Does the Cash Value of Whole Life Make it Better than Term?
On the surface, this would make sense. A whole life policy does in fact build up cash value over time, whereas a term policy is “use it or lose it”, meaning if you don’t die before the term is up, you get nothing out of it. Even though building up cash may sound better than not, it is important to understand how a whole life policy actually works.
Whole Life Insurance
Whole life insurance is designed to pay out a predetermined benefit upon death, while also building cash value via an investment component. There are various types of whole life policies, from universal, variable, and traditional, but they are all the same aside from how the cash value portion is invested. The problem with whole life is that not only are you paying for the coverage premium, but you’re also paying into the cash value portion. This makes the premiums much higher than term insurance.
Rate of Return and Fees
A typical whole life policy will have an internal rate of return, which is how much interest your cash value will earn after fees and expenses are deducted. Unfortunately, most whole life policies are like mutual funds with high expense ratios; after you factor in the annual fees, the actual return is minimal. In some cases you may only earn a couple percentage points. You’ll also want to be aware of penalties or fees incurred when canceling a policy, as these can be quite steep.
Why Term is Better
Even though you may never receive a payout from your term policy, remember, you are just buying protection for your loved ones. Insurance always seems like a waste when you never see the rewards, but if you don’t have any coverage and the unfortunate does happen, the results can be devastating. So, what seems like a better deal; paying a lower premium that builds no cash value, or paying a much higher premium to earn 3% on only a fraction of the amount?
For working adults, term is almost always the way to go. Typically you purchase insurance once you get married and/or have children. Once the kids are out of the house and you’re beginning to approach retirement, your need for life insurance drops rapidly. This is why a 30 year old would be perfectly fine with a 30 year term policy.
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Does Whole Life Have Any Use?
Whole life policies do have their place, just typically not for working adults. These policies can provide significant wealth transfer and estate planning benefits, but are more than likely far too costly for someone in their 30s or 40s. You really need to be careful when dealing with an insurance salesman as they can do a pretty good job at making whole life sound like an investment. Granted, there is an investment component, but you can save money by buying a term policy and earn far more by investing the difference elsewhere.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Make sure the life insurance will cover any kind of death (this includes suicide).
You don't want the insurance company to refuse to pay because they found a loophole in the policy.
Saying Whole Life is better than Term Life is far too broad a generalization. Based on an individual's financial and physical health, one option may be better than the other. Term Life typically suits most people, and it's important to remember that Whole Life typically does not pay that cash value to the holder's family upon death.
I currently have a money market and mutual funds account through Northwestern Mutual. I recently met with an acquaintance who works for Synergy Group. Synergy Group offers an Index Universal Life Insurance Policy which (allegedly) pays 5-8% interest annually (payouts are apparently measured by the S&P 500's annual performance. If the market does well, your savings earns interest based on the performance, and if goes down, you don't lose anything - unlike basic universal). Index is relatively new, so I'm trying to do my due diligence to find out the possible cons. Which is better? Whole or Index Universal?? The broker at NW Mutual is trying to sell me a 200K whole policy in addition to an 800K term policy (as security against any potential future health issues) (p.s. may not matter, but I'm 25 with no family of my own).
the biggest prbs with whole life (which i own by the way and am not associated with the industry):
1. the cost is very high. there just isnt enough transparency and good competition in the industry to reduce the price on these things. the agents make a ton of money for what they provide, a lot goes into stuff that has no value to you, and they get it within the first few years so they have little incentive to make sure the policy continues to work for you and frankly the insurance company is better off if you cash surrender or miss a payment etc then get the death benefit so they care much more about your ability to make initial payments then the long term plan.
2. you need to be sure u will be able to make those expensive payments far into the future. my 2 million whole life through guardian costs 35-36k per year initially and although dividends reduce premium each year its very costly for 1.5 decades. how many people really know they will have that type of money lying around given the economy.
3. once u start you are stuck or u take a big loss. while you can take out loans, ending a policy early on means a big financial loss.
