I'm Not Sold on Whole Life - and You Shouldn't Be Either

×
paper family in a businessman's ...
Oktava/Shutterstock
Many financial advisers love whole life insurance, and I'd love to offer a conservative investment to my clients that pays a safe return, but the numbers just don't jibe.

I have a $2.5 million, 30-year term policy on myself, and I pay $1,790 per year. I priced a $250,000 whole life policy for a 30-year-old male, and the cost was $3,440 per year. For a tenth of the coverage, the annual premium almost doubles.

I can already hear whole life insurance zealots foaming at the mouth.

I can already hear whole life insurance zealots foaming at the mouth, waiting to shout things like, "whole life insurance offers great returns," and "it's much safer than the stock market."

And I've heard it all before, but every scenario I have ever encountered where an individual has been paying on a whole life policy for an extended number of years, what they were told they would have accumulated by that point has never been even close to what they actually have.

When I wrote about that elsewhere, the article generated this comment: "Whole life policies don't really start kicking in until retirement. Your clients that have those policies have usually just gotten past the insurance cost and won't see their cash value compound rapidly until they're 35 years in ... unless the policy was designed to do so."

Did you catch that? This whole life enthusiast wants me to wait 35 years until I start seeing my cash value accrue. No thanks.

Still wanting to believe that whole life insurance can make sense, I polled several other certified financial planners. Here's what they had to say.

The Difference Between Term and Whole Life

At its core, life insurance is about replacing a person's income in case of their untimely death. If you're only interested in income replacement, then term life insurance will generally suffice: You are insured for a certain period, generally 10 to 30 years. Whole life insurance (also known as permanent or universal life insurance) doesn't expire like term insurance does, unless you let your policy lapse.

Whole life insurance is a great deal more expensive than term insurance. For that reason alone, individuals who earn less than $200,000 or so per year, according to certified financial planner Joshua Thompson, should stick to low-cost term life.

Benefits of Whole Life Insurance

In addition to the fact that your death benefits from whole life insurance never expire -- meaning your family will see the insurance pay out whether you pass away young or live to a ripe old age -- there are some good reasons for choosing whole life over term.

  • Age and price. If you go for a term policy when you are in your 30s, the price difference between it and a whole policy will be enormous. However, as you age, term life insurance becomes more expensive. Eventually, you may find that you are uninsurable with a term policy because of age or health.
  • Potential cash value benefits. Basically, as you pay premiums for whole life, your policy's cash value grows. Often, whole life policies will present a minimum cash surrender value, guaranteeing that your policy will grow to a certain level in a certain number of years -- although the cash value amount will be lower than the face value of the policy. For instance, according to Kiplinger, "It's entirely possible that a $250,000 policy bought at age 35 could accumulate a cash surrender value of $100,000 by the time you reach age 65." "Could" is the key word here. The cash value is tax-sheltered, meaning neither the interest nor the earnings are taxable. When you turn in your policy, you can collect whatever the cash value tax-free, provided that the cash value does not exceed what you have paid in premiums. Once you reach a certain level of cash value, the investment will be earning dividends sufficient to pay the policy's premiums -- if you chose to use them that way -- making the policy self-sustaining.
  • A source of money. You can borrow against your cash value while leaving the policy in place. If you do so, you are not required to pay back the loan, although you will owe interest on it -- and your beneficiaries will see the amount of interest and debt outstanding deducted from the death benefits.
The Rich Man's Roth

Whole life insurance is sometimes referred to as the rich man's Roth. That's because once you reach a certain income level (over $191,000 for married couples and over $129,000 for individuals), you can no longer contribute to a Roth IRA, which means you lose out on the tax benefits. But these individuals can still put after-tax money into tax-sheltered whole life insurance.

Whole life will allow high-earners to take advantage of tax-free growth and potentially add a tax-free source of retirement income if they decide to cash out or take a loan from the policy.

Alternatively, whole life insurance can allow high-earners to create a safe legacy for their heirs while being more aggressive with other aspects of their portfolios. Even if your investments are in a downturn at the time of your death, your family will still receive the life insurance payout. This gives you more freedom to invest aggressively elsewhere.

