The Pros and Cons of Whole Life Insurance

A good financial plan should include a life insurance policy. If something happens to you, your life insurance will give your loved ones a death benefit that they can use to pay for your funeral, pay off your debts, or cover your loved ones’ regular living costs.

If you are looking for life insurance, one option is whole life insurance. This kind of policy gives you coverage for life and lets you save money. The cash value builds up at a fixed rate, so you know exactly how much cash value you’ll build over time.

But is whole life insurance a wise investment?

What is a whole life insurance policy?

Whole life insurance is permanent life insurance that can cover you as long as you live. The policy won’t lapse as long as the payments are made. When you pass away, the policy gives your life insurance beneficiary the death benefit.

For whole life insurance, the premiums won’t change over time. Part of each payment goes into a cash value account, where it earns interest.

The cash value grows at a guaranteed rate of return while taxes are not taken out. You can take money out of it or borrow against it. If you want to end a whole life insurance policy, you can take the “surrender value,” which is the cash value minus any surrender charges.

At the moment, the average rate for adding dividend interest to whole life insurance is 4.65%.

Is it a good idea to buy whole life insurance?

Most of the time, whole life insurance shouldn’t be thought of as an “investment.”

Michele Lee Fine, founder and CEO of Cornerstone Wealth Advisory in Jericho, New York, says, “Investments are usually a balance between risk and reward.” Whole life insurance is better thought of as a tax-advantaged, strategic way to use cash flows.

In the first few years of the policy, most of the premiums you pay go toward paying the death benefit, while some of the money goes toward administrative costs. What’s left goes into your account for cash value.

More of your premium goes into the cash value account as time goes by. Money in this account grows at a rate that is guaranteed. Most life insurance companies invest in bonds and mortgages backed by the government.

Most companies that sell whole life insurance are mutual insurers that pay dividends that you can periodically add to your cash value account. The more time you have to pay into the policy, the more cash value you can build up.

Whole life insurance can be less stressful than other investment options because the growth of the cash value can be predicted. “Unlike any other asset class, whole life provides guaranteed year-over-year, tax-free growth of cash values without market risk or volatility,” says Fine.

On the other hand, whole life insurance is not a good use of money if all you need is a death benefit and nothing else. Universal life insurance can usually offer a lower-cost death benefit.

Pros and cons of investing in whole life insurance

Whole life insurance can be good and bad in different ways. Here are a few of the most important pros and cons.

Pros:

• Whole life insurance builds up a cash value that is not taxed.
• The cash value that has been saved can be used to pay premiums.
• If you don’t have any other money, being able to borrow against a policy’s cash value or take a withdrawal can be helpful.

Cons:

• When you die, your beneficiaries do not get the cash value. No matter how much cash value you have built up, they get the face value of the policy (minus withdrawals and policy loans). The insurance company gets back the cash value.
• It can take a few years of paying premiums before the cash value becomes significant.
• Whole-life insurance policies may not give you as good a return as some other investments.
• If you take money out of your policy or borrow against it and don’t pay it back, your death benefit will be less.
• How you feel about the pros and cons depends on what you want, says Howard Sharfman, senior managing director at NFP Insurance Solutions in Chicago.

Sharfman says that whole life insurance is a great investment if you want stable, predictable long-term returns from a tax-advantaged vehicle with a very low-risk profile. “It’s probably not the best choice if you want to maximize returns regardless of risk and you only have a short time horizon.”

When is whole life insurance not a wise investment?

Even though there are some good things about whole life insurance, it’s probably not the best choice if you:

• Life insurance is only needed for a certain amount of time. If you only need life insurance for 10, 20, or 30 years, it probably doesn’t make sense to pay higher premiums for whole life insurance. If you want pure life insurance at a good price, a term life insurance policy is the better choice.
• You are willing to take on a lot of risks when you invest. People who don’t like taking risks or who want a safe, guaranteed way to build cash value often choose whole life insurance.
• You want to make decisions about your investments. Whole life insurance has a fixed rate of return on cash value, and you can’t choose how to invest it. You won’t benefit from the stock market’s possible highs.
• You want a higher return on your investment. With a whole life policy, the interest and dividends you get may be far behind what you can get elsewhere.

Whole life insurance also requires some patience because it can take a while before the cash value starts to grow. Sharfman says that people who want higher returns than the market or who need cash quickly might want to look at other ways to save and invest.

When is it a good idea to buy whole life insurance?

Whole life insurance is a good choice if:

• Want to give money to people when you die, no matter when. Whole life insurance can make sure that you can leave your loved ones a death benefit without your premiums going up over time.
• Want to put your money somewhere safe? If you’re willing to wait, whole life insurance can give you stable returns. Cash value grows slowly from year to year, but it isn’t affected by changes in the market.
• Each year, put as much money as you can into your retirement account. Your long-term savings plan may include a 401(k) or an Individual Retirement Account (IRA). If you can contribute the most to these plans each year, you might want to look into a whole life insurance policy to get a few more tax breaks because the cash value grows without being taxed.
• Would like to have money to use in the future. If you plan to use the cash value, it makes sense to build it up in your life insurance policy. For example, you could use the cash value to add to your savings for retirement or pay for your children’s college education.

Don’t mix up a death benefit with cash value. Adding cash value to your life insurance does not make your beneficiaries richer. When you die, the cash value does not go to your beneficiaries. They get the policy’s death benefit, which is the face amount minus any withdrawals and policy loans you’ve already taken out.