Whole Life Insurance is one of your options, but is it a good fit for you?
Let’s take a look at this type of policy and explain how it works, its pros and cons, and who should buy it, so you can make an informed decision.
What is Whole Life Insurance?
Whole life insurance is one of the policy choices in what is called ‘Permanent Insurance’.
This type of policy is intended to cover you for life.
It is a complete package of insurance coverage that is used to cover the policyholder for long term financial obligations. When you are considering this policy there are 3 components that make up this type of life insurance coverage and includes:
1. Death Benefit – This is a fixed level benefit that exists for the life of the policy and is paid to your named beneficiary. The death benefit is tax deferred which means that it cannot be taxed when it is paid out.
2. Cash Accumulation – A portion of your premium is set aside and invested by the insurance company in interest bearing account. Over time, the investment portion accumulates in value through the interest earned. Like the death benefit, the cash amount accumulated is tax exempt both during the accumulation phase and even can be withdrawn tax free if taken as a loan.
The cash value generally has a minimum guaranteed rate of interest and can be borrowed against or used to pay premiums if you find yourself in a stringent financial situation.
3. Fixed Premiums – Some types of insurance exist, like universal life insurance, which allows flexible premium payments. Your policy stays active as long as enough cash is in the cash value to support the cost of insurance. You don’t typically have that option in Whole life, however. Premiums must be pain on-time, *every time. If you can’t make the payment, your premium will be “borrowed” from the existing cash value. This accrues interest, however, and may need to be paid back to keep your policy in good standing.
Who Should Get Whole Life Insurance?
Whole Life insurance is ideal for comprehensive estate planning, death taxes and to cover your family for your entire life span.
Some insurance agents and financial advisers say it’s an ideal plan to supplement your retirement needs as the accumulated cash value will be available in loan format, resulting in potential tax-free income for retirement, to purchase a building or business, put your kids through college, or other needs.
In my viewpoint, I think whole life is oversold (mostly by greedy agents trying to make a big commission), but that whole life has its place in the following scenarios:
- Business insurance – A lot of big businesses fund executive compensation plans with whole life. It cuts through a lot of red tape and administrative issues that other plans carry.
- Final expense – Many policies offered over age 70 or 75 are only available as whole life policies. These are typically small amounts of coverage like $5,000 to $20,000. Our list of top final expense companies reviews some of them.
- Health issues – In some instances, people can only qualify for a “guaranteed issue” policy due to health issues. These are often types of cash value whole life policies and could be a good choice if options like universal life or term are not available.
- Advanced Estate Planning – there are situations when an estate may require life insurance for liquidity or estate tax purposes, and depending on the setup, it may be advantageous if the policy is a cash value plan.
- For Accredited Investors – Most advisers these days agree that whole life offers low returns (it often doesn’t even break even for 7 to 10 years). A lot of people buy too much and can’t afford the premium, miss crucial payments in the first 10 years (as the cash value base is building), or simply don’t see the return they had hoped for and cancel the policy early. All of these people end up wasting their money. However, for the right type of investor, one who will pay on time, every time, and stick to the policy long term, there can be attractive benefits on the back end, such as tax free access to cash values, which in some cases, can outweigh the lackluster performance of whole life during its accumulation phase. That being said, I would only ever sell a whole life policy as “an investment” to an investor worth $1 million or more, or who makes $200,000 per year, and who has some investing experience. These are the best people to get all the benefits out of whole life.
If you need life insurance for a shorter duration, term life insurance may be more suitable (and less expensive). Universal life can also be used for a shorter term insurance need with the potential to cover you for life.
How does Whole Life Insurance Work?
When you decide on the amount of coverage, your premium is used by the insurance company and divided between the following costs:
1. Administrative Costs – For administering the policy.
2. Mortality Cost – Applied toward the death benefit coverage.
3. Investment or Savings Portion – Is put toward the savings/investment feature after the above costs have been applied.
Most policies offer a guaranteed minimum interest rate that your savings portion (cash value) earns, such as 1.5%, but again, only the premium directed into cash value (what’s left over after expenses) is guaranteed to earn this interest.
Non guaranteed dividends also play a big part in whole life cash value gains. You can use your dividends (again, not guaranteed, but the companies pay them out just about every year like clockwork) to pay down your premium, or you can take them to buy what are called “paid up additions,” which increase your cash value and death benefit, or you can take them as cash like a stock dividend, and use them to supplement your income.
You can also borrow from you cash value, which most people do, as this is typically a form of tax free income (since it’s a loan). This is easy to screw up, so be sure to speak to a tax advisor.
Pros of Whole Life Insurance
- Estate Planning – This is a good policy for estate planning because it covers you for life, and provides a death benefit and cash value which are both tax exempt.
- Guaranteed – The premium you pay, the death benefit, and the cash value is guaranteed. Although it might seem more expensive at the outset, you also have to remember that inflation rises over time which in effect decreases the cost of your premiums over the life of the policy.
- Convenience – This is an excellent type of policy if you are primarily concerned about providing both a fixed death benefit and an investment feature, but have little understanding about investments.
- Premium Costs – When you buy this type of policy, your premiums are fixed for the life of the policy. Initially, they will be more expensive than what you would pay for Term Life Policy, but reach greater parity as you age.
- Available Cash – You can borrow against the cash value as an added convenience, or access the entire accumulated cash value should you cancel your policy at any time.
- Exempt from Creditors – The cash value and death benefit may be exempt from creditors in the event you are sued as the money is intended for your beneficiary.
Cons of Whole Life Insurance
- No Investment Choice – A Whole Life policy does not allow you to invest in separate accounts like a Universal or Variable Life insurance policy so you cannot move your money between the money market, bonds, or stock market account. You cannot split your money into different accounts or move you money to different accounts.
- No Premium Flexibility – Your premium is fixed and you cannot change it for the life of the policy.
- No Premium Disclosure – You cannot see how the insurance is splitting your premium between, administrative, death benefits or investment expenses.
- More Expensive – Because of the investment and administration costs, your monthly premium is much more expensive than Term insurance which covers death benefits only.
- Repayment of Cash Value – If you borrow against the cash value, you have to pay it back and are also charged interest as it is treated much like a loan.
- Conservative – The interest you earn is conservative and the investment returns may be much less had you invested the money yourself.