8 Variables for Buying Whole Life Insurance

Joshua Thompson, a certified financial planner, has identified eight variables for determining if whole life is a good addition to a given person's portfolio:

  1. Are you contributing the maximum to your qualified retirement plan -- e.g., 401(k)?
  2. Are you contributing the maximum to an IRA? Can that IRA be converted to a Roth?
  3. Will you truly benefit from tax-free growth? That is, are you in the 28 percent or higher tax bracket?
  4. Will you potentially be in the same or higher tax bracket in retirement?
  5. What type of liability do you have due to your work or lifestyle? Does your state of residence protect the cash value of your life insurance and annuities?
  6. How much are you investing into a normal non-qualified investment account?
  7. Would you be better served with an annuity?
  8. Do you have a plan for estate taxes?
You should also consider just how long you intend to hold the policy. While whole life insurance policies are theoretically in place for life, policyholders who hope to use the cash value during retirement may want to reconsider if their retirement is less than 35 years away. It will generally take that long before the cash value of the policy begins compounding rapidly.

Clearly, whole life insurance is not a product that every person will benefit from, and only under very specific circumstances cab even high earners expect to truly profit from it.

Buyer Beware

There is a general consensus among financial gurus like Dave Ramsey that whole life insurance is evil. And to be honest, many of the issues that Ramsey and others point are true. In particular, commissions for whole life policies can start at 55 percent of the first year's premiums and can be as high as 100 percent.

That means that insurance agents can be very motivated to sell you a policy. And since the insurance industry is not required to follow fiduciary standards (which would require agents to put your best interests ahead of theirs), there is a huge potential for conflict of interest.

The other aspect of whole life insurance that makes personal finance experts twitchy is that illustrations of potential cash value offered by agents are so often unrealistic. Signing on the dotted line for a whole life policy that is supposed to make you rich in retirement -- especially when you aren't already -- is a terrible idea. You'll simply be sending good money into the ether and not necessarily seeing the return you could get with other investments.

Insurance Is Not an Investment

Insurance is not an investment. As certified financial planner Susan Quigley puts it, "Insurance is a transference of risk, spread out over many people in a similar category to reduce everyone's risk."

This is why whole life insurance generally has a place only in the portfolios of high-earners who have maxed out their other investment opportunities. According to financial adviser Bill Dix, "whole life insurance is the conservative part of a client's portfolio." If you're putting money into a whole life policy in the hope that it will mean smooth sailing in your retirement years, then you are wasting your money.

What Average Earners Should Do

Many financial experts recommend that people who do not enjoy a Scrooge McDuck level of wealth buy term insurance and invest the difference between the term premiums and the whole life premiums. However, investing the difference is like not eating the Rocky Road ice cream in the freezer -- it's a rare bird who can actually do that.

Otherwise, it's best to uncouple your life insurance needs from your investment needs. You need life insurance presumably as a hedge against lost income now, and as a legacy later after you have retired. Your investment needs are about ensuring a comfortable retirement. Even though it is all your money, it will make more sense to earmark money for your life insurance as separate from the money for your investments.

Most earners should purchase a sufficient term life policy and a modest permanent life insurance policy. That means your family will be economically taken care of if you die during your earning years, and you will have something in place for your heirs if you make it into your 90s -- when no term life insurance agent would touch you with a 10-foot pole.

"Whole life is dangerous because it is so expensive," says Neal Frankle, a certified financial planner and DailyFinance contributor. "It soaks up so much of your cash. You may not have enough money to buy all the coverage you really need. As a result, many people go terribly underinsured, and it's the family that pays the price."

The Bottom Line

There is a very good reason why talking about life insurance at a cocktail party will mean that you are not invited back. Not only do we not enjoy thinking about our own mortality, but the products can be confusing, the agents can be pushy, and even the experts can disagree on the right course of action.

This is why it's so important to partner with a trusted financial advisor who can help steer you to the products that will best serve your needs. Your family will be glad that you did.


Increase your money and finance knowledge from home

What is Inflation?

Why do prices go up?

View Course »

How Financial Planners go Grocery Shopping

Learn to shop smart and save.

View Course »

Add a Comment

*0 / 3000 Character Maximum

30 Comments

Filter by:
JOHN

My wife had a term life policy, and when that term was up, the price quadrupled to keep it--term life is not my advice!

