This is Just Another Example of Why Whole Life Policies Suck!

The Ramsey Show Highlights
1 Mar 202109:01
EducationalLearning
32 Likes 10 Comments

TLDRIn the script, Donna from Utica, New York, discusses her whole life insurance policy with Dave. She learns her dividends are tax-free and her cash value must first pay off a loan. Dave explains that dividends are essentially a return of overcharge, not true dividends. He advises Donna against whole life insurance, suggesting term policies and investments like mutual funds or a Roth IRA for better financial returns, highlighting the inefficiency of whole life policies and the deceptive nature of insurance companies' practices.

Takeaways
  • 📝 Donna is considering cashing in her whole life insurance policy and is curious about the tax implications of the dividends and cash value.
  • 💰 She has discovered that her policy has accumulated dividends, which are typically tax-free, and a small cash value.
  • 🏦 Donna has a loan against her policy, which is common in whole life insurance where policyholders can borrow against their cash value.
  • 🤔 She is unsure whether to take the dividends first or if cashing in the policy will include the dividends.
  • 🧮 Dave explains that the dividends should be included if they haven't been used to buy paid-up additions, which in Donna's case, they haven't.
  • 💡 The basis for calculating potential capital gains on the policy is the total premiums paid over the life of the policy.
  • 📉 Donna's premiums paid over 30 years exceed the cash value, meaning there would be no capital gain tax on the policy surrender.
  • 🚫 Dave emphasizes that life insurance dividends are not the same as traditional dividends from a company's profit and are not taxable.
  • 🏘️ Life insurance companies are wealthy because they invest policyholder premiums in various ventures, including commercial real estate.
  • 🔄 Policyholders essentially pay extra for their policies to create a cash value, which they can then borrow against, paying interest to the insurance company.
  • 🤑 The insurance company benefits by using the cash value for investments while the policyholder receives a return in the form of dividends, which is actually a return of their overpaid premiums.
  • 💔 Donna realizes that her whole life insurance policy may not have been the best financial decision, as the returns are not as beneficial as other investment options.
Q & A

  • What is Donna's situation regarding her whole life insurance policy?

    -Donna has a whole life insurance policy with dividends and a small cash value. She also has a loan out on the policy and is considering cashing it in.

  • Are the dividends on Donna's policy tax-free?

    -Yes, the dividends on her policy are tax-free as they are not used to buy paid-up additions and are considered a return of a deliberate overcharge.

  • What is the purpose of the loan Donna has on her policy?

    -The loan is likely taken out against the cash value of the policy. Donna is paying interest on this loan, which is essentially her own money.

  • What is the concept of cash value in a whole life insurance policy?

    -The cash value is a savings component within the policy that builds up over time. Policyholders can borrow against this cash value but have to pay interest on the loan.

  • How does the basis of a whole life insurance policy work?

    -The basis is the total amount of premiums paid into the policy. It is used to determine if there is a capital gain when cashing in the policy.

  • Why might there be a capital gain on Donna's policy when she cashes it in?

    -A capital gain might occur if the cash value of the policy is higher than the total premiums paid (the basis). However, in Donna's case, it is unlikely due to the premiums paid over 30 years exceeding the cash value.

  • What is the difference between a stock company and a participating company in the life insurance industry?

    -A stock company does not pay dividends; only the policyholders of a participating company receive dividends. In a participating company, the policyholders are the owners and receive a share of the profits.

  • Why are life insurance dividends considered non-taxable by the IRS?

    -Life insurance dividends are non-taxable because they are considered a return of a deliberate overcharge, not a profit distribution like in the case of stock dividends.

  • What is the financial advice given to Donna regarding her whole life insurance policy?

    -The advice is to reconsider keeping the whole life policy due to its low returns and to consider investing in a mutual fund and buying an inexpensive term policy instead.

  • How does the life insurance company benefit from Donna's policy?

    -The life insurance company benefits by using the premiums paid by Donna and other policyholders to invest in various ventures like commercial real estate, making a profit on the interest spread.

  • What is the alternative investment strategy suggested for Donna?

    -The alternative strategy suggested is to invest in a mutual fund and purchase a term policy, which could potentially result in significantly more financial growth over time compared to her whole life policy.

Outlines
00:00
💼 Whole Life Insurance Policy Inquiry

The script begins with Donna discussing her whole life insurance policy with Dave. She is interested in cashing it in and is curious about the tax-free dividends and the small cash value it has accumulated. Dave explains that if the dividends haven't been used to buy paid-up additions, she should receive them upon cashing out. They also discuss the policy's loan and cash value, and Dave clarifies that the dividends are not taxable. He calculates Donna's basis based on her premiums paid over the years and concludes that there would be no capital gains tax due to the premiums exceeding the cash value. Dave also educates Donna on the nature of life insurance dividends, explaining that they are not the same as traditional dividends from a company's profit but are instead a return of a deliberate overcharge on the policyholder.

05:01
🏦 Critique of Whole Life Insurance and Financial Advice

In the second paragraph, the conversation continues with Dave criticizing whole life insurance policies, calling them a scam and highlighting the financial inefficiency of such policies. He points out that Donna paid extra to create a cash value account within her policy, from which she had to borrow her own money at interest. Dave suggests that life insurance companies are wealthy because they use policyholder money for profitable investments, such as commercial real estate. He advises Donna to rethink her decision to cash in her policy, considering her financial situation and the actual value of her policy. Dave emphasizes the importance of understanding the basis of a policy and the potential for capital gains tax, and he recommends consulting a tax professional. He concludes by advising against buying whole life insurance and suggests investing in more profitable ventures like mutual funds and term policies.

Mindmap
Keywords
💡Whole Life Insurance
Whole life insurance is a type of permanent life insurance that remains in force for the insured's entire life, as long as premiums are paid. It combines a death benefit with a cash value component that grows over time. In the video, Donna has a whole life insurance policy which she is considering cashing in, highlighting the financial complexities and long-term implications of such policies.
💡Dividends
Dividends in the context of life insurance refer to a portion of the profits that participating insurance companies return to their policyholders. In the script, it's mentioned that Donna's policy has dividends which are considered tax-free, illustrating a common misunderstanding about the nature of these 'dividends' in insurance policies.
💡Cash Value
The cash value of a life insurance policy is the savings element that accumulates over time, which can be borrowed against or paid out upon cancellation of the policy. Donna's policy has a small cash value, which is a central point of discussion in the video, as it relates to the financial decisions she faces.
💡Loan
In the context of life insurance, a loan refers to a policyholder borrowing money from the cash value of their policy. Donna has a loan out on her policy, which has implications for the amount she would receive if she were to cash in her policy.
💡Tax-Free
The term 'tax-free' refers to income or gains that are not subject to taxation. In the script, it's suggested that the dividends from Donna's policy are tax-free, which is a point of contention and part of the broader discussion about the financial benefits and drawbacks of whole life insurance.
💡Capital Gains
Capital gains are the profits that result from the sale of assets, such as stocks or real estate, and are subject to tax. In the video, there is a discussion about whether Donna would incur capital gains tax if she cashed in her policy, which depends on the relationship between the cash value and the premiums paid.
💡Basis
In tax terms, the basis of an asset is the original cost or other original value of the asset, which is then used to calculate capital gains or losses. In the script, the basis is discussed as the total premiums Donna has paid into her policy, which is crucial for determining any potential capital gains tax liability.
💡Participating Company
A participating company is a type of life insurance company that returns part of its profits to policyholders in the form of dividends. The script explains that Donna's policy is with a participating company, which is why she has received dividends.
💡Paid-Up Additions
Paid-up additions are additional premiums paid by a policyholder to increase the policy's death benefit or cash value. In the video, it's clarified that Donna's dividends have not been used for paid-up additions, which affects how the dividends are treated financially.
💡Inflation
Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, the purchasing power of currency is falling. The script uses the concept of inflation to illustrate the potential financial disadvantage of having money tied up in a whole life insurance policy as opposed to other investments.
💡Term Policy
A term policy is a type of life insurance that provides coverage for a specified term, without a cash value component. The script suggests that Donna might be better off with a term policy combined with other investments, as a way to optimize her financial situation.
Highlights

Donna's inquiry about cashing in her whole life insurance policy and the tax implications of dividends.

Discussion on whether dividends on the policy are tax-free and how they are added to the cash value.

Clarification that Donna's policy dividends have not been used to buy paid-up additions.

Explanation of the non-taxable nature of life insurance dividends as a return of deliberate overcharge.

Donna's policy has a loan out and a small cash value, leading to a question about capital gains tax.

Dave's doubt about Donna incurring capital gains tax on her policy's cash value.

Calculation of Donna's policy basis based on her premiums paid over the years.

Dave's assertion that Donna has no capital gains because her premiums paid exceed the cash value.

Dave's explanation of how dividends work in the context of life insurance and their non-taxability.

Donna's age and her current life insurance needs are discussed, questioning the necessity of her policy.

Dave's suggestion that Donna should consider buying term insurance before canceling her whole life policy.

Critique of whole life insurance policies as a poor investment compared to other options.

Discussion on the practice of life insurance companies using policyholder's money for investments.

Dave's revelation of the 'great whole life insurance scam' and its impact on policyholders.

Donna's realization of the potential financial loss due to her whole life policy and the alternatives she missed.

Advice for Donna to consult a tax professional to ensure there is no capital gain on her policy's cash value.

Final thoughts on the importance of understanding financial products and making informed decisions.

Transcripts

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Life InsuranceDividendsTax-FreeCash ValueLoansPolicyholderInvestment AdviceFinancial ScamsRetirement PlanningInsurance Industry