Whole Life Insurance - Does It Make Sense for You?

Planning for the future often takes a backseat to today’s problems. Most people want to know their families are protected financially in case something happens to them. This is where having life insurance can make a big difference.

However, there is conflicting information out there when it comes to getting a life insurance policy. If you’ve ever worked with someone who works for an insurance company (an insurance agent...regardless of what they call themselves), you may have been pushed to a whole life insurance policy.

While whole life insurance can be a good option in some cases, in my opinion, it’s the wrong product for the vast majority of people. Here’s what you need to know about whole life insurance to make an educated decision about the type of policy that’s right for you.

What is Whole Life Insurance?

A whole life insurance policy will cover you as long as you live. When you die, your named beneficiaries will get a payout based on the policy value plus interest. The policy has cash value, which can be used as collateral for a loan amongst other options.

Whole life insurance policies are multiple times more expensive than term life insurance policies, all things being equal. This difference is often thousands of dollars more for the life of the policy. This is because of the cash value/savings component of a whole life policy.

The policy loan option that comes with whole life insurance policies can serve as a safety net in case of emergencies. While insurance companies do charge interest on outstanding policy loans, there’s no requirement to make payments.

If you have the time and financial resources to invest in a whole life insurance policy, it can help serve as part of your estate plan. However, this needs to be part of a bigger wealth building strategy.

Talk with a qualified financial advisor or an estate planning attorney before taking on the steep premiums inherent with whole life policies.

The Importance of Life Insurance

If you have dependents, it’s a good idea to have a life insurance policy in place. This can help offset funeral costs and other related expenses. Plus it will give your spouse some breathing room after your death and help with expenses.

However, most people only need life insurance for a certain time period such as 10, 20 or 30 years. Once your children are fully grown and out of your house, it no longer makes sense to have a life insurance policy in place...for the most part.

Term life insurance policies are the cheapest way to protect your family and give yourself peace of mind. These policies don’t have a cash value component and serve just one goal - to protect your dependents in case you pass away suddenly.

While term life insurance can help you save money over whole life insurance, it’s not the best life insurance for every situation. Once the term is up, you will pay much higher rates if you want to renew or get a new term life policy.

If you have dependents that permanently rely on you for financial support, you need to evaluate all life insurance options before making a decision.

Check out these top 10 life insurance companies to ensure you're working with the best!

Why Whole Life Insurance is Not a Good Investment

Whole life insurance policies are often hawked as the best choice because they protect your beneficiaries while also serving as a savings vehicle. However, there are many reasons why a whole life insurance policy is the wrong choice for the majority of people.

The right kind of insurance will align with your needs and goals for the future. While at first glance, a whole insurance policy seems like a good investment, there are many caveats that make this the wrong coverage for many people.

Here are a few things to consider when looking at whole life insurance as an option.

It’s Very Expensive

There is a big price difference between whole and term life insurance. According to NerdWallet, a $500,000, 30-year term life insurance policy for a 30-year-old male would cost $403 annually. All things equal, the same whole life insurance policy would set you back $4,675, more than 10 times as much.

The average person does not need the amount of coverage offered by whole life insurance policies. Getting term life insurance would offer sufficient coverage for most situations. If you’re looking to protect dependents such as young children, a 20- or 30-year term life policy would offer sufficient coverage at a fraction of the price of whole life insurance.

How much your life insurance costs depends on a number of factors including your health, age, hobbies, and gender. Insurance companies use these parameters to determine how risky you are to insure.

The less likely you are to die during the course of the policy, the cheaper your payments. This is one of the reasons a whole life policy is so expensive. It means that the insurance company will be paying out the death benefit if the policy is active and all parameters are met.

The cost of a life insurance policy depends on several factors, including the type of policy you select, the coverage and term length. In addition, your current health, family history and bad habits such as smoking will also play a role.

Other factors include your age (the older you are the more expensive the policy); your hobbies and how dangerous they are, and finally, your gender - men pay more than women, on average.

There’s Limited Insurance Benefit

The cost of whole life insurance is high in more ways than one. So much of the premium goes toward investment fees and life insurance coverage that there is little left over for investment within the plan.

In other words, the insurance benefit can be limited because the premiums are so pricey. There are certain cases where whole life insurance can make sense as a way to diversify investments. However, for the vast majority of people, the cons definitely outweigh the pros.

