“Last week I bought a life insurance retirement policy. All I’ve got to do is keep up the payments for 15 years, then my agent can retire.”
How much commission does a life insurance agents make? You might be very surprised…
In the last two weeks, we have exposed the shocking affect that those “little” mutual fund commissions can have over time. First, we showed how the average American family loses six figures (an average of nearly $155k) of their retirement to fees and commissions. Last week, we demonstrated how qualified plan participants who leave their dollars in target-date retirement funds (or other mutual funds) can lose up to 79% of their hard-earned dollars to the tyranny of compounding fees.
But what about the commissions you’ll pay on whole life insurance? Aren’t they even worse!?
Financial authors and educators name “huge commissions” as proof positive that whole life insurance is a terrible financial strategy. Insurance agents are rumored to take home 80%, 90%, or more of the first year’s premium, which is difficult for many people to stomach. But is this the whole truth?
Recently, Tom Dyson at the Palm Beach Letter and Palm Beach Wealth Builders Club investigated this and published a ground-breaking report called “The Shocking Truth about Life Insurance Commissions,” exclusively for their paid subscribers. (Palm Beach Letter publishes exclusive newsletters about lesser known investments and money-making opportunities used by the wealthy. They do not sell insurance or receive insurance commissions.)
The special report showed the real facts and figures – how life insurance commissions work, and how these insurance cash value accounts (and the commissions) compare in the long run with mutual funds. We were so blown away by what they discovered that we begged their permission to share liberal portions of this “for paid subscribers only” report with our own readers. (Fortunately they said “yes”!)
An Evening with a Life Insurance Agent
Dyson begins by describing his first meeting with an insurance agent from a mutual life insurance company, which happened to be Northwestern Mutual. (This was before he knew about the “Income for Life” strategies that Palm Beach Letter endorses and that Partners for Prosperity have assisted people with for years.)
At the time, Tom and his wife weren’t sold on permanent life insurance. Plus, they were frustrated that the agent was prying into their personal finances and taking up too much of their time. Tom started looking for a way to cut the meeting short. As Tom tells it,
I knew the perfect question to end the meeting…
“So how much commission do you make from this policy?” I asked.
“I take a 100% commission,” he replied.
I was expecting a high number, but this seemed impossible.
“That’s right,” he said. “We take 100% of your first year’s payment as commission.”
No wonder everyone thinks permanent life insurance is a rip-off, I thought. And with that, we excused ourselves and left.
Life insurance companies have a reputation for charging the highest commissions in finance. This reputation is so bad that you can find pages and pages on the internet telling you “Why permanent life insurance is a scam” or “7 reasons not to buy whole life insurance.”
Best-selling financial authors campaign against permanent life insurance because of the fees, and even your financially-savvy friends are likely to hold the same beliefs. “Buy term and invest the difference” is the typical financial advice, and with mutual fund fees so much lower, it seems a no-brainer.
That is, until you look at the whole truth.
Tom didn’t think the agent would try to rip them off. He had come recommended and worked for a well-respected company. And Tom knew the government regulates life insurance fees and commissions, and anyone overcharging their customers would lose their license – or worse. But how could such a high commission make sense in any situation?
How a High Commission becomes a Low Commission
What Tom didn’t know back then was that the first-year commission (which is not nearly 100% in a properly-set-up policy, as we’ll explain) actually becomes a great deal after 10 or so years. But he realized that to compare fees on investments, you can’t look at just one year.
So Tom and his team looked at the big picture. And when they did, their research revealed that life insurance commissions are “one of the biggest misunderstandings in finance.”
They evaluated the fees that investors were charged over 10, 20, 30, and 40 years. Shockingly, the numbers revealed that a mutual fund that is otherwise identical (same rate of return, same investment dollars) would have to charge as little as 0.15% to match the results and take as few fees as a permanent life insurance account set up the correct way! Dyson explains,
Life insurance companies charge a 100% commission on the first year payment upfront. Then the fees taper off. Mutual funds charge almost nothing in year one. Then the fees get bigger every year. To compare the two, you have to add up how much you’d pay over the entire life of the investment, under identical circumstances.
When the Palm Beach Letter team did just that, the truth became obvious. Dyson concluded, “Permanent life insurance has LOW fees. You can end up paying less than 0.15% in annual fees. That’s as low as it gets… lower even than the famously cheap Vanguard Index funds.”
We’ll let Tom demonstrate with a concrete comparison and some simple charts to illustrate. You’ll never look at life insurance the same way again!
The Big Commission vs. “Little” Fees Experiment
Dyson’s team downloaded the fee schedule of American United Life Insurance Company and produced a 40-year simulation in an Excel spreadsheet. They used actual data from a life insurance policy, starting at age 62. Then they added up the total amount of fees the policyholder would have paid to hold this policy.
Next, they produced a 40-year simulation of a mutual fund investment. They put the exact same amounts of money into the mutual fund each year, on the same dates, as for the life insurance policy. And they grew the money at the exact same rate. Then they added a 1.5% annual management fee to the mutual fund.
(In the mutual fund business, this annual fee is called the “expense ratio.” The mutual fund industry claims its average expense ratio is 1.31%, but according to research by Forbes and the WSJ, mutual fund customers actually lose an average of 2.75% per year to expenses. That’s because trading costs generate an expense of 1.44% per year on average, but mutual funds don’t have to report them.)
What Did Dyson’s Team Discover?
After 10 years:
Life Insurance fees = $33,825
Mutual Fund fees = $34,160
Life Insurance account value = $340,552
Mutual Fund account value = $345,297
So far, the mutual fund seems to have generated slightly more equity, in spite of (barely) higher fees. But what happens next might surprise you:
After 20 years:
Life Insurance fees = $39,075
Mutual Fund fees = $108,111
Life Insurance account value = $734,269
Mutual Fund account value = $607,534
The mutual fund now fees are now over $69,000 higher than the life insurance fees – a difference of 276%! Even more surprisingly, the life insurance account value exceeds the mutual fund balance by over $126k!
After 30 years:
Life Insurance fees = $44,325
Mutual Fund fees = $226,242
Life Insurance account value = $1,280,336
Mutual Fund account value = $921,889
The more years that pass, the wider the gap becomes in both fees and equity!
After 40 years:
Life Insurance fees = $49,575
Mutual Fund fees = $397,336
Life Insurance account value = $2,017,154
Mutual Fund account value = $1,298,721
The bottom line is that “little” 1.5% mutual fund fee generated eight times as much fees as the life insurance policy over 40 years. More importantly… that 1.5% mutual fund fee caused a difference of $718,433 in final account value… for a loss of 36%.
Next, Dyson’s team calculated what fee a mutual fund would have to charge each year to compete with a properly structured dividend-paying whole life insurance policy. Here’s what they found:
After 20 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.50% fee.
After 30 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.25% fee.
After 40 years, the fees in the life insurance policy equate to what would be a mutual fund with an annual 0.15% fee!
How Small Fees can Create Big Damage
Not only did the high commission end up costing very little in the end, but those 1.5% expenses compounded each year to cost the investor multiple six figures! Dyson explains why:
There are two ways you can extract fees from an investment…
First, there’s the standard mutual fund way, which is now the standard Wall Street way. They assess your fee on the total money under management, once per year. It could be 1% per year. Or 2% per year. The fees get bigger and bigger as the money grows. They compound. This is Wall Street’s little secret.
In other words, you pay the same fees again and again… on the same money, year after year! And you don’t simply lose the fee, but you lose the money the fee could have earned. (We call this your opportunity cost.)
I never realized how devastating these “little” fees could be until I started investigating this issue. Look at this chart. The green dots represent your account growth. And the red dots represent the fees your account generates. Look how the fees grow in size as your account value grows in size.
We already know that mutual fund fees add up over time. But what about those big life insurance commissions?
Then there’s the life insurance method of charging fees. First, the insurance company bases its fees on the money you put into the policy each year, not the account’s total value.
You pay the fee once, not year after year on the same money. And you don’t pay the big first-year commission (which can be as high as 100%) on your whole premium, rather, only on the base premium portion. And the way we set up policies using the Income for Life strategy (a key strategy of Prosperity Economics, coined by the Palm Beach Letter as Income for Life), the base premium is usually around only 35% of the actual money you’ll put into the policy in its first four years.
Then the insurance company front-loads the fees. So you pay a big fee upfront, a small fee for the next 8-10 years, and then a maintenance fee for the remainder of the policy.
This way, the fees shrink instead of growing. Look how the fees (the red dots) get smaller with each passing year.
It’s a vital distinction. And it makes a big difference. How big?
After 40 years of collecting fees, the mutual fund’s red dot – and the fees you would have paid – are eight times larger than the life insurance strategy’s red dot – and fees. Look at the charts again, and notice how the fees paid for the mutual fund strategy total eight times the Income for Life insurance saving strategy.
The report concluded,
Investing the same dollars at the same time and growing them at the same rate, the mutual fund generated $347,761 more in fees. And because the fees obstructed the compounding power, it ended up with $718,433 less in the account after 40 years.
The bottom line is that you don’t need to worry about fees and commissions when it comes to buying permanent life insurance. As long as you hold your policy for more than a few years, the fees are tiny.
Instead, you should be concerned with the fees you’re paying on your mutual funds and in your 401(k). Because whenever you pay a fee based on your total account value—even if it seems like a small percentage—you’re getting ripped off. That’s because the fee compounds as your money compounds and eventually becomes enormous.
Once you understand how life insurance commissions work over the long haul, you shouldn’t let them get in your way of making a decision based on what is best for YOU.
Where can your money grow safely, shielded not only from taxes on the growth, but FEES on the growth?
In a permanent life insurance policy! But you can’t just get any permanent life policy (some are bad news), or even any whole life policy. The key to maximizing your cash value is setting up the right policy correctly with a PUA (Paid-Up Additions) rider. The proper rider allows the cash value to grow much more quickly in the early years of the policy.
Thanks again to the Palm Beach Letter for their ground-breaking research. You can find them at PalmBeachLetter.com.
To find out more about how you can start your own Income for Life policy, contact us for a no-obligation consultation. Our own Kim D. H. Butler is one of the top experts in the country on innovative financial strategies that utilize dividend-paying permanent life insurance (also called “whole life” or “participating” insurance). You can also explore how else this strategy can benefit you by reading Kim’s best-selling little book on life insurance, Live Your Life Insurance.