Whole life insurance policies are a lot like Rodney Dangerfield, they get no respect. Spend five minutes researching term life vs. whole life and you’ll quickly learn that everybody except life insurance salesmen recommends term life. The reason for this is simple–term life insurance is almost always the better option.
But like most financial choices we confront, there are exceptions. So rather than just accept a blanket pronouncement that whole life insurance is always the bad choice, let’s look at the pros and cons so you can decide for yourself what type of life insurance to buy.
Term vs. Whole Life
As a quick refresher, term life insurance is as basic and inexpensive as it gets. You’ll get life insurance for a set term at a set premium. If the insured dies during the term of the policy, his or her beneficiaries will receive the death benefits. If the term expires, the policy terminates. There is no cash value to the policy. It’s the type of life insurance my wife and I have carried since we adopted our children seventeen years ago.
In contrast, whole life insurance includes not only death benefits but also an investment component. In effect, the insurance company charges significantly more than the cost of the actual insurance and invests the extra premium in stocks, bonds, or both. Unlike term insurance, whole life does not have a set term; the insured can keep the insurance for life. And whole life policies have a cash value that is returned to the insured if the policy is ever canceled. Whole life policies, also called permanent insurance, include universal and variable life insurance.
At first glance, whole life policies seem very attractive. