Welcome to Lesson #1 of "5 Big Ways Your Financial Advisor May Not Be Acting In Your Best Interests"
Overview: In today's session I'm going to show you several reasons why you should skip "tax free" investments that financial advisors sell to doctors. I'll show you two examples of actual physician finances I reviewed, and I'll also give you many reasons why these investments are not in your best interests.
Oh, and here's something that will make your financial advisor soil his pants: I'm going to reveal how much of a commission he might get paid for selling you these lousy investments.
Doctors hate paying taxes.
I hate paying them too. Out of the 300 million people in this country I would probably rank right up near the top of the people who dislike taxes -- especially because I’m a physician.
Think about it.
You busted your butt through 4 years of college, then 4 years of medical school, and then another 3 to 7 more years of postgraduate training. During those years you were paid less than minimum wage and you probably came out with a six figure debt load.
Then when you started making some “real” money -- which doesn’t happen for many physicians until they are 30-35 years old -- the government taxes you at a higher level than most people.
So in comes your financial advisor who lures you with a sales pitch that goes something like this:
“Wouldn’t it be great to stuff as much money as you can in a tax free investment vehicle instead of a taxable account and pay no tax when you withdraw the money?”
Pretty tempting isn’t it? You may even start salivating like a rabid dog as you daydream over the buckets of money you would save by not paying any taxes on the investment gains.
Unfortunately it’s just a dream.
Many insurance salesman -- because that’s what they really are -- mask as financial planners/advisors and sell doctors life insurance policies to be used as investing vehicles.
A common example is whole life insurance.
Here’s the basic way whole life insurance works: you pay a premium into the whole life policy annually. Part of the premium covers the cost of insurance and that cost generally increases as you age. The second part of the premium builds up cash value in the policy.
When you pay the premium, the insurance company takes part of that premium and invests it and then the insurance company credits you with dividends that get added to the cash value in the policy.
So what does this have to do with taxes?
This is where your financial advisor (aka insurance salesman) tells you that the cash value built up in the policy is tax free because you can take that money out and not pay taxes on it. This is possible because cash values in life insurance policies are taxed differently than other investing vehicles.
“What’s not to like?” you say.
Well let’s take a look at two examples of why this tax free investment is a bad idea. These examples are from me personally reviewing actual physician finances:
Example #1: 35 year old married physician paying $12,000 annual premium into a whole life insurance policy
This physician is only a few years out of residency training and is married to another physician. They have a young child who is less than 5 years old.
Their financial advisor sold them whole life insurance policies as a way to build a “tax free” investment over time. Their annual premium is $11,763. According to the life insurance policy illustration, the cash value of the whole life policy after paying 10 years of premiums will be $118,210.
The financial advisor tells them that the cash value is tax free so if they decide to take out the cash value, they would pay no taxes.
But wait a minute.
Let’s do some simple math here.
If they pay $11,763 annually in premiums for 10 years, then their total outlay is $117,630. The cash value after 10 years is $118,210.
In other words over a 10 year period they made a pitiful $580 return. Now granted they had a death benefit to the life insurance, but you can get a similar death benefit for far cheaper with other types of life insurance.
Yes, withdrawals (they're actually called loans) from the cash value are tax free, but who cares?
The return on their investment is lousy!
That’s one of the many reasons why you shouldn’t buy a whole life insurance policy. In this example there is another issue -- most physicians will not need life insurance for their entire lives.
Unfortunately this advisor tried to sell them even more whole life policies.
Here’s another example...
Example #2: 50 year old married physician paying $50,000 annual premium into a whole life insurance policy
This physician got a late start practicing medicine and his retirement portfolio is about $300,000. Now he’s started making significant income -- more than $500,000 annually. He’s an independent contractor also so he could set up his own retirement plan.
But his financial advisor’s solution was to stuff money into a whole life insurance policy.
After 5 years of paying $50,000 annual premiums for a total outlay of $250,000, the cash value in the policy was about $125,000.
In other words he had a loss of almost -50%!
Let me ask you this. If a financial advisor or anyone else came up to you and said that they can assure you that an investment will lose money over the next 5 to 10 years or more, would you invest in that?
But there are other problems in this situation.
You see, while the cash value is tax free he could have taken those $50,000 annual premiums and invested them into a qualified retirement plan (like an individual 401k) to get a whopping tax deduction especially because he’s in the highest tax bracket. With a whole life policy you lose out on that because you do not get a tax deduction for the premiums paid into the policy.
So why would a financial advisor sell this policy to this physician?
Well, here’s something your financial advisor probably won’t tell you.
The commission that he gets paid by selling you permanent life insurance policies -- such as whole life insurance policies -- could be a whopping 50% to 80% of the first year premium!
You read that correctly.
In the second example above where the physician’s premium is $50,000 annually, that translates into a nice pay day for the insurance company and the advisor -- possibly $25,000 to $40,000.
Do you smell conflict of interest?
But wait....here are more reasons not to buy these tax free investments:
1. Taking money out of the cash value is not cost free. It may be income tax free, but the insurance company will charge you interest. The reason is that you have to borrow against the cash value (take a loan) and that loan can potentially have adverse consequences.
2. Your total cost of investing is much higher. A mistake many physicians make -- and the financial advisors they hire -- is to think that taxes are the only cost of investing. The only cost that matters in the end is TOTAL cost. Taxes are part of total cost, but there are many other costs. The other costs can easily exceed the tax cost, so usually it’s better for you to pay the tax because your total cost is lower.
3. You lose control of your asset allocation. Academic studies have shown that asset allocation -- the broad mix of investments in your portfolio -- drives returns. You don’t know whether a whole life insurance policy is a stock or a bond, and if you don’t know that then you don’t have an asset allocation or an investment plan.
4. You can do better with other investments. For example, if you haven’t maxed out your tax deferred accounts, you need to do that first before pumping money into a whole life policy.
5. Most doctors need a higher rate of return to achieve their goals than the low returns you get in a whole life insurance policy. The reality is that many physicians’ income isn’t going up much, so you need to invest money and take some risk to potentially get a higher rate of return. Whole life just doesn’t solve that problem.
In the next part of this report, I’m going to show you another way your financial advisor may not be acting in your best interests.
In the meantime, if you've been sold an expensive life insurance policy and you are sensing that your current financial advisor is not watching out for you, I strongly encourage you to set up your FREE Financial Coaching Session with me here:
Talk to you soon.
Making Work Optional For Doctors,
Setu Mazumdar, MD, CFP®
The Financial Planner For Doctors