When shopping for life insurance, your agent or broker may begin pushing whole life insurance as an investment that will benefit you in the long run.
For consumers who do not like the idea of “throwing away” money on term coverage, permanent whole life insurance offers an alternative because the accumulated cash value can be withdrawn or used as collateral for a low-interest loan.
However, is whole life insurance a good investment? For about 95% of U.S. households, the answer is a resounding “no”. Here’s why whole life insurance is a bad investment.
Is Whole Life Insurance A Good Investment? The Real Answer…
But First, What Is Whole Life Insurance?
Whole life insurance, a type of permanent life insurance, is actually a hybrid insurance and investment product in one. One part of the policy is the insurance coverage.
Unlike term life insurance, which is temporary and limited to a predetermined number of years, whole life will last your entire lifetime and pay out the benefit upon your death. The premiums are fixed, although an upfront lump sum payment can pay off a policy.
Furthermore, the death benefit is fixed, minus any outstanding loans against the cash value account.
The second part is the investment account. Like universal or variable universal life insurance, companies deposit your premiums, after subtracting insurance costs and administrative charges, into your policy’s cash value account. Life insurance companies then pay annual dividends between 4% and 6%, with a guaranteed minimum of 2% to 4%.
At this rate, it usually takes whole life about 15 to 20 years to accumulate a meaningful cash value. Nonetheless, policyholders are able to withdraw or borrow against their cash value account and use the funds for anything, including a down-payment on a home, college tuition, or collateral for business purchases.
When comparing term versus whole life insurance, you will realize that term policies do not offer a cash value and only serve to pay out a death benefit while the policy is in force. The cash value is the reason whole life insurance is marketed as an investment. Finally, the biggest difference between term and whole life is that a healthy 30-year old will likely pay 5 to 10 times more for whole life compared to term life.
Whole Life: Pros and Cons
Every type of life insurance has its advantages and disadvantages, and no kind can be absolutely perfect because there will always be trade-offs. The trick to finding the best whole life insurance is getting a policy with low fees, high dividends, and affordable rates.
Unfortunately, most whole life policies encounter the same problems: high commissions for agents, high premiums for life, high administrative fees, and low dividends or rates of returns compared to other investment options. These characteristics may explain why a study by the Society of Actuaries revealed that approximately 20% of whole life policies are canceled within 3 years, and 39% within 10 years of purchase.
Below, you will find a comprehensive list of whole life insurance pros and cons.
- Permanent Coverage: One of the benefits of whole life insurance is that you will have coverage until the day you die as long as you continue to make premium payments. This can be advantageous if you develop a serious illness in the future, which could make it impossible to buy term life insurance.
- High Interest, Forced Savings Account: If you have trouble budgeting or saving for retirement, whole life insurance will force you to set aside money and pay you a modest, but guaranteed interest rate. Plus, no one likes “wasting money”, so a portion of your premiums will be returned to you as the cash value.
- Tax-Free Loans and Withdrawals: You can cash out or borrow from the equity account (the cash value) and still avoid taxes.
- Expensive Premiums: Whole life insurance is very expensive. Average whole life rates are approximately 5 to 10 times more expensive than term life rates, and if you stop making payments, you lose your life insurance. For example, a 30 year old, healthy male can expect to pay approximately $650 per year for a $1 million, 20-year term life insurance policy. A $1 million whole life insurance policy would cost about $10,000 per year.
- Not Enough Coverage: Because whole life is unaffordable for most U.S. households, it doesn’t allow you to buy enough coverage, which can put your family’s long-term financial security at risk.
- Long Term Commitment With Minimal Flexibility: Because whole life is a permanent policy, the death benefit and payments do not change. If you experience unforeseen financial hardships such as job loss, you may not be able to afford the premiums any more. If you have another child and need a larger death benefit, you can’t adjust your existing policy.
- Whole Life Insurance Is A Bad Investment: Before you start contributing to a policy’s cash value, a whole life insurance company charges you mortality and administrative fees. Afterwards, a fraction of your premiums accumulates in the cash value account, where it earns a mediocre rate of return. In the long run, policyholders would earn higher rates of return investing in other assets, including stocks, bonds, real estate, commodities, etc.
Alternatives To Whole Life Insurance
Life insurance is an essential component of estate and financial planning, especially when you have others (spouse, children, parents) who depend on you to take care of them.
The best and cheapest alternative to whole life insurance is a 20 or 30-year term life policy. A 20 or 30 year term period will protect you and your family during your most financially vulnerable years. Meanwhile, cheap and affordable term life rates allow you to take the difference in premiums and invest in higher yielding financial instruments, such as passively-managed, low-cost index funds.
For instance, did you know that the S&P 500’s geometric average rate of return from 1928 to 2013 is 9.55%? Even from 2004 to 2013 (which includes the Great Recession), the average return was 7.34%, which is well above the guaranteed average yield of a whole life policy.
The point being that, given the benefits of compounding interest, the amount of money you could earn and accumulate for retirement is far larger investing in the stock market versus a whole life policy. However, if you don’t think the stock market will see modest appreciation over the next few decades, choose whole life insurance.
What If I Already Have Whole Life Insurance?
If you’re relatively young and healthy, have recently purchased a whole life policy and do not think you will be able to afford it in the future, you may want to consider canceling and buying term life insurance. Sometimes it’s better to cut your losses while you can before you’ve sunk too much into premiums.
Just be sure that you purchase your term life policy first and have it in place before you cancel your whole life coverage because any protection is better than none, and if you find out that you will not qualify for a term policy, your family will be left without protection. Smokers, diabetics, and others who have developed a medical condition since their purchase of life insurance are better off leaving their current coverage in place because they may not be able to find affordable alternatives.
On the other hand, if you do decide that you want to buy whole life insurance, you will need to be very discerning about the policy and company. First, you need to ask about the fees/charges/penalties related to the policy, under what conditions you may cash out, the worst-case scenario of your investment’s growth, and how soon you will qualify to receive a return. Some whole life policies do not pay out during the first 2 or 3 years of issuance.
Life Insurance As An Investment
Overall, whether life insurance is a good investment or not depends on your personal finances. For the overwhelmingly majority of families, life insurance is not a wise investment option because expenses and fees reduce the amount contributed to the cash value, thereby providing an extremely low net return.
Unless you are a high net worth individual searching for investments offering tax-advantages, whole life insurance should be avoided. Instead, our recommendation is to buy an affordable term life policy and contribute the difference to your IRA or 401K, or invest in stocks, bonds, real estate, and other assets.