Whole Life Insurance – Making a 4.5% return equal to an 8%+ return for high income earners

September 11, 2023

For high income earners, a 4.5% after-tax return can be equivalent to an 8%+ pre-tax return. Whole life insurance can provide this without the high investment risk that comes with investments that are expected to earn 8%+.

If you are a high income earner living in states with high income taxes like California, New York, New Jersey, etc, then it’s most likely that you are paying more than 40% of your earnings in federal and state income taxes.

High income earners who earn their income from high salaries or business revenues are often looking for safe places to invest their after-tax earnings since they are already taking significant risk either with their businesses or their equity portfolio.

Such individuals are trusting in their own earning potential, businesses, and equity portfolio to grow their wealth. They understand that while investing in these opportunities comes with significant risk, it also allows them the best opportunity for them to grow their wealth significantly.

But if these individuals are taking significant risk in growing their wealth with these opportunities, what is the best way for them to protect their wealth with the rest of their investments?

The traditional way for clients to do this is to increase the allocation of their portfolio to bond like assets that are more stable than the risk they are taking with their other equity investments.

This is the same reason why advisors and target date funds increase the client’s asset allocation towards bonds as clients get older and closer to retirement when they will need the income from their portfolio and can’t take as much risk with their investments.

The problem with this is that while it’s easier for advisors and target date funds to allocate clients to bonds to reduce risk on a pre-tax basis, it doesn’t really make sense for high net worth clients on an after-tax basis. This is because on an after-tax basis the client is earning very little from the bond allocation and is still subject to large losses if interest rates rise—as evidenced by bond returns in 2022. This is especially pragmatic in retirement when clients are withdrawing funds to meet their income needs.

States with the highest marginal ordinary income tax rates for residents

State/District Highest State
Income Tax-
Rate in 2023
Highest Total
Income Tax-Rate
(Federal and State)
for State Residents
California 13.30% 54.10%
New Jersey 10.75% 51.70%
10.75% 51.60%
Oregon 9.90% 51.60%
Minnesota 9.85% 50.70%
Massachusetts 9.00% 50.70%
New York 10.90% 49.80%

Certain states assess high marginal tax rates on ordinary income (eg bond dividends)—in addition to the federal tax rate residents pay (top federal rate is 37% +3.8% Net Investment Income Surcharge). This means that high earning individuals in these states can end up paying more than 50% in federal and state taxes on their gains.

So the heavy allocation to bonds is a solution that helps advisors and target date funds easily scale their business, but doesn’t actually provide better retirement solutions for high net worth clients.

Whole life insurance is a way for clients to get more long-term stability than long-term bonds without the heavy tax and interest rate risk exposure.

Instead of investing in 4%-4.5% taxable bonds and earning 2%-2.5% on an after-tax basis, clients can invest through whole life insurance and earn that 4%-4.5% tax-free.

The key to doing this is to invest for the long-term and structure the investment properly.

Understanding Whole Life Insurance as an Investment
Whole life insurance is a vehicle that allows clients to invest in long-term bonds tax-free. There are two main “catches” here:

1) Whole life insurance is a zero-sum game: Most policyowners will lose money

What most policyowners don’t realize when they purchase a whole life insurance policy is that they will most likely cancel the policy. In fact, Society of Actuaries’ studies show that almost 50% of policyowners will cancel their policy within 10 years and nearly 70% of policyowners will cancel their policy all together.

Why is this bad?

Well, for starters, life insurance companies charge both heavy early expenses and surrender charges in the early years of the policy. Therefore, unless the policy is structured properly (see point 2 below), if the policy owner cancels the policy within the first 15 years of the policy, they will often lose money on their investment.

This is horrible for the policyowners who cancel the policy. These policyowners will end up spending tens to hundreds of thousands of dollars into an “investment” and walk away with almost nothing—and then die afterwards.

Which of course means that the life insurance company collected tens to hundreds of thousands in premiums without ever having to pay a death benefit. Policyowners who are in poor health and/or older in age should try and keep their policy because of this instead of canceling it. Their beneficiaries will get a large death benefit relative to the premiums they have to pay going forward to receive that death benefit.

However, these policyowners who can’t afford to keep the policy should look to see if they can sell the policy on the life settlement market instead of canceling it as they will get significantly more for doing so than simply canceling it.

Policyowners in good health, but stuck in a very expensive/bad policy, should look to see if they can exchange the policy they are in for a better policy via  a 1035 exchange.

That being said, while whole life insurance is horrible for policyowners who cancel the policy in the early years, this behavior is absolutely necessary for the policyowners who keep the policy in order to maximize the benefit they receive from the policy.

Why do policyowners who keep the policy for the long term benefit from those who cancel in the early years?

