Whole life insurance is often pitched as an investment alternative to traditional investment options such as brokerage or retirement accounts. Answering the question "is whole life insurance worth it" requires breaking the evaluation into two components.
The first component is to evaluate whole life insurance against other types of life insurance. How does it stack up? And in which circumstances is it appropriate to use whole life insurance over other forms of life insurance?
The second component is to evaluate whole life insurance as an investment against other comparable investment options. How does it stack up? And in which circumstances is it appropriate to use whole life insurance as an investment?
In this blog post, we’ll explore the features of whole life insurance, weigh its advantages and disadvantages, and compare it to alternative options such as term life, universal life, or other common investment options.
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Whole life insurance is just one type of life insurance. It offers lifelong coverage, which can be split into a death benefit and a cash value component.
The purchaser would pay premiums over time to retain their life insurance coverage, premiums being the cost of the policy.
Factors influencing the premiums paid for whole life insurance include the policyholder’s age, health condition, and the type of permanent policy chosen. It’s crucial to maintain payments on a whole life insurance policy; otherwise, the policy will lapse, and the associated coverage will be terminated.
The cash value component of whole life insurance functions as a savings account that accrues over time and can be accessed through withdrawals or loans by the policyholder. Whole life insurance policies earn dividends or interest, typically ranging from 1% to 3.5%.
It is important to understand that the dividend portion of earnings on cash value are a return of premium, not an interest rate or rate of return. Essentially when certain types of life insurance companies have a profit, they return a portion of premiums paid by customers to the customers in the form of these dividends.
Although the cash value component grows tax-deferred, contributions to the insurance policy are not eligible for tax deductions. When taking out a loan against a whole life insurance policy, the insurer will deduct any outstanding loans from the total payout upon death. This means that accessing the cash value component can have tax implications and may reduce the death benefit for your beneficiaries.
The death benefit of whole life insurance is the sum of money paid to designated beneficiaries upon the policyholder’s death. This benefit is the "life insurance" component of the tool.
It is designed to provide security or temporary relief for the family (beneficiaries) of the deceased at the time of death. The death benefit proceeds can be used to cover expenses such as funeral costs, outstanding debts, or as a source of income replacement. It’s essential to note that accessing the cash value component of your policy before passing may affect the death benefit.
When withdrawing or borrowing from the policy’s cash value, the death benefit will be reduced accordingly by the insurer. Additionally, if you access the cash value, you could be liable for taxes. Any amount that exceeds your policy basis is subject to income tax. It’s crucial to consider these potential tax implications and the reduction of the death benefit when accessing the cash value component of your whole life insurance policy.
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Before deciding on whole life insurance, it’s essential to compare it to other life insurance options to ensure it’s the best fit for your individual needs. Life insurance can be broken into two categories - temporary insurance, or permanent insurance.
Permanent life insurance coverage, such as whole life insurance, offers protection for the policyholder’s entire life, unlike term life insurance, which only covers a specific period (ex: 20 year term life insurance covers a 20-year period).
Because the policy is "permanent", whole life insurance is typically more expensive than term life insurance.
Note: There are a variety of types of permanent life insurance including universal life insurance, indexed universal life insurance, and variable universal life insurance. While these all offer permanent life insurance, they function differently from an investment standpoint. In this guide we will focus on whole life insurance as an investment option. In a future guide we plan to address where variable, universal, and indexed life policies fit in.
Term life insurance is a more affordable option that provides coverage for a specific period, usually ranging from 10-30 years.
This type of insurance is more straightforward than whole life insurance, as you pay a premium for the duration of the term, and if the insured person passes away during the term, the death benefit is paid out to the beneficiaries.
Term life insurance can be an attractive option for those who require coverage for a limited duration or who are seeking a larger death benefit at a lower cost.
However, term life insurance does not have a cash value component, which means it does not offer any financial advantages beyond the death benefit. If you outlive the term of your policy, you would need to either renew the policy, convert it to a permanent policy, or purchase a new policy to maintain coverage.
Term life insurance is often cheaper and more flexible than whole life insurance.
You can obtain a much larger death benefit for much smaller life insurance premiums, which, after all, is the objective of purchasing life insurance!
While there are occasions to consider whole life insurance (permanent coverage) - for instance if you are concerned about your health in the future, or want funds at your death to cover costs of funeral and burial - we generally believe that the premiums paid into whole life insurance feel wasteful as those dollars can often be put to better use elsewhere.
You will see how we quantify this in the next section when we discuss whole life insurance as an investment option.
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The second element of addressing our primary question, "is whole life insurance worth it" must be done through the lens of evaluating it as an investment.
The question is - how does the cash value that accumulates in a whole life policy compare to reasonable investment alternatives?
Let's illustrate this using an example. We will compare the performance of a whole life insurance policy (a real policy submitted by a prospect for our review) with the following specifications:
The monthly premium payment would be $250 ($3,000 annually). The death benefit amount would be $175,000. In this example, the couple purchasing the policy would pay premiums for 10 years, at which point they would stop paying premiums, keep the policy in force by letting the cash value pay the premiums, and let the cash value accumulate.
After two years of paying premiums, the couple would accumulate $950 in cash value. This means they would have paid in $6,000, most of which would have gone to expenses, fees, and the cost of insurance, leaving them with $950 in "savings" at the end of that 2 year period (thumbs down already!). Assuming they keep paying the premium for the first ten years, according to their policy illustration they would have roughly $27,000 in accumulated cash value at the end of ten years.
