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One way or another, someone has probably tried to sell you a whole life insurance policy. There are more than 400,000 insurance agents in the U.S., and many of them press hard to sell whole life because they receive lucrative commissions—in some instances, amounting to 100 percent of your first year’s premium.
Because of this, an agent’s recommendation that you purchase a whole life policy is often motivated by their own interests rather than yours.
Whole life is a contract that includes insurance and investment components. The insurance component pays a set amount to beneficiaries (usually family members) when the insured individual dies. The investment component builds an accumulated cash value that the policy owner can borrow against or withdraw.
These policies are distinctly different than term life insurance, which accumulates no cash value and simply provides a death benefit for your loved ones.
Arguments for whole life include:
- It’s a way to save for those who lack the discipline to do so on their own.
- With whole life, saving and investing is automatic—by default. Insurance companies will take the premium right out of your checking account every month.
- It provides a minimum guaranteed amount decades from now—a certain cash value—and a death benefit for your beneficiaries.
These reasons are predicated on the inability of the insured individual to save and invest deliberately. Those who can do this can build wealth by following a strategic, long-term financial plan. And in addition, they can get a term life policy, at a much lower cost than whole life, to provide a death benefit for their loved ones.
However, whole life has some major drawbacks, including:
- It’s expensive relative to your likely returns. Commissions are typically twice as high as those for selling term life, and this significantly increases costs to consumers. Also, what you receive over time from an insurance company’s investing your premiums may end up being far less than that what you might earn by investing on your own in guaranteed U.S. government bonds. And if you choose to take a bit more risk, investing in a globally diversified portfolio of low-cost, no-load index funds, you might get even higher returns. But when you buy whole life, you introduce a well-paid middleman, between your money and your investment returns. Thus, the actual returns from these policies almost always end up being lower than the projected returns.
- The complexity of even basic whole life policies, let alone elaborate variations, can be overwhelming. How can you be sure this is a good investment if you don’t understand it? Remember, the more complex an investment is, the more it favors the issuing company over the consumer.
- Whole life returns usually don’t compensate investors for the loss of liquidity on their investment capital. Liquidity—the availability of your money on short notice—can be extremely important. With whole life insurance, you lose penalty-free liquidity for years because these policies usually carry long surrender periods with hefty penalties for early termination of the contract so the insurance company can recoup the high sales commissions paid to the agent. These surrender periods often last as long as 10 to 15 years.
These disadvantages aside, whole life policies can provide a minimum amount of savings if you’re willing to hold them for decades. And if you keep them until death, your beneficiaries get the proceeds of the death benefit.
However, studies show that the majority of insureds don’t hold them this long. Instead, many end their policies early, sometimes incurring a stinging surrender penalty. If you’re one of the minority who keep the policy for many years, you might be missing out on potentially greater returns attainable from investing the same monies elsewhere with much lower expenses.
Yet there is one scenario where whole life insurance can be quite useful. This involves providing cash needed for estate taxes on very large estates (those exceeding $10.98 million per couple) that often include significant illiquid assets such as real estate.
As with any financial decision, be certain you independently determine whether you need life insurance and evaluate policies on your own—rather than accepting this analysis from a salesman. And when there is a real need, the best use of your dollars is with a reputable, financially stable insurance company.
Tim Decker is president of ISI Financial Group (isifinancialgroup.com), a wealth management firm in Lancaster, and a fee-only financial planner (he sells no products). His weekly call-in radio show, "Financial Freedom," airs Saturdays at 10 a.m. on WHP580 AM.
This content is based upon information believed to be accurate by ISI Financial Group, Inc., and is not intended to provide specific financial advice. Always seek professional guidance before making any financial or legal decisions.