Well, the reason for this is that mutual life insurance companies share their profits with policyowners who keep the policy in the later years through dividend payments made to policyowners. Since there are very few policyowners left in the later years, these policyowners who keep the policy are reaping ALL of the benefits that otherwise would have to be shared with the other policyowners who bought policies from that carrier.

Since the policyowners who keep the policy don’t have to share these dividend payments with the policyowners who canceled the policy, their returns are boosted at the expense of those who canceled.

The other reason why policyowners who keep the policy need other policyowners to cancel the policy is due to the amount of death benefit that the life insurance company provides to the policyowner if they pass away.

Since the life insurance company knows that ~70% of the policyowners will cancel the policy, they can afford to offer more death benefit relative to premium paid by the policyowner since they know most policyowners won’t keep the policy.

So similar to the dividend payment example I mentioned above, the policyowners who keep the policy don’t have to share the death benefit payouts that would have gone to the other policyowners who canceled the policy.

If all the policyowners kept the life insurance policy, then this wouldn’t be the case. Policyowners who keep the policy are often paying ~50% less in premiums for their policy than they would be required to pay if all of the policyowners kept their policy.

And as you can imagine, if policyowners had to pay twice the amount of premiums for a life insurance policy with a given death benefit, then the life insurance company would sell a lot less policies.

So the life insurance company’s entire distribution strategy is dependent on a large number of policyowners canceling the policy without the life insurance company having to pay a death benefit on these policies.

2) Policyowners can improve the return on the policy by reducing the commission paid on the policy

Another critique made of whole life insurance policies is that the return on the policies is low, often in the 2%-3% range. But even this is a high after-tax return for high income policy earners who are paying 40%-50% plus in taxes every year.

Most whole life insurance policyowners don’t realize that they can improve the after-tax return of their policy to 4%-4.5% (equivalent to an 8%+ after-tax return for high income earners) simply by minimizing the commissions paid on the policy.

A typical whole life insurance policy pays 80%-100% of the first year premium to the life insurance agent who sold the policy. This is a huge expense for the life insurance company to bear. But the life insurance company has to do this in order to incentivize the insurance agents to sell the policy. As you can imagine, the life insurance company has to make this expense back someway. It does this through high early year expenses in the policy and high surrender charges for policyowners who cancel the policy (as described previously).

Policyowners can improve the return on the policy by reducing the commissions paid to the life insurance agent who sold the policy relative to the premium paid into the policy. They can do this by utilizing paid-up additions instead of traditional whole life insurance as I’ve talked about previously here.

Paid-up additions allow clients to dump large amount of premiums into the policy that have a low commission rate. Instead of 80%-100% of the first year premium amount being used to pay commissions, the commission rate on the paid-up addition portion of the policy is only 3%-5%.

Since the insurance company pays less commissions on the paid-up addition portion of the premiums than on the traditional whole life insurance premiums, the more the policyowner uses paid-up additions instead of traditional whole life insurance the less the expenses in the policy are and the higher the policyowner returns will be.

Maximizing the use of paid-up additions versus traditional whole life insurance premiums is the difference between earning a 2%-3% tax-free return versus a 4%-4.5% tax-free return.

In the image below we can see the IRRs from a whole life policy illustration that is structured properly to earn a 4%-4.5% tax-free IRR on the cash value.

Whole life policy structured to earn 4%-4.5% tax-free

By properly structuring a whole life policy utilizing Paid-Up Additions, clients can earn a long-time tax-free IRR on their cash value of 4%-4.5%.

The policy illustrated above pays $95,620 for 8 years (total cumulative premium of $764,920) at which point premiums are stopped by utilizing the reduced paid-up feature. In year 21, the client takes out $375,417 (~26% of the total value of the policy) through a tax-free withdrawal to help with their retirement needs.

Note, however, that if the policyowner cancels the policy before year 5, they will actually lose money on the transaction (-2.30% IRR). Hence, the 4%-4.5% is only actually earned by policyowners who keep the policy for 20+ years.

In the above example we see that the tax-free IRR on Total Net Cash Value is 4.02% after 20 years, and 4.5% after 40 years.

For those wishing to see the full illustration, you can access it here.

Note that the client can take out more of their value in tax-free withdrawals and loans (~90% of their value) if they wish. However, doing so will reduce future returns due to the drag of the loan as well as reduced dividend payments.

In the illustration below, the client still pays $95,620 for 8 years into the policy (total cumulative premium of $764,920).

However, in year 21 the client takes out 90% of their policy value ($1,325,000) instead of 26% in the previous example.

As seen below, the tax-free IRR after 20 years is 4.02% just like it was in the previous example. However, it starts to decrease after that for the reasons mentioned above.