4. even if u like the guaranteed features of whole life, dividends are not like dividends on a stock. what they really are is a refund of money you overpaid that year. its like paying too much on your taxes and being happy that you get a refund when really you should just pay less during the year. this is just one of the many areas where insurance agents dont appropriately explain things. They try and make you think the company is doing a great job investing and thus u made money.
5. finally given the high cost of whole life what many people do is under insure themselves in order to afford whole life. they likely need higher death benefits to support their family and given all they have spent on whole life, now cant seem to afford additional term.
while i have whole life (and term by the way), if i had to do it all over again, id buy more 30 year term (im 39) and either invest the extra or just spend it. tying it up in whole life has made it such that im more vulnerable to any unexpected prb except death and given my health those are all more likely to happen.
While I was struggling for life insurance company, I found a company that offer you a big discount and many other benefits on your life insurance.
Whole Life insurance is NOT an investment. Investing by definition involves risk of loss. You invest in something with hopes of a positive return. Whole Life insurance is a guaranteed permanent death benefit that has a savings (not investment) component. There is no risk. Universal and Variable Universal policies are different, and in most cases crap. That's why insurance companies keep changing them, because they can never get them to work the way they are sold. That being said, there are Whole Life policies out there that are crap. I would stick to one of the 4 major mutuals (Mass, Northwestern, New York Life, Guardian) when it comes to WL policies. I personally hate term, and will convert as much as I can each year. I want to own my life insurance policy, not rent. I am paying into my life insurance policy (structured to completely paid off by age 65, unless I choose to use the dividends to pay the premiums), much like I am paying a mortgage so one day I will be 100% owner of my home.
I don't know where you get your information, or what policies you have seen, but that's absurd. Most policies have a period of 2 years where the company can contest the claim if the applicant committed fraud or suicide. However, once your policy is delivered, you could die the next minute and that benefit is payable period. There might be some crap companies out there that will make it difficult for you to receive your claim, but they will have no case as long as there is no fraud or suicide. After that 2 year period, you can jump off a bridge and the company has to pay the claim.
I have noticed lately that there are alot of concerns about life insurance policies and the fact that you have to keep them for at least a year or whatever the term says before you can actually bank on the policy. So if you get a life insurance policy and you die in 2 weeks, then you do not get the life insurance payoff because you died too fast (no matter what the reason is). It is important to check out the life insurance company you are going to be dealing with on this aspect.
If a whole life insurance is an investment, why is it regulated by the insurance commission and not by the securities and exchange like any other investment? If whole life has an investment, why is it that agents do not need an investment license to sell them?
Your mentality is unfortunately why so many retirees, widows, etc are contemplating suicide right now. To assume a 10% rate of return is completely foolish. You are talking about an average first of all, which is debatable, but historically I think 8% is more accurate. But what happens if one year the rates go way down? As soon as you start making withdrawals, you are solidifying those losses. For example, if you are living off of a "10%" interest per year on $650,000, you have $65,000. Did you factors taxes, INFLATION, or market fluctuations into that equation??? Let's say one year, the market goes down (today they DJIU dropped below 9000), and you end up up with a negative return. Your wife needs some money, so she has to dip into the $650,000. Now let's say there is $600,000 left. Oh thank goodness, the next year we got 10%. But now it's only $60,000, and the liberal administration just raised taxes across the board. Inflation went up a modest 3%. Uh oh. But the next year is better and an amazing 15% return gives your wife a whopping $90,000. Problem is now she is in a higher tax bracket, so she decides she is just going to take $65,000, and now you have 625,000 in the mutual fund. Score! Next year, major problems, a terrorist attack, political turmoil, market crisis, and you got a negative return of -5%. Your wife has to dip in again, but she has some more expenses because she started her own business and the kid is looking at colleges. Plus, inflation is now roughly 10% higher than what is was the first year you died, so that $60,000 just doesn't cut it, so when all is said and done, she decides she needs $100,000 to meet her needs.
Basically, every morning, your wife will walk down the driveway and pick up the newspaper and go straight to the Business section to gauge how much money she can expect to spend.
I'm not putting my family through that nonsense.
