Sandra and James' Story
Sandra and James were struggling to figure out how to save money for their child’s future while also saving money for their own retirement.
They had to make a choice between using a 529 college savings plan coupled with a 401(k) or… using whole life insurance to fund their future financial goals.
Using a 529 plan and 401(k) meant splitting up their goals and possibly risking their future retirement. Using whole life insurance, they would avoid having to choose between their child’s future and their own — they could save money for both financial goals, simultaneously.
The couple’s choice ultimately gave them the freedom to help their daughter while also saving money for their own future, without making any personal sacrifices along the way. It took the pressure off retiring and also gave them peace of mind.
This is their story.
The Problem
Case Study Prepared By David Lewis AKA The Rogue Agent. David is a licensed independent life insurance agent (License No./NPN: 8462895), specializing in life insurance planning and The Perfect Policy™ design concept. He is also the owner of Monegenix®. To learn more about him and his work, read his full bio.
The Plan
James (age 41) and Sandra (age 37) came to me several years ago with an interesting (if not common) problem.
They wanted to start saving money earlier for their daughter, Amelia (age 5), when she was born so that she could go to college or trade school or start her own business. As is usually the case, life happened and they weren’t able to save any meaningful amount of money. At the same time, they realized they were getting older and they needed to start saving money for their own retirement. Sandra wanted to retire at age 65 or maybe 66, and James was undecided, but said he didn’t want to work much longer after his wife retired.
They couldn’t afford to save for Amelia’s future education and alsosave for their own retirement at the same time. This created a problem. They were strapped for time and money, but wanted to accomplish both financial goals. The traditional solution was to try to do both, make some sacrifices on one, or do them back-to-back (save money for one goal, then save for the next goal after that). They decided the only feasible way to do this was to save for one goal, then move onto the next one. So, they started with Amelia.
After meeting with a financial planner, and then with me, they were considering one of 2 different options.
Option 1: The 529 Plan + 401(k)
Most parents save money for their children using a 529 plan. In fact, when James and Sandra went to their financial planner, this is what he recommended they do.
Their financial planner mentioned that annual tuition and fees at a private non-profit college average about $34,000 per year versus $10,000 at a public college or university. But… those costs tend to rise over time as tuition inflation tends to be higher than the average level of price inflation in the United States. And, the exact amount of tuition and fees varies based on what kind of degree the student wants. A medical doctor pays way more for college than someone attending trade school to become an electrician.
But maybe Amelia doesn’t want to go to college. Maybe she wants to become an electrician or… maybe she’ll want to start a business of some kind. The kid is only 5 years old… James and Sandra can’t know what she’ll want when she’s old enough to make that kind of decision. Good thing 529 plans can be used for just about any qualified education expense. The key here is education. Sandra and James can’t use the money to help Amelia start her own business, so the 529 plan kinda pegs her to some sort of higher education route.
They were fine with that at the time and asked the financial planner what they would need to save each month for a reasonable amount of savings by the time Amelia was 18 or 19 years old.
The financial planner told them if they could do $600 per month, that should be a good start. But, he also warned them that they could only use the money for qualified education expenses. If they spent the money on anything else, the IRS assesses a stiff penalty and they would have to pay tax on the money. In addition to putting money away in a 529 plan, their financial planner recommended they buy a term life insurance policy. If Sandra dies before saving up enough money, the policy will pay for Amelia’s college and Sandra’s final expenses. He also recommended a term policy on James for the same reason.
James and Sandra mulled it over.
Between the life insurance and the 529 plan, it seemed like a lot of money. They weren’t expecting to have to save that much, but they also wanted the best for their daughter so they prioritized their spending to make sure they could save that much every month and afford the term insurance premiums. After they’re done saving money for Amelia’s future, they can get started on their own. The financial planner recommended maxing out a 401(k) plan for that, since this is the normal way people save for their future retirement. Waiting even longer to save money for retirement isn’t ideal, but that’s the way it has to be. Since 529 plans and 401(k)s are generally accepted as the “right” way to save money for future needs, the decision almost seemed like a no-brainer.
But, James and Sandra had a second option.
Option 2: Custom Whole Life Insurance
Before signing up for the 529 plan, James and Sandra came to see me, a life insurance agent and advisor. The idea of saving money through whole life insurance isn’t new, but James and Sandra weren’t as familiar with it as they were 529 plans and 401(k)s. So, they (understandably) had lots of questions.