Cash Value Takes Time to Build Up

One of the biggest benefits of whole life insurance that gets touted is the cash-value build-up. It’s sold as a savings vehicle that offers you access to the money you put into the policy. This is a myth that can cost you dearly.

While you can eventually access the cash value of the policy, this can take anywhere from five to 10 years. It takes a while before you build up cash value equivalent to the amount of money you paid in premiums into the policy.

This means years and years of paying thousands of dollars for a policy without being able to access the funds. Many people like whole life insurance policies as an investment because the money grows in the policy tax-deferred.

You won’t have to pay taxes on the interest, which is an added benefit. A whole life insurance policy is something you take on for the long haul. Since it takes so long for the value to build up, this is not a way to grow your money for the short term.

However, you are guaranteed that your beneficiaries will see a benefit from the policy as long as you pay the premiums every month and all rules are followed.

It’s Best to Buy Term and Invest the Difference

There is such a steep difference between term and whole life that you’re better off buying term and investing the difference. Term life insurance can provide you with sufficient protection during your high earning and high spending years.

Take the difference between term life and whole life and invest it in the stock market. The investment performance of mutual funds and index funds, in particular, typically will outperform that of any insurance product over the long-term.

Investing your money in a mutual fund instead of a life insurance product gives you more flexibility. It also accumulates much faster, giving you access to the balance sooner than a whole life insurance policy.

Depending on how you choose to invest the balance, it can be used for many different purposes before you pass away. It also doesn’t lock you into an inflexible financial product the way a whole life insurance policy does.

You can also diversify your investments in the stock market to balance your risk. A whole life insurance policy, on the other hand, does not allow this option.

There are High Management Fees

Before deciding if a whole life insurance policy is a good investment, you need to review the associated fees. Whole life insurance policies tend to have high management fees and commissions.

A big portion of the whole life insurance premium goes toward the investment fees. This can limit your interest earnings and also contributes to slow value build up at the onset of the policy.

Fees such as premium loads and sales charges compensate insurance companies for sales expenses and state and local taxes. They are usually taken out of your premium payment before it’s applied to the policy.

Another common one is the administration fee, which pays the cost of accounting, recording keeping, and so on. These are deducted from your policy value once a month. There are several other fees that may eat away at your premium and increase the cost of a whole life policy.  

More than What Most People Need

A whole life policy is the Cadillac of insurance plans. It offers the ultimate in coverage as it has no expiration date, unlike term policies. It lasts until you die as long as you pay the monthly premiums. This makes it more likely that you will die while the policy is still active.

The cash-value component is another benefit that is touted by insurance brokers - but it also adds to the steep price. Insurance premiums are split between the insurance component and the cash-value component, making the rates much higher.

While whole life insurance can make sense as an investment in certain situations, more oftentimes it does not. The sky-high price tag also makes it difficult for people to keep paying the premiums for the long-term.

If you decide you no longer want your whole life insurance policy and want to cash out? If this happens in the early years of owning the policy, you’re going to walk away with little to no cash value; you will also be out thousands of dollars.

While it may seem like term life insurance is always the best option, there are situations when it makes sense to go with a whole life policy. Wealthy families can use whole life insurance as an estate planning tool and create an insurance trust to pay estate taxes out of the policy proceeds and pass the trust on to the heirs.

If this is something that could be a good fit for your situation, you need to consult an estate planning attorney.

The Bottom Line on Whole Life Insurance

If you have dependents, having a life insurance policy will provide your family with protection in case you die. However, for most people, a term life insurance policy will provide sufficient coverage at a fraction of the cost. A life insurance policy can serve as a safety net for your family.

There are many factors that go into getting life insurance coverage. Talk to a trusted financial advisor or an estate attorney about which policy options fit best for your individual situation.

Before getting a policy, shop around and compare prices. Learn as much as possible about each life insurance policy option before making a decision. What works well for one person may be a bad idea for another.

Having life insurance in place will give you peace of mind that your family is protected no matter what happens. To learn if whole life insurance makes sense for you, be sure to check out Cfainsure.

This is a post from Clint Haynes, a Certified Financial Planner® and Financial Advisor in Kansas City, Missouri. He is also the founder and owner of NextGen Wealth. You can learn more about Clint at the website NextGen Wealth.