July 07 2014 at 1:33 AM Report abuse rate up rate down Reply
JIM

I have to disagree with Mr. Rose regarding his thinking on Whole Life. I purchased a $100,000 Whole Life policy 3/17/1978 at the age of 41. I have paid an annual premium of $2,423 for 36 years. $2,423 X 36 yrs. = $87,228 (My cash outlay to date) As of the recent anniversary date of the policy, namely 3/18/2014, my total cash value is $306,151. If I cashed this policy in now, my net gain would be $218,923. $306,151-$87,228=$218,923. How do I arrive at these figures? When purchasing the policy, you have a choice of having the annual dividend purchase additional paid up insurance (PUA), or using your annual dividend to reduce your premium, or leaving the annual dividend accumulate and earn interest on the dollar amount accumulated. Providing you buy from a company that pays dividends. In my case, I chose to use the annual dividend to purchase Additional Paid Up Insurance. The PUA generates a cash value in addition to the cash value of the basic policy. As of this last anniversary date, the base cash value of the policy was $66,971, wheras the cash value generated from the Additional Paid Up insurance was $239,181. Add the two together and you come up with $306,151. Now I can collect the PUA's of $239,181 immediately and still have a death benefit of $100,000. $239,181 to subsidize my retirement and $100,000 to leave to my heirs. My cash value increase just this past year was $14,435. This is one of the best investments I have and don't have the risk I have with stocks. I would like to have Mr. Jones explain to me how I could have a guaranteed better investment. and by the way, this policy was issued by State Farm Life Insurance Company..

July 07 2014 at 12:10 AM Report abuse rate up rate down Reply
Es49candy

I don't really know but I think all insurance companies has a secret way of controlling cash value because it sometimes gets confusing because they tell you that you have a cash value policy but if you want to withdraw the cash value then you may have to pay it back BUT when I take a close look at how a young person can buy a $50,000 WL policy for $25 per month and this young person pass away after having the policy for 12 months which cost only $300 but the insurance company has to pay out $50,000 so I think this is how they make their money back, off cash value so insurance can be a win or lose situation. When I took out a WL policy on myself and my granddaughter I didn't give a hoop about the cash value on my policy
because at my age I can never pay into this policy for what it would cost to bury me. My granddaughter's policy is paid up in ten years so once she turn 23 years old I will never have to pay another dime. When she get older she can add more coverage without having to take a physical. If she create bad credit and can't get a loan then she can borrow from her cash value without a problem BUT she may have to pay it back. I didn't take out this policy for her sake, I took out this policy for my sake so she won't come to me for a loan.

July 06 2014 at 11:22 AM Report abuse +2 rate up rate down Reply
truthseeker7000

There are some companies that offer whole life, universal life, or other cash value policies that are not very good deals, BUT--- there are plenty of others that do a very GOOD job, and there are many well-trained agents who are also quite conscientious about recommending to clients ONLY what they would choose for themselves if their fact situations, goals, and needs were the same as the cllient's. That may not always have been the rule of law, and there are some agents who do not have good ethics, but everyone in the agency where I was trained subscribed to that ideal, which is also the credo of the Chartered Life Underwriter's society. To improve your chances of working with such an agent and also getting a high-value product that will far outperform that 35 year garbage in the article, get in touch with an agent with Mass Mutual Life or Northwestern Mutual Life, two of the finest companies, with many well-trained ethical agents. Might there be a few who do not match that description? Yes, but the chances are much better that you will get the right recommendations for your needs and ability to pay with those two companies. It may be for you to buy all term, all permanent, or some combination of the two. But don't listen to the extremists who carry on about only buying term and investing the difference. Life spans are pretty long now, and I have never met a beneficiary at any age who thought he or she had been left with too much insurance, so it is not actually very realistic to think that one's need for insurance evaporates at any point, unless all the beneficiaries have pre-deceased the insured. And term will not be affordable for most people in their later years, even if it is still available. It typically expires before the insured does, and all those premiums are paid with no return on the dollar at all. I have only paid two death claims on term, both to men who died early, one from a heart attack, the other from cancer. All others were from whole life policies. And if the dividend option is set up to be "Paid-up Additions," both the cash value and the death benefit will grow far more over time than with any other choice. One of my family members died last year, and her benefits far exceeded what had been originally projected, which was pretty impressive itself. Of course, the younger one gets into whole life policies, the cheaper the premium and the higher the cash values will grow. Any doubts? Call a good MML or NML agent and ask for some more specific information on yourself or your offspring.

July 05 2014 at 10:44 PM Report abuse +2 rate up rate down Reply
Saint Michael

As with anything else, shop around. Consider my example:

My $250,000 whole life policy costs $626.20 per month for 60 months...essentially the cost and terms of a new car loan. At any time, I can cancel the policy and the company will refund the GREATER of the premiums paid or cash value. Within two years, the cash value exceeded the premiums paid. The only risk to me was inflation, which the government says is "low," and that the company would go bankrupt, which no major life insurer has in nearly 100 years. In addition, the death benefit has risen and will continue to rise.

The key to whole life is getting the payment period down so something manageable, not the 35 year crap that the author wrote about, and being able to access your money lie I can.