By taking out the maximum tax-free distributions possible, the tax-free IRR drops to 3.61% after 40 years here compared to 4.5% in the previous example.

Whole life policy structured to utilize Paid-Up Additions with Maximum Distribution

Clients can take out up to 90% of their policy value via tax-free withdrawals and loans. Doing so, however, will diminish future returns.

For those wishing to see the full illustration, you can access it here.

The Stability of Whole Life Insurance as an Investment

As discussed previously, standard asset allocation practices involve shifting client assets away from stocks towards bonds in retirement due to the relative stability of bonds in comparison to stocks.

However, bonds don’t come without risk.

If interest rates rise, then bonds will take heavy losses. The coupon payments on the other hand are fairly stable as indicated by the table below.

Bond Returns and Standard Deviations from 1928-2022

Returns Standard Deviation
6.68% -0.11% 6.80% 7.75% 6.65% 2.93%

Since 1928, the entirety of bond returns have been driven by the dividend return of bonds and not the price return. Furthermore, the price return is significantly more volatile than the dividend return of the bond.

As the table above shows, the entirety of the bond return over the past 95 years has been driven by the dividend return of bonds (6.80%) as opposed to the price return of bonds (-0.11%). Furthermore it is the price return of the bond that is driving the volatility here (6.65% standard deviation of the price return of the bond as opposed to 2.93% standard deviation of the dividend return).

The point being here is that when advisors talk about using bonds for safety, it’s purely the dividend return that is providing the safety—not the price return. The price return of the bond is actually adding risk here.

In order to capture the safety of the coupon payments of bonds in comparison to the risk associated with the price return of bonds due to rising interest rates, many advisors will invest in bond ladders in which advisors buy and hold bonds of varying maturities. That way they can just hold the bond to maturity and not have to worry about the embedded interest rate risk that comes with investing in bond funds.

The downside of this approach, of course, is that any attempt to exit the investment prior to maturity will expose the client to the same interest rate risk they were trying to avoid. Using bond ladders is truly a long-term retirement approach that requires the investor to have a long-term investment horizon with preplanned liquidity needs. Furthermore, the utility of this bond ladder approach is minimized since the coupon payments are taxed at high ordinary income rates.

The best way to use bonds for downside protection in retirement is to capture the safety of the dividend return of bonds while passing on the risk of the price return portion of bonds to another party.

This is exactly what insurance products like whole life insurance do while providing tax-free benefits and liquidity provisions to policyowners as well. Yes, it requires investors to have a long-term retirement approach, but the use of bond ladders or any other retirement plan requires the same approach.

Whole life insurance allows investors to invest in long-term bonds similar to bond ladders except with better liquidity provisions and tax benefits. Remember that when policyowners purchase whole life insurance policies they are essentially investing in the underlying general account of the life insurance company which are primarily invested in long-term bonds with an added bonus of profit sharing in the later years via dividend payments.

Investing in long-term bonds via a whole life insurance policy allows the returns to be tax-free and for protection against interest rate risk since the insurance company is the one holding the bonds to maturity while allowing the client to take money out of the investment prior to maturity.

In fact, clients can take out 70%-80% of principal and gains tax-free via a combination of withdrawals and tax-free loans.

This allows for a liquidity option free from interest rate risk that isn’t available with bond funds or bond ladders.

Another question that is often asked about how stable whole life returns are relative to bonds.

Whole life returns are based on three elements:

1) Long-Term Bond Returns without Interest Rate Risk:

As discussed above, when you pay a premium into a whole life insurance policy the insurance company deducts insurance expenses and then invests the rest into their general account portfolio which just consists of primarily long-term bonds. The insurance company has long-term liabilities, so for the most part are trying to buy long-term buy and hold assets to match these liabilities. Any interest rate risk here is born by the insurance company because they have a long-term horizon and can afford to hold bonds for the long-term whereas the individual investor does not have the same investment horizon.

As we saw in Table 1, the yield rates on long-term bonds have been amazingly stable over the last 100 years. So the pure coupon rate here is very stable over the long-term even if interest rates change over the short term. So even if interest rates change in the short term, the effect of that short-term change on Whole Life returns will be small relative to if the client were invested in the underlying long-term bonds directly since the insurance company is bearing the full weight of the change in market value of the bonds.

This means that if interest rates rise in the short-term, whole life investors will not see a large change in their long-term whole life returns whereas if they held the bonds directly, these policyowners would see a large upfront loss in market value. The opposite is also true however. If interest rates drop, whole life investors won’t see a large change in their long-term returns, whereas if they held the bonds directly they would have experienced a large gain in the upfront market value of their investment.

