because of the front loaded fees, and maybe one of the other financial products would be a better fit for them. Clients are always amazed when they see this report. They often ask how this can be possible. I educate them on how the variable/participating loan feature works and how when they are taking a loan from the policy the accumulation value is still earning a full rate of return based on the selected index crediting option. I further expand on how the annual reset works, as well as option pricing and how that affects caps and spreads. Most important, I explain why I chose that specific carrier. Another typical question I hear is, “Why don’t more advisors sell this product?” I’ll be honest, I believe it’s because of the misperception of the fees. When an advisor designs these funding plans correctly, the fees are a fraction of what a typical fee-based advisor will make over a 10-, 20- or 30-year period. That’s why it’s so rare for any financial planner, when selling a security product, to select an A share option. They know they will be paid a lot more over 10 years if they pick a C share option.
For the most part, Suze and Dave are correct when it comes to most permanent life insurance policies. But there are a few select companies out there that provide full disclosure fee reports, historical returns over the past 20 to 30 years, and how those returns are calculated and assessed to the policyholder. When designed correctly, an IUL is a perfect and cost-effective college funding vehicle and should be included in a client’s balanced portfolio.
The true test would be finding out what Suze and Dave would do if presented with an actual full disclosure IUL report. Would they then acknowledge the benefits of having an IUL as part of a client’s balanced portfolio? Or would the argument stay true that Suze and Dave are only loyal to their personal investors and do not watch out for what is truly best for the clients? I am looking forward to having that conversation with them someday.