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

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paper family in a businessman's ...
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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.


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