July 05 2014 at 9:29 PM Report abuse -1 rate up rate down Reply
1 reply to Saint Michael's comment
Saint Michael

*like I can.

July 05 2014 at 9:30 PM Report abuse -1 rate up rate down Reply
maggiemoe1950

Many years ago I read a book by :
Arthur Milton
Title : How Your Life Insurance Policies Rob You
Every American who cares about their financal future should read it.
I worked with a company which only sold term insurance.
By term, and invest the difference is the only way to go.

July 05 2014 at 6:15 PM Report abuse +1 rate up rate down Reply
maggiemoe1950

LOVE

July 05 2014 at 6:08 PM Report abuse +1 rate up rate down Reply
emlipp

While the cash value of a whole-life policy may accumulate tax free, the dividends are taxable to the extent that they exceed the premiums. This is true also of the interest income on accumulated dividends. I took out a whole-life policy for $12,500 when I married in 1954. At the time, it was a lot of money. And there were no IRAs of 401ks. Now, even with the accumulation, it isn't all that much. Since I've had the policy for so long, it now pays for itself. In today's world, I would not purchase such a policy, but would carry term insurance.

July 05 2014 at 10:23 AM Report abuse -1 rate up rate down Reply
LINDA V.

WHOLE LIFE INSURANCE VERSUS TERM LIFE INSURANCE. Whole life insurance premiums remain the same and Whole Life insurance accumulates cash value through the years where Term insurance premiums increase periodically as a person ages. and Term does not accumulate cash value. From the Whole Life policy, you can borrow this cash value and pay interest on the borrowed amount. If the loan is not paid in full prior to the death of the insured, the loan balance will be deducted from the death benefit. Of course, if the insured withdraws the cash value from the policy before death the policy is no longer in effect. If the cash value is greater than the total amount of premiums paid, the difference is taxable. Most Whole Life policies pay an annual dividend. You can choose to receive the dividend in cash (which is taxable) or you can select the option to have the dividend purchase Paid-Up Additional Insurance which increases the death benefit of the policy. If you should choose to discontinue paying premiums on the Whole life policy and not cash surrender the policy, the Whole Life policy will contiune to carry itself for a number of years and the length of time will be according to how long you have been paying the policy. Also you have an option of selecting a Reduced Paid-Up policy should you discoutinue paying premiums. At the time the policy is written the, insured can select the option of a 20-year payment life, Age 65 payment life, Age 90 payment life or what other age that is available.

July 05 2014 at 10:11 AM Report abuse -1 rate up rate down Reply
g0lfandgumb0

Let me start by saying Dodger is wrong. I've been in selling life insurance for 41 year and investments (mutual funds, variable annuities, fixed and Indexed annuities) for 20. During my career I have sold Par whole life(Participating), Interest sensitive whole life , non par whole, life, paid up at 65, 20 year endowments,Variable universal life, term and the latest and greatest "Indexed Universal life" Out of all these and more, I like the Indexed universal life the best, but only if it is sold right. A person that needs a lot of coverage needs term to buy a lot of coverage while your young. But the cost will get so high that you won't be able to afford it when you get older. For a younger person I sell Indexed universal life (plus term).
The reason I use life insurance is because it is the only vehicle that allows us to put money away now that will:
1. grow tax deferred
2. You can have access to it once your cash value grows (not 35 years as Dodger thinks
3. Take out money for opportunities during your life time and pay yourself back the interest (be your own banker concept)
4. Take out money to supplement retirement on a tax free basis at retirement using loans while still maintaining a death benefit
5.add a self completing feature (wavier of premium)
An indexed is linked to a major index like the S&P the one I use the most will credit your cash value 100% of the gain in cash value up to a cap of 14% per year (current) Once your gain is credited, it can't be lost to market declines. Ex. If the market drops 30% , you don't lose any of your cash value, you don't make anything for that year but you don't lose anything either. Hope this helps but if you have more questions, just ask.

By the way, your question: YOu can set the policy up so that your cash value is added to the death benefit so your family recieves both. Set up the right way, theirs nothing out there that can beat it.

PS: if they didn't have Indexed UL, I would sell Variable UL(market risk and rewards) and if I didn't have those I would still sell Participating whole life

Ernie
PS I have never had a client come in and cancel their insurance because they were old and didn't think they needed it anymore but I've had plenty of older people come in and cancel their term insurance because they couldn't afford it anymore and try to buy insurance in their 70's or 80's because when it comes down to it "There's only 1 thing worst than dying and that' dying without life insurance"

July 05 2014 at 3:41 AM Report abuse rate up rate down Reply