Financial Horror Story:  The Life Insurance Scam

Bernie Madoff ripped off his clients by lying to them. He claimed that they were getting tremendous returns, but rather he was blowing all of their money and making false financial statements. Other financial scammers don’t need to lie to rip you off. Instead these con artists use legal financial products, good sales skills, and a trustworthy victim. Thankfully a client of mine was smart enough to sniff out the scam before becoming the next victim. Here is an email that I received from him.

I just met with my insurance agent and he is suggesting the following moves: Withdraw all of the money from our 529 plans and Roth accounts and contribute the money into a permanent life insurance policy. Also, stop contributing to my 401(k) and instead all of my savings should go into an annuity. What are your thought?

My thoughts: RUN!

I have heard life insurance salesman horror stories in the past, but I think this takes the cake. Is it even more egregious than when a client told me about an insurance salesman charging nearly $50,000 a year to insure his 83 year old father for $100,000? Maybe not, but both insurance agents should have their insurance license revoked.

Yes, life insurance for many people is important. Trust me, I have a stay at home wife and a 4-year old son. I’m chalked full of life insurance. Any more and my wife may start to wonder how important I am to keep around (I’m kidding hun!). That being said life insurance is not a good investment. The life insurance I have and recommend for nearly everyone is a term-life insurance policy. My policy is roughly $1 million and it expires when I’m 60. It cost me a whopping $33 a month for this policy. Hopefully, I don’t die prior to 60 and and my $32 in premiums are completely wasted. If I do, my family will be taken care of. This is how life insurance is supposed to work. It isn’t meant to be a college savings account for my kids, like the dreadful Gerber Life College Plan.

First, it is important to understand the different types of insurance. Term-life insurance is typically the lowest cost policy but there is no benefit unless you pass away while the insurance policy is in effect. For example, after my 20-year term policy expires, there is no benefit. There is no cash value or investment part of term life insurance. Permanent insurance is more expensive and consists of life insurance and a cash value that builds up as you make premium payments. I wrote an article about how most people don’t need permanent insurance, because most of us don’t need insurance forever. Not to mention permanent insurance is expensive, and after the high fees and commissions, the investment growth is miserable.

Now, there are some benefits of permanent life policies. The insurance salesman will sell you on tax free distributions (not necessarily true), and an investment account that you can use for any reason. Also, if you were to die, your heirs would get a nice payday. The problem is that the fees are extremely high. You are almost always better getting a low cost, term-life insurance policy, and invest the rest of the money. For example, you may pay $250 per month for a $500,000 permanent life insurance policy. After the fees and expenses only $50 or $100 is invested and these are usually high cost investments. Instead, you may be able to buy a $500,000 term life insurance for $50 per month and take the $200 of savings and invest on your own. More money will be saved and investment costs can be much cheaper.

So, why did the insurance agent attempt to sell my client all of this life insurance? Permanent life insurance policies are some of the highest commission products out there. The insurance agent would receive no commission for telling this client to stay in the tax-free Michigan 529 plan. So, he suggests moving to a less tax favorable permanent life policy, and incur a big tax and penalty from moving the funds out of the 529 plan. Talk about awful advice.

Also, on top of the nice payday he would receive initially from moving the 529s to life insurance policies, he is also setting himself up for steady income from this client. By suggesting my client stop making pre-tax 401(k) contributions, and instead making annuity payments, he would be making a monthly commission when the client contributes to the annuity. You have to hand it to this guy. He can’t make commissions on the Michigan 529 plan, so he suggests rolling into a life insurance policy where he can get a high commission. He can’t make commission from the 401(k), so he suggests stop contributing there, and instead contribute to an annuity in which he can get a nice commission.

Being a fiduciary means that a financial advisor is required to act in the best interest of the client. You have probably heard that Trump has recently axed this rule. This means that you are on your own to protect yourself from being scammed by a shady financial advisor. The first step in protecting yourself: Stay away from non-fiduciary financial advisors, like life insurance agents. Life insurance is great for protecting your family if someone passes away. It is awful as an investment to save for college or retirement.

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