Whole life insurance is a hotly contested topic in the financial planning industry. In my experience, the advisor community can be segmented into two schools of thought:
- Those who love whole life insurance and use it as their “go-to” solution for every financial need
- Those who will use anything but whole life insurance
Personally, I fall into the second category—the group that doesn’t believe in whole life insurance. Why? There are a lot of reasons. But mostly because I find that whole life insurance, in its effort to be everything to everyone, fails in its attempt to be the best at anything.
Whole life insurance lovers typically sound something like this….
- Do you want to save more? Buy whole life.
- Do you want to protect your family in the event of a premature death? Buy whole life.
- Do you want your money to grow tax deferred? Here, have some whole life.
- Want a guarantee? Guess what I have for you! More whole life.
- How about retirement income? Do you want retirement income too? HERE, TAKE THIS MAGIC PILL CALLED WHOLE LIFE!!!
It’s whole life for everything, all the time, no questions asked!
To be fair, whole life insurance can do these things I’ve mentioned. I’m not saying that it can’t. My argument is that there is a better way to achieve most, if not all, of these financial goals!
Life Insurance Design
Insurance, when designed and implemented appropriately, can be strategically formulated to serve a variety of personal and business needs. These needs, to be overly general, can be summarized by the following two objectives:
- Maximize death benefit
- Maximize cash value
If my goal is to maximize my death benefit, whole life insurance isn’t the best option. The best option is often a guaranteed universal life insurance policy.
If my goal is to maximize cash value, whole life insurance, again, is not the best option. The best option is a policy designed with the death benefit as low as possible, based on the annual expected premium. (The lower the death benefit, the lower the cost of insurance charges… but this is beyond the scope of today’s discussion.) This type of policy drives down the costs of insurance, subsequently creating a higher cash value.
What Else About Whole Life Insurance?
It’s not just that whole life insurance tries to be the best at everything that I find difficult to overcome. In fact, these additional considerations are what keep me on the sidelines.
- Lack of Premium Flexibility – Whole life is very inflexible. You are contractually required to pay a premium every year. No excuses. No “I can’t afford it this year.” The contract, per the agreement you sign, requires the premium to be paid.
- Lack of cash value – Whole life insurance is sold as an insurance vehicle with a savings component. While this statement is true, it tends to be misleading.
- The “savings” in the early years – If you look at a whole life insurance illustration, you’ll notice the cash surrender value in years 1-10 is low. Probably lower than your total premiums paid. If you want out of the policy, you will likely take a big loss! That doesn’t sound like savings to me.
- The “savings” in the later years – Eventually your cash surrender value will be higher than your premiums paid (either guaranteed or by dividends earned). However, even in these later years, the rate of return on your cash value is low. If you are buying whole life insurance for the rate of return, expect to be underwhelmed.
- Lack of income flexibility –Tax-free income is a big selling point when it comes to whole life insurance. Whole life agents love selling the retirement income (to be fair, whole life insurance can create a tax-free retirement income). However, so can other permanent insurance policies such as universal life. When illustrated, the retirement income numbers may look very attractive. But I caution you.
- Ask your agent to illustrate your income at 50% of the current dividend and at the guaranteed dividend (they will know what this means).
- Keep in mind these are income numbers that you will receive years and years down the line. $100,000 in 30 or 40 years is not nearly the same as $100,000 today.
What About the Death Benefit?
I would be remiss if I didn’t mention the death benefit associated with whole life insurance. When buying a whole life insurance policy you get both a guaranteed cash value accumulation (although at an extremely small rate as we have already determined) and a death benefit.
While a death benefit should be a valuable consideration (you should only buy insurance if you need the death benefit), I believe there are better methods for achieving your goal. If you were to buy the same amount of death benefit in a term policy, it would be significantly cheaper. For example:
- Cost of whole life: If I were to buy a whole life policy with a $2,000,000 death benefit, it would cost me $28,350 with XYZ company (this policy would be paid up at 65).
- Cost of term insurance: If I were to buy a 30-year term policy for $2,000,000, it would cost me approximately $1,500.
So What is Whole Life Best At?
Whole life insurance is best at providing a guarantee. Whole life insurance, per the contract, offers a stated guaranteed cash value each year during the policy, so long as the premium is paid.
While the guarantee does sound attractive, offered whole it is insignificant when calculated as a rate of return. Using the same example from above, my guaranteed cash value would be $1,078,000 at my age, 65. Assuming I paid $28,350 per year for 32 years, and ended up with $1,078,000, I would have earned a resounding 1.43%.
If you already have a whole life policy in force, it may or may not make sense to keep it. You should talk to a professional about the pros and cons of the policy. Additionally, you should order an in-force illustration to see the projected performance of your policy.