How does this work, exactly? How much can they put into life insurance? How does it compare to their financial planner’s recommendations? What can the money be used for? And so on…
So, I worked up a plan for the both of them, and here’s what it looked like:
| YR | AGE | NET OUTLAY | POLICY LOANS | LOAN BALANCE | NET CASH VALUE | NET DEATH BENEFIT |
|---|---|---|---|---|---|---|
| 1 | 38 | $6,000.00 | $0.00 | $0.00 | $4,796.00 | $247,999.00 |
| 2 | 39 | $6,000.00 | $0.00 | $0.00 | $10,065.00 | $273,105.00 |
| 3 | 40 | $6,000.00 | $0.00 | $0.00 | $15,833.00 | $297,932.00 |
| 4 | 41 | $6,000.00 | $0.00 | $0.00 | $22,308.00 | $322,393.00 |
| 5 | 42 | $6,000.00 | $0.00 | $0.00 | $29,249.00 | $346,520.00 |
| 6 | 43 | $6,000.00 | $0.00 | $0.00 | $36,488.00 | $370,390.00 |
| 7 | 44 | $6,000.00 | $0.00 | $0.00 | $44,163.00 | $394,034.00 |
| 8 | 45 | $6,000.00 | $0.00 | $0.00 | $52,302.00 | $417,485.00 |
| 9 | 46 | $6,000.00 | $0.00 | $0.00 | $60,934.00 | $440,771.00 |
| 10 | 47 | $6,000.00 | $0.00 | $0.00 | $70,072.00 | $463,903.00 |
| 11 | 48 | $6,000.00 | $0.00 | $0.00 | $79,709.00 | $486,889.00 |
| 12 | 49 | $6,000.00 | $0.00 | $0.00 | $89,903.00 | $509,737.00 |
| 13 | 50 | $6,000.00 | $0.00 | $0.00 | $100,699.00 | $532,503.00 |
| 14 | 51 | $0.00 | $25,000.00 | $26,250.00 | $79,724.00 | $507,200.00 |
| 15 | 52 | $0.00 | $25,000.00 | $53,813.00 | $57,449.00 | $479,951.00 |
| 16 | 53 | $0.00 | $25,000.00 | $82,753.00 | $33,709.00 | $450,567.00 |
| 17 | 54 | $0.00 | $25,000.00 | $113,141.00 | $8,476.00 | $418,970.00 |
| 18 | 55 | $18,912.00 | $0.00 | $105,177.00 | $27,990.00 | $444,560.00 |
| 19 | 56 | $18,912.00 | $0.00 | $96,815.00 | $48,558.00 | $470,728.00 |
| 20 | 57 | $18,912.00 | $0.00 | $88,035.00 | $70,314.00 | $497,707.00 |
| 21 | 58 | $18,912.00 | $0.00 | $78,816.00 | $93,332.00 | $525,535.00 |
| 22 | 59 | $18,912.00 | $0.00 | $69,135.00 | $117,656.00 | $554,218.00 |
| 23 | 60 | $18,912.00 | $0.00 | $58,971.00 | $143,357.00 | $583,747.00 |
| 24 | 61 | $18,912.00 | $0.00 | $48,299.00 | $170,512.00 | $614,163.00 |
| 25 | 62 | $18,912.00 | $0.00 | $37,093.00 | $199,194.00 | $645,518.00 |
| 26 | 63 | $18,912.00 | $0.00 | $25,327.00 | $229,498.00 | $677,883.00 |
| 27 | 64 | $18,912.00 | $0.00 | $12,972.00 | $261,498.00 | $711,323.00 |
| 28 | 65 | $18,912.00 | $0.00 | $0.00 | $295,275.00 | $745,880.00 |
If James and Sandra opted for the custom whole life insurance option, they pay premiums of $500 per month ($6,000 per year) until Amelia is age 18 — same as what their financial planner recommended.
I also recommended a separate supplemental term insurance policy — again, similar to what their financial planner recommended — on James’s life. Since Sandra was younger than James, and also female, she is a better candidate for the whole life policy (she has a longer expected life span and generally pays lower insurance costs as a female).
Paying premiums into a custom, high cash value, whole life insurance triggers immediate growth of the policy’s cash value. Cash value is the equity value or savings portion of the insurance policy. Once cash values have accumulated in the whole life policy, the couple could either withdraw money from it or borrow against it (similar to how individuals borrow against the equity in their home).
I recommended they borrow. Here’s why:
Cash withdrawals from their whole life policy permanently decrease the savings portion (and death benefit) of their policy and result in a loss of current and future interest and dividends on the money they withdrawal. This causes the same problem they would have if they chose the 529 plan and 401(k).
If James and Sandra use a 529 plan, coupled with a 401(k) for their future retirement savings, they must save up money for their daughter, then cash in their 529 plan, and then start all over again from $0 when saving money for their own future. This essentially puts them back to square 1… they were under a huge time crunch and this only added to the pressure.
If they used the life insurance option, they could simply borrow the money against the value of their policy, and repay the policy loan (illustrated above).
I had them putting $18,912 per year back into the policy after Amelia graduates from school, which they were comfortable doing (they figured by that age, they would be in an even better financial position than they are now).
But, if they invested the same $18,912 per year into their 401(k) plan, starting in the year Amelia graduates from trade school or college (Sandra’s age 55), and keep saving until Sandra is 65 years old, they would need to earn about 8.30% in their 401(k), net of all fees, taxes, and other expenses to match the non-guaranteed cash value of their whole life insurance policy when Sandra is ready to retire at age 65.
This means they most likely must earn a gross annual return between 9% and 11% each and every year in their 401(k) for the 10 years before they retire without suffering any significant losses in their investments. It’s unlikely either of them could pull this off since they are not professional investors.