Then, if they stop paying premiums and let that cash value grow for an additional 20 years, their policy illustration showed a total of roughly $46,000 in cash value.
So how would this couple have faired if they had simply invested the $250 per month in the same manner into a typical brokerage account at a conservative 6% rate of return?
Well to begin - after the first two years they would have $6,357 accumulated compared to the $950 in the whole life policy.
The brokerage account would have $5,407 more at the end of year 2.
Then after 10 years of contributions this couple would have roughly $41,000 compared to the $27,000 in the whole life policy.
The brokerage account would have $14,000 more at the end of year 10.
Again, assuming the couple follows the same pattern and STOPS putting in $250 per month and just lets the money sit and continue to grow at a 6% rate of return, the brokerage account would have $135,000 at the end of 30 years, compared to the roughly $46,000 in the whole life policy.
The brokerage account would have $89,000 more (293%) at the end of year 30.
Using this example, it is clear that whole life insurance does not function nearly as well in an investment capacity as it is advertised.
It dramatically underperforms even a conservatively invested portfolio.
And the longer the time frame, the worse the whole life policy underperforms from a rate of return perspective.
Whole life insurance is simply not an investment. It's an expensive form of life insurance that can have a place in a persons financial plan - but not positioned as an investment.
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One of the main advantages of whole life insurance is its lifelong coverage. Unlike term life insurance, which only provides coverage for a predetermined period, whole life insurance offers protection for your entire life. This means that as long as you pay your premiums, your beneficiaries are guaranteed a death benefit upon your passing. This feature can provide peace of mind and financial security for your loved ones, ensuring they are taken care of after your death.
Moreover, whole life insurance offers fixed premiums, meaning your payments will not increase over time, providing predictable, stable insurance costs over time.
While whole life insurance has its advantages, it also comes with some drawbacks. The most notable disadvantage is the higher premiums compared to term life insurance. These higher costs can make whole life insurance less accessible for some individuals, especially those with limited budgets or who require a larger death benefit at a lower cost.
A second disadvantage with whole life insurance is the sluggish rate of growth on the cash value component of the policy. It dramatically underperforms compared to other comparable investment options. In many cases it can make more sense to "buy term and invest the rest". A conservative, diversified portfolio of stocks, bonds mutual funds, or money market accounts held in taxable brokerage form can provide a better rate of return and greater flexibility.
It’s vital to weigh these potential drawbacks against the benefits of whole life insurance to make an informed decision.
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Choosing the right whole life insurance policy involves assessing your financial goals, comparing providers and policies, and consulting a fee only fiduciary financial advisor. A fee only fiduciary financial advisor who works in your best interest and is not involved in the sale or compensation of a life insurance policy will give you best, unbiased review of where a life insurance policy fits into your financial situation.
Before considering whole life insurance, it’s essential to assess your financial goals and determine if this type of insurance aligns with your long-term plans. Consider the following factors when evaluating if whole life insurance is a suitable option for you:
Whole life insurance is usually more expensive than term life insurance. In most cases it will never perform comparably well as an investment vehicle. As such, whole life insurance is usually only a viable option for those who are relatively young, have a high income, and wish to pass on money to their family.
To find the best whole life insurance policy for your needs, it’s essential to compare providers and policies. Here are some steps to follow.
When comparing policies, pay attention to the policy features, such as the cash value growth rate, investment options, and riders available. These features can greatly impact the overall performance and suitability of a whole life insurance policy for your individual needs and financial goals.
Consulting a fee only fiduciary financial advisor is the best method of evaluating a permanent life insurance policy's place in your financial plan. Make sure the advisor is unbiased and does not receive compensation for referrals or sales of life insurance products so that they can evaluate your life insurance needs free of conflicts of interest. Additionally, a financial advisor can offer advice on other investment opportunities that may be more suitable for your financial objectives.
Click here to schedule a free no obligation consultation with our Fee Only Fiduciary Financial Planning team.
Whole life insurance offers lifelong coverage, fixed premiums, and a cash value component. However, it’s essential to weigh the pros and cons. You should compare it to other life insurance death benefit alternatives like term life insurance. By carefully considering your options and consulting a fee only fiduciary financial advisor, you can make an informed decision that best suits your long-term financial planning needs.
Whole life insurance offers subpar investment returns, lower death benefits at greater cost, and has higher fees, making it a poor choice as both a life insurance tool as well as an investment option.
Whole life insurance is more expensive and complex than term life insurance, and generally provides lower returns than other types of investments. As a result, it can be much more expensive than its term life counterpart.
Whole life or universal life insurance policies are best suited for adults aged 30 to 60 years old who can afford the permanent coverage. In most circumstances, a high-value term life policy is more suitable.
Whole life insurance offers lifelong protection with a cash value component and guaranteed death benefit, whereas term life insurance provides coverage only for a predetermined period of time without any cash value.
Whole life insurance is a great option for those looking for long-term protection and a cash value component. It offers a guaranteed death benefit and lifelong protection. On the other hand, term life insurance is a good choice for those who need coverage for a predetermined period of time.
Accessing the cash value of a whole life insurance policy may have tax implications, as any amount exceeding the policy basis is subject to income tax.
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