How to Decide if Whole Life Insurance is Right for You

Insurance, as a whole, is confusing at best. Moreover, life insurance is just one of the myriad of insurance types available, and it comes in many different forms.

In my last article, I discussed the merits of term and permanent (sometimes called ‘whole’) life insurance. The conclusion was that term is, for most people, the only type of life insurance worth looking into. “Permanent” life insurance, on the other hand, is an umbrella term which encompasses many types of life insurance. These include whole and universal insurance.

To recap, permanent life insurance provides lifetime coverage. Whole life insurance and universal life insurance carry “investment” accounts (note the quotation marks; we’ll get into that in a bit) and insurance components. Other common characteristics include higher premiums than term life insurance, and the ability to use the cash value built up in the “investment” portion as a loan.

Note that the cash value is different from the face value: face value is the amount beneficiaries receive upon death, and cash value is the accumulated savings you can actually access. You cannot borrow against the face value, so it’ll take a significant amount of time to build the cash value to a point where it’s worth borrowing against. You can, however, borrow at favorable rates, and your cash value can be used to pay premiums in case of an emergency.

Let’s look at the pros and cons of universal and whole life insurance.

Cons of Whole Life Insurance

The biggest issue for savvy individuals will be the significantly higher premiums when opting for whole life insurance. We’re talking about a $100 per month premium for term, to north of $1,000 for the same benefit for whole. Given the difference in what you could be earning by putting that towards a more traditional retirement account, it’s wiser to take out a term policy and invest the remainder.

Another negative is that the cash value portion of your insurance policy will also be hit with various fees, both from the investment side and the insurer’s side. This means that your returns from the cash value will always trail the index fund or funds it’s allocated toward. There’s no “beating the market” here.

Pros of Whole Life Insurance

For starters, universal life insurance offers greater flexibility when evaluating your premium payments and death benefits. You can increase or decrease your premiums depending on how much you can afford, compensating for your earnings and potential financial issues over time.

Furthermore, you can control how your money is invested. Look out, however, for guaranteed rates compared to projections. Because life insurance is such a confusing subject, it’s easy to see rates that vary wildly. Make sure to diligently check projected investment returns against their guarantees, and against other investment vehicles like traditional IRAs and 401(k) plans.

Borrowing from your cash value can also be a benefit. The cash value grows tax-deferred, and there’s often no limit on how much you can contribute to the policy. These may be beneficial, but those wins will be limited to extremely high-income or very wealthy individuals. There’s no such thing as a free lunch. Keep in mind that tax-free borrowing will incur interest or potential surrender penalties, and will also impact your death benefit.

One final benefit, which may be relevant to a select few of you, is that extremely wealthy individuals with estates left to beneficiaries could see major tax advantages through the proper use of a whole life insurance policy. You can avoid estate taxes and federal income taxes on death benefits based on your policy’s conditions.

Learn More: How to Avoid Estate Taxes on Life Insurance Proceeds

Buyer Beware

The primary thing to understand about permanent life insurance is that it is not an investment. You’ll often hear universal life insurance described to you as “similar to an IRA” or as an investment with “guaranteed returns.” This couldn’t be further from the truth.

Permanent life insurance carries high fees, and your higher premiums can eat into your returns. Dave Ramsey put it best: “‘Cash value’ life insurance is one of the worst financial products available.” You should be maximally contributing to your 401(k) and an IRA before you even begin to consider a whole life insurance policy, and even then, it’s likely not the best fit for you.

“Permanent” life insurance is exactly as it sounds, and you’re penalized heavily if you withdraw from your policy early. This is a policy you’re taking out for life, so compare it to other common insurance commodities like car insurance. You change your car insurance as your car ages, dropping coverages or changing deductibles. Do you want to lock yourself into a policy that remains in effect until you turn 100?

Be sure to weigh all of your options before choosing a life insurance plan. And remember that the best option for you today may not be the best option for you in ten years.

If you hold a life insurance policy, did you choose term or whole? Why?

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