If they were to choose the custom whole life insurance option, they don’t face this dilemma. Here’s a summary comparison of the two different approaches:
| Years To Retirement After Daughter Graduates | 10 |
|---|---|
| Proposed Monthly Contribution To 401(k) | $1,576.00 |
| Net investment return needed on 401(k) | 8.300% |
| Future Value Of 401(k) Savings | $295,226.73 |
| Alt Custom Life Insurance Plan: | |
| Life Insurance Non-Guaranteed Cash Value @ Sandra’s Age 65 | $295,275.00 |
As you can see, James and Sandra need an 8.30% net return to match the non-guaranteed growth (current dividend scale) of their their life insurance policy.
The reason this works the way it does is because of the way policy loans in a whole life insurance policy work.
By borrowing money against Sandra’s life insurance policy, the money never leaves the policy. It stays in there and continues to grow. Again, if they withdraw money from their policy, however, it’s just like withdrawing money from a 529 plan or a 401(k). Any money they withdraw stops earning interest and slows the growth of their savings — something Sandra and James cannot afford to do at this point.
But by borrowing money against the value of their policy, their cash value is used as collateral, but keeps earning interest. So, even though the net cash value drops pretty low at Sandra’s age 54 (while they borrow money to give to Amelia), interest is still paid on the total accumulated cash value, which is roughly $130,000 at that point. This leverage helps James and Sandra effectively grow their savings while they are using it for other purposes before retirement.
This is a finer point of whole life insurance that is often ignored. Insurers don’t stop paying interest on cash values because of loan values. In some cases, they do alter how interest is paid, and the exact amounts paid, but they don’t stop paying interest on cash values. Meanwhile, the efficiency created by this approach means they can accomplish more with the same amount of money they would otherwise use in another financial strategy, and they take less risk than they would investing Amelia’s education money.
Their financial planner told them their 401(k) probably could average 8% over the long-term. This seemed reasonable to James. Sandra was skeptical.
As of this writing, over the past 10 years, the actual annual compounded return of the S&P500 (a major stock market index) was just 7.25%:
And over the past 20 years, the return from the markets was even lower.
Still, maybe the financial planner could have outperformed the stock market or… maybe the future holds better returns than the past — we just don’t know — but… this is the point of life insurance.
In spite of the fact that I’m showing the current (non-guaranteed) dividend growth rate of a whole life policy, dividends tend to be relatively stable over time. And, while it’s likely the exact cash value growth will be different than illustrated, the ride should be relatively smooth. Dividends on whole life policies tend to gradually increase or decrease slowly over time.
And, once dividends are paid, and used to buy paid up additional life insurance, they become part of the guaranteed cash value, so they cannot be lost.
With a non-guaranteed stock investment, outsized gains are possible, but so are outsized losses. And, it’s not always a smooth ride. Often, the smoothed out return assumptions of a spreadsheet meet a choppy and hard reality.
All this to say that it’s doubtful their financial planner’s ideas will pan out exactly as planned on a spreadsheet, and James eventually realized it. Not only that, the risk of loss was great enough that they could not afford a setback just years before their retirement.
So, after giving it some serious thought, they chose to go with the custom whole life insurance policy and haven’t looked back since then.
By doing so, they are now covered in several different ways.
- With their first premium payment, Sandra is now insured for $247,946. If she dies before she and James can save up enough money for Amelia, then Amelia is taken care of.
- Assuming Sandra lives a long life, they can afford to give Amelia up to $100,000 in cash to use for any reason through policy loans — life insurance cash values can be used for college tuition, books, room and board, vocational school, trade school, to start a business, to help Amelia with a down payment on her first home, or… for any other reason (or no reason) at all. Policy loans can be taken any time and for any reason. The loans do not have to be repaid on a set schedule. Any outstanding policy loans are deducted from the death benefit when Sandra dies. However…
- By repaying the policy loans, Sandra is able to leverage her own life insurance policy to help save more money for retirement. She takes virtually no risk by doing this because all life insurance policy loans are secured by the policy’s cash value. At any time, the loans can be repaid from policy values. But, assuming repayments come out of pocket, both Sandra and James can benefit from the accumulated cash value when Sandra retires.
- In addition to the cash value, Sandra and James still have a life insurance death benefit when they retire. This means they can spend whatever other savings they have and when Sandra dies, the death benefit is paid to James to pay her final expenses or to help pay ongoing monthly bills after his wife is gone. The pressure of retirement is off.
- Life insurance cash values are generally not factored into the calculation for Expected Family Contribution (EFC) when applying for financial aid. So, if Amelia does attend college, she can apply for financial aid and the cash values will not be considered as assets. Furthermore, if the cash values aren’t needed for Amelia’s education, they can be used for some other purpose. This is an important point of difference over the 529 plan, since college education funds must be used for qualified education expenses.
- Their life insurance policy nets them about $5,000 more than what their 529/401(k) strategy would, and yet… the couple takes substantially less risk than they would if they had used conventional investing strategies to achieve their financial goals since whole life cash values are guaranteed and grow each and every year premiums are paid.
Learn More About The Perfect Policy™
If you want a deeper understanding of the underlying principles that drive this type of life insurance planning, then keep reading about The Perfect Policy™.
