Financial Planning

Advisors Behaving Badly (001)

Today I had lunch with a financial advisor friend of mine, and I learned about a disgusting situation he uncovered with a new client. He can’t share this story because compliance says no blogs allowed, so I’m sharing the story.

Allow me to set the scene:

  • Baby boomer couple nearing retirement
  • An IRA with around $220,000, a 401(k) with around $100,000, and a pension
  • An advisor with dollar signs in his eyes
  • A recommendation to establish an LLC, start a 401(K), and use a universal life policy to fund

Now, it is possible the scenario painted above MIGHT work in certain situations, but I can assure you this is not one of them.

The Story

With the couple nearing retirement, the former advisor recommended opening an LLC in the wife’s name–she did not have a business or even a hobby that could pass as a business. In doing this, she would be able to open 401(k), I’m assuming a solo 401(k), into which she could transfer her IRA. Why would she want to do this? Great question. The obvious answer is to fund a universal life policy.

This is where the scenario becomes very aggravating, and unfortunately, the clients followed the recommendation.

The universal life policy is set to be funded over 10 years at over $20,000 a year in premiums…TWENTY THOUSAND DOLLARS A YEAR. Do you know what that commission looks like? It’s been a long time since I’ve written a life insurance policy, but I know it’s a big commission. At the end of the 10 years, the entire IRA balance would be in the 401(K) “invested” in the universal life policy. As you can see from above, the clients would be left with little liquid assets as they enter the early years of retirement.

At this point, most financial advisors and insurance professionals are bothered by reading this. It’s obvious WHY this strategy was recommended and WHO benefited the most, but for the readers not in the business, let me shed light on the numerous issues this has caused for the client.


Technically, the cash value in the life insurance policy is liquid, but if you’ve never seen a universal life illustration (the numbers used to paint a pretty picture of what could be with the “investment”), the beginning of the policy sees the cash value growing very slowly because of the expense of the life insurance–think of the beginning years of a mortgage; most of your mortgage payment goes toward interest and it’s not until the later years that you see the principal paid down. It’s the same, except with life insurance, it’s not until the later years that you see the cash value begin to grow. In addition to the high insurance expense in the beginning, these policies tend to have surrender periods that cost clients to take money out.

If the universal life “investment” works out, it would be years before the clients could actually use the cash value for the income they will need in retirement and that’s a big IF; the once liquid IRA would gradually become an illiquid asset at the most critical time for the clients. They would be left relying on the husband’s pension, his 401(k) of about $100k, and eventually, Social Security to fund their retirement–losing the IRA takes away liquidity that might be needed if life doesn’t go as planned–and it never does.

An Unnecessary Death Benefit

I’m not privy to the original conversations, but in the most recent conversations they’ ve had with my friend, the couple did not voice estate planning concerns. No legacy goals. No need to incorporate a life insurance benefit. Yes, when the wife passes away the husband will receive the death benefit, but if she lives a normal life expectancy, he will receive a large life insurance payout late in life–and for what?

With this strategy the couple would be sacrificing retirement income during the years they would enjoy it the most for a benefit that would not be needed later in life. In this situation, you cannot convince me universal life insurance was necessary or helped the couple reach any of their goals.

Lack Of Understanding

Neither the husband or wife were able to explain the benefit of the universal life policy to my friend. They did not know why they did what they did, other than they were told it was a good thing to do. This is why financial literacy is so important; it is imperative clients understand the investments they are making. If there is any uncertainty, do not sign anything or move forward with a recommendation. Continue to ask questions until you understand and can explain back to your spouse (or someone else) why you are following the recommendation.

While we’re at it. Don’t be impressed by complicated strategies…they are often a distraction. Complicated strategies can give a false sense of expertise, expected success, and an advantage over others; when in reality, they often are overcompensating for a lack of these.

No Positives For The Client

In this scenario, there are no positives for the clients. If they do not unwind the universal life 401(k), they are on a path to have the bulk of their retirement savings tied up in a life insurance policy and could potentially find themselves having cash flow issues. If they do surrender the universal life policy they will only receive a fraction (a small fraction) of the first premiums paid–they will be forced to realize a significant loss and will have to deal with the psychological impact of realizing that loss.

It’s a tough decision for the clients and for my friend; the best financial decision is to stop the bleeding, cancel the life insurance, take the loss, and get back to a more traditional allocation for the IRA, but that may not be the easiest. Behavioral finance has demonstrated how hard this is for people to do.

There is one person seeing a positive in all of this–the former advisor. He got paid and paid handsomely. If I had to guess, this is not the only LLC-401(k)-universal life scheme he has recommended.

The Takeaway
  • Be wary of overly complicated strategies.
  • Ask questions.
  • Ask more questions if necessary.
  • Don’t move forward with a recommendation if you don’t understand it and can’t explain it to someone else.
  • Trust your gut.

Stories like this make me sick. A couple who did everything they were supposed to: save diligently, seek a professional for advice, and follow the advice give are taken advantage of by an advisor a fraudster only concerned with making a buck.

This is why the fiduciary conversation is so important, and why I think posts like this are so important. The more these types of stories are told, the more likely the same mistake won’t be made–I’m concerned about the families and individuals that find their way into the offices of advisors like this one. If collectively we (blog writers and readers) can warn others, more people will be aware of these schemes and avoid them. This is why I included the (001) like a podcast in the title–there will be more posts like this to expose more bad practices to avoid.

Karma will take care of the advisors.

Sidenote: My intent was not to dunk on life insurance or advisors recommending/selling life insurance (unless they are recommending trash like this). Life insurance has its place in most financial plans, universal life can be a fit for some situations. It just so happened that universal life was an important part of the story.

Disclaimer: Nothing on this blog should be considered advice, or recommendations. If you have questions pertaining to your individual situation you should consult your financial advisor. For all of the disclaimers, please see my disclaimers page.