Is Whole Life Insurance a Good Investment?
A life insurance policy can be a valuable addition to a comprehensive financial strategy. If you pass away, your life insurance will provide your loved ones with a death benefit that they can use to pay for final expenses, pay off debts, or cover living expenses.
Whole life insurance is one option to consider when shopping for life insurance. This type of policy combines permanent coverage and cash value. The cash value accumulates at a fixed rate, so you know exactly how much it will grow over time.
But is whole life insurance a wise investment?
What is Whole Life Insurance?
Whole life insurance is permanent life insurance that provides coverage for the duration of your life. So long as premiums are paid, the policy will remain in effect. The policy pays a death benefit to your life insurance beneficiary upon your passing. Premiums for whole life insurance won’t change over time. And a portion of each payment is deposited into an interest-bearing cash value account.
The cash value portion grows tax-deferred at a guaranteed rate of return. You can borrow or withdraw funds from the cash value. If you decide to cancel your whole life insurance policy, you can receive the "surrender value," which is the cash value minus any surrender fee. 4.65 percent is the current average dividend interest crediting rate for whole life insurance.
Is Whole Life Insurance a Good Investment?
Generally speaking, whole life insurance should not be considered an "investment" vehicle. Investments are typically characterized by a balance of risk and return. Consider whole life insurance as a tax-advantaged, strategic cash flow allocation. In the first few years of the policy, most of the money you pay in premiums goes toward paying the death benefit, while the rest pays for administrative costs. The balance is transferred to your cash-value account.
More of your premium is deposited into the cash value account as time passes. This account offers a guaranteed return on investment. The majority of life insurance companies invest in bonds and government-backed mortgages. Most companies that sell whole life insurance are mutual insurers that pay dividends that you can periodically add to your cash value account. The longer you pay premiums, the more cash value you can accumulate over time.
Compared to other investment options, the predictability of cash value growth in whole life insurance can be less stressful. Whole life insurance is different from other types of investments because its cash value grows every year, tax-free, and without market risk or volatility.
On the other hand, if you need life insurance mainly to provide a death benefit and nothing else, whole life insurance is not a good use of money. Universal life insurance can usually provide a death benefit at a lower cost.
The Pros and Cons of Investing in Whole Life Insurance:
Whole life insurance has both advantages and disadvantages.
Here's a quick rundown of the main pros and cons:
- Whole life insurance generates tax-free cash value.
- Premiums can be paid using the accumulated cash value.
- If you don't have any other financial resources, being able to borrow against or withdraw from a policy's cash value can be useful.
- When you pass away, your beneficiaries do not receive the cash value. Regardless of how much cash value you have built up, they receive the face value of the policy (minus withdrawals and outstanding policy loans). The cash value is returned to the insurance company.
- If you pay your premiums for a few years, you might not have a lot of cash value at the end of that time.
- When compared to the returns you can get from other investments, whole-life policies may not do as well.
- Withdrawing money or taking out a policy loan and not repaying it reduces the death benefit paid out when you die.
What you're looking for will determine whether the pros outweigh the cons for you.
Whole life is a great choice if you want stable, predictable long-term returns from a tax-advantaged investment with a very low risk level. If you want to maximize returns regardless of risk and have a short time horizon, it's probably not the best option.
When is Whole Life Insurance Not a Good Investment?
While whole life insurance has advantages, it is probably not the best option if you fit any of the following descriptions:
1) You only need life insurance for a limited time. If you only need life insurance for ten, twenty, or thirty years, paying higher premiums for whole life insurance is probably not worth it. A term life insurance policy is the better option for pure life insurance at a reasonable price.
2) You have a high risk tolerance when it comes to investments. People who have a low risk tolerance or want a safe, guaranteed way to build cash value are drawn to whole life insurance.
3) You want to be in charge of your investments. With no investment options, whole life insurance provides a fixed rate of return on its cash value. You will not benefit from the stock market's potential highs.
4) You want a higher rate of return. The interest and dividends paid out by a whole life policy may lag far behind the returns available elsewhere.
Additionally, the current cash flow is impacted as the premiums can be pricey and there is a high cost associated with the commission. It can take some time before you start to see the cash value grow, so whole life insurance also calls for some patience. Those who want to beat the market or who need cash quickly may want to look at other ways to save and invest.
When is Whole Life Insurance Worth It?
Whole life insurance can be attractive if:
1) You want to leave money to loved ones when you die, no matter when. Whole life insurance can make sure you can leave your chosen beneficiaries with a death benefit without your premiums going up over time.
2) You want to invest in something safe. If you are willing to wait, whole life insurance can give you stable returns. Cash value grows slowly from year to year, but it is not affected by changes in the market.
3) You max out your retirement accounts each year. Your long-term savings plan might include a 401(k) or an Individual Retirement Account (IRA). If you can put in as much as you can each year, you might want to look into a whole life insurance policy to get a few more tax benefits because the cash value grows without being taxed.
4) You want to have money to use later. If you plan to use the cash value, it makes sense to build it up in a life insurance policy. For example, you could use the cash value to add to your savings for retirement or pay for your kids' college.
Don't mix up a death benefit with a cash value.
Building cash value does not create wealth for the beneficiaries of your life insurance policy. Beneficiaries do not receive the cash value when you pass away. They receive the policy's death benefit, which is the face amount excluding any previous withdrawals and outstanding policy loans.
Whole life insurance always pays out a death benefit, no matter when the policyholder dies. This is clearly superior to term life insurance, which only pays out if the death occurs within a certain time frame. Whole life insurance, on the other hand, is significantly more expensive. That being said, whole life insurance builds cash value, offers permanent protection, and can help your family build wealth over time. Additionally, compared to other forms of coverage, these policies provide more guarantees, which makes them a viable choice for many people.
Get in touch with me if you have any questions about whole life insurance or any other type of insurance. We can set up a free 1:1 session to discuss any questions you may have.
I hope this information was helpful. If you have any other financial-related questions, feel free to reach out. I’d be happy to chat with you!
About the Author
As a Partner and Financial Advisor at Vincere Wealth, Tim assists clients in navigating financial challenges and making sound financial decisions. Having someone guide you in making sensible financial decisions today can have a substantial impact on your future financial wellbeing. Tim takes immense pride in guiding customers through the complexities of insurance, estate planning, and cash flow optimization.
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