If you know anyone retiring or retired, ask them how they are doing? Some might be okay, but youre bound to come across some real hard core suffering. Do you spend more money during a work week or during a week of vacation? Retirees are supposed to be on vacation, but many having to go back to work, and many are not able to. Like I said, there are some retirees that are enjoying retirement right now. I'd be willing to bet that some of those can thank their whole life insurance policy and a good solid foundation of protection for that.
I'm not saying that one should not invest in the market or real estate or other potentially higher yielding investments. However, if you don't have a solid foundation of protection and contingencies, you effectively have no plan.
Just look around you right now. It's happening all over, and it is extremely sad, because someone with your mentality convinced these people to buy term and invest the difference, or put their money in stocks and real estate, whatever. They were not shown the truth. Failure should NOT be an option when it comes to a financial plan, but you are essentially basing your financial strategy on ideal and unrealistic predictions, assumptions, and opinions about the future. Your plan should be able to work under any circumstances, and be based on facts and economic principles. Then, if you have money in there to play with, by all means, throw into the ring and see what happens.
a couple of things. First, another rehashing of the old Term vs. Perm debate. Usually the comparisons I see do not take into account trading costs to invest the difference between term insurance and permanent insurance. Second, while it is all well and good to say that a person will invest the difference, I have seen that most people don't have the internal discipline to actually follow through with that strategy. Ipods are introduced, let's go to the bahamas this year on vacation instead of the lake, let;s go out to eat instead of stay at home and cook. Third, needs change over time, so the reason that you took out a policy when you were thirty may not be the reasons that you want Life Insurance when you are 45 or 50. You don't have to be a millionaire to recognize that Life Insurance is the most efficient way of transferring money to someone else at your death. Fourth, LIfe insurance is not an investment. there are alot of things that LI can do for you or your beneficiaries, but it is a protection product. finally, a good advisor will advise you on the type of LI that meets your needs, this is as opposed to a 'salesman'. You could easily make the same comparison about physicians? are they health advisors or just drug salesmen?
Whole life can actually be an incredible investment if done right. It should focus on death benefit but on cash value. If you emphasize cash value you can create a self sustaining policy, and it will out grow any other investment you can imagine. By using it as a financing solution it will grow even more.
I can purchase 1.1 million 20yr level term for my wife and myself for $44/mn. This amount is equal to our annual salaries with a return of 10%. For example: I make 65,000/yr and my wife makes 45,000/yr. If I were to die with a $650,000 policy and my wife invested that into Mutual Funds with a 10% rate of return, she could live off of the 65,000 (my annual salary). The cost for both of us to get $250,000 in whole life was $350/mn. If I were to invest the difference of the 2 policies ($306/mn) into Mutual funds at a rate of return of 10% for 30yrs, I would have $554,556. Hope this makes sense. One more thing, ask the person who sells you whole life what happens to the cash value you buildup in a whole life policy if you die! You don't get it. They'll try to tell you something like it takes care of their fees.
Great post and I agree with your assessment entirely, well almost. While for younger working families I too believe that term life insurance is definitely the best choice to keep premiums low and affordable.
Now the case for a permanent policy while younger, in our experience the key to making life insurance work as a cash accumulation vehicle is to over fund the policy. We like variable universal or index products that you have the opportunity to get a higher rate of return in the policy, this also helps offset the cost's and fees in the policy.
Typically we use this concept with someone who is high income earner with discretionary income and they are fully funding their 401k, IRA etc. Now we can look at over funding a VUL contract for a number of years the longer the better (compound interest) and look to use the cash build up as a supplemental retirement income.
The most powerful aspect of life insurance is the awesome tax leverage you obtain which is tax deferred growth inside of the policy and tax free withdrawals of your cash value via withdrawals and loans from the policy.
If someone can commit to this type of plan it works very very well as a tool for retirement planning. Plus no penalties for early withdrawals of your cash value unlike a qualified plan. The key is to commit to the plan!
Do any of you have any comments on the pros and cons of cashing in a life insurance policy vs. borrowning against it to pay of high interest debts? Thanks.
Right, if you or I can't afford whole life insurance, how many in this demographic can? If someone could scrape up enough money to pay the premiums, hey that's fine, but it is a lot of money to pay for a minimal benefit.
And I was a financial planner and also an insurance salesman in the past. We used that same 5% payout statistic to scare people all the time. I sold insurance for three years and during that time I had 3 clients actually have to file a claim. Each of these were term policies and were paid out in full.
That statistic is thrown around just like I was taught about the FDIC claim. Maybe you've heard it, where FDIC has 99 years to repay you so it is worthless, etc just to get people into non-bank investments. It is just a scare tactic that uses a tiny piece of truth that is exaggerated as a sales technique.
But you are right, it is always easier to insure yourself when you are younger and have less health issues, but if you can't even afford whole life anyway that 20 years of compounding is moot. Plus, what good is a vehicle that barely compounds at the rate of inflation?
I am 25 - I do not have whole life, simply because I can't afford it, but if cash flow is not an issue its better than term. I have term mainly to protect my fiance.
Ask any insurance agent/financial planner - term pays out less than 5% depending on the company, there is a reason it is cheap.
Remember, you are never as insurable as yesterday, so your whole life premium would be considerably less at 25 (ignoring cash flow implications) then at 45 when you think you need it. This also ignored 20 years of compounding!
Again, just a few comments against preconcived notions of insurance
Evan, you are correct, and if you read the last paragraph of the post I say this: "These policies can provide significant wealth transfer and estate planning benefits."
Whole life policies certainly DO have significant benefits, which you highlighted perfectly. But this site is tailored towards those who are still relatively young, generally speaking, early 30s. So, for the average reader, they may not have any, or have just started a family, and their estate is probably nowhere near the estate tax threshold.
During this phase in life, most people only need short-term coverage to protect their spouse or dependent children in the even of a loss of income, and whole life is not the best way to accomplish this.
But like you said, as you age, have created wealth, substantial investment assets or possibly a business, there are many more important tax and estate planning issues to consider that could warrant a different type of policy.
While I generally like your website and similar sites, I have to disagree with you on this one (Just to note - I am Director of Financial Planning at a Wealth management firm associated with MassMutual....also hold a J.D. - only mention this because of the estate tax impliciations)
I'll go with the easiest rebuttle to the argument and if there are further comments I'll chime in...
1) If your estate is worth over the $2million mark what assets are going to be liquidated to pay the HUGE (45%) Tax bill???? Is it your family home? Is it the business you strived to build? Is it the IRA which could be stretched to give your grand kids enough money where they don't have to work? etc etc? By its very nature life insurance IS LIQUID. As such, you can pay that bill (due within 9 months of death) without liquidating anything.
As far as an argument of buy term and invest the rest - Term (in NY) ends at 80 - by statute! So you die at 81 that lovely and cheap term policy is GONE and now your family owes $X amount in taxes. Further, who is better than an insurance company to invest your money? MassMutual has a triple A rating and has been around for 150+ years - Guardian has a AA rating and has been around the same. BETTER THAN MOST STATES IN THE UNION LOL
Just a few thoughts on the subject - if there is interest by the blogger or others I will comment further!
Very informative post, thanks. One point I'd like to make though about Term Life Insurance is that if it looks like you are going to have health problems later on then this may not be the way to go because if your term policy runs out when your health is really bad then you may be uninsurable. You may ask: how can we know if our health will be bad in 20 or 30 years? Well, if you have risk factors for heart disese or cancer in your family or if you have a history of health problems yourself then by the time your 60 you might have some serious problems. For an alternate opinion on the Life Insurance issue Randi over at Boulevard R wrote a good post about this: http://blog.boulevardr.com/2007/08/24/life-insurance-the-basics/
Obviously you sell cash value policies, which pays you 8 - 10 times more commission than term, which is why you must defend it. What you are not saying is that the tax benefits only helps about 2% of the population. You need to have a couple of millions in assets for this to be true. Otherwise, your money will accumulate much faster if you invest it separately on your own, especially when the policy doesn't begin to accumulate cash value for up to 5 years because of the high commissions it pays out to the agent.
That is not necessarily true as long as you choose a company that offers term life that is renewable to another term insurance, without drawing blood. I know of one company that does this till the age of 90, and by then, chances are you won't need life insurance anymore.