2. Mortality Expectations

Another key driver of whole life returns are mortality expectations versus actual observed mortality. In other words, how many people who purchased whole life insurance policies actually died in a given year versus how many people the insurance company expected to die in a given year.

As you can imagine, if more people die in a given year than the insurance company expected that means the insurance company is losing money.

However, insurance companies and their actuaries are excellent at estimating mortality based on their past experience with these products. In fact, most insurance companies tout actual to expected mortality ratios of 90%+.

So similar to long-term coupon rates, the volatility around mortality is low and rarely sways whole life returns significantly.

3) Lapse Expectation

As discussed previously, the entire mechanism of whole life insurance is dependent on a large amount of people canceling the policy. If less people canceled the policy, then insurance companies would have to increase their reserves so they could pay future death benefits and it would make the product less profitable for the insurance company.

Luckily for the insurance company, policyowners are very consistent in canceling the policy. When an individual policyholder purchases a policy, the insurance company doesn’t know with certainty that that individual policyowner will cancel the policy. But they do know with a high level of confidence that on average a large amount of people will cancel their policies and that amount will be very close to what they expected.

It is the stability of insurance company’s investment, mortality, and lapse expectations that allow actuaries to be able to build these types of life insurance products to begin with. If these expectations were extremely volatile, it would be too difficult to design a profitable product around it without extremely high profit margins that would make the product unsellable.

By building a product around stable assumptions, the insurance company is able to generate a product with stable profits and share some of those profits with policyowners who keep the policy so that they also receive stable long-term after-tax returns.

The only people who are losing in this equation are the large amount of policyowners who cancel the policy or structure it poorly. And unfortunately the people who structure it poorly and/or cancel it end up being people from lower income brackets who don’t understand the product that was sold to them or can’t afford it anymore. On the other hand, wealthy people who buy larger face amount policies tend to be the ones who keep these policies for their investment and estate benefits and benefit from the poorer policyowners who cancel it.

It’s yet another form of income inequality in which wealthy individuals capitalize and benefit from the economic loss experienced by middle class policyowners who are sold products they don’t understand. But if you’re an advisor to wealthy clients, this is an arbitrage opportunity that can’t be easily replicated in the investment world where clients are getting stable long-term after-tax returns with limited volatility.

Whole life as a retirement planning tool

With whole life insurance, high net worth clients are getting better risk-adjusted after-tax returns and downside protection than they could get investing directly in taxable bonds.

This is of significant advantage to high net worth individuals who are phased out of contributing to traditional retirement plans and would be forced to invest in bonds via taxable accounts in order to try and protect against downside risk.

In a previous article, we’ve talked about how the rebalancing away from the equity portfolio towards the bond portfolio doesn’t make sense for high net worth clients because the portfolio is being shifted away from higher earning, tax-efficient equity investments into lower-earning, tax-inefficient bonds.

Instead of clients rebalancing away from stocks into bonds as clients get older—thereby experiencing tax drag from the constant buying and selling of assets—clients can slowly increase the percentage allocation of the portfolio into whole life by paying yearly annual premiums into the policy instead of investing in the equity markets in later years.

By the time they retire, instead of a 70% equity/30% bond portfolio, the client will have a 70% equity/30% whole life portfolio. This portfolio will be both higher earning and less risky on an after-tax basis than the 70% equity/30% bond portfolio.

Conflict of Interest in the Financial World

Since whole life makes more quantitative sense for high net worth individuals saving for retirement than taxable bonds, you might wonder why more financial advisors aren’t using it.

Well, there is a huge conflict of interest here.

Advisors who charge an asset under management fee are not going to recommend whole life insurance—even if it is in the best interest of their client—because doing so would take assets away from them which would decrease their fee.

Advisors who earn a commission instead of an AUM fee are more than happy to sell clients whole life insurance and earn a commission. The problem here is that these advisors are going to sell the high commission whole life insurance product that earns 2% to 3% instead of the low commission whole life product that will earn the client 4%-4.5% on an after-tax basis. And what’s worse, the clients who purchase the product from these advisors will probably end up canceling the product because they were sold it instead of understanding how to use it from an investment and financial planning perspective—thereby defeating any tax benefits the product would have had for them.


Whole life can help provide better diversification, risk-adjusted, and tax-efficient returns than taxable bonds for high net worth clients who are planning for retirement.

The difficulty is finding an advisor who is willing to work in your best interest to create a solution that benefits you instead of his or her business interests.

Rajiv Rebello

Rajiv Rebello


Rajiv Rebello, FSA, CERA is the Principal and Chief Actuary of Colva Actuarial Services and Colva Capital. Colva helps family offices, RIAs, and high net worth individuals create better after-tax and risk-adjusted portfolio solutions through the use of life insurance vehicles and low-correlation alternative assets. He can be reached at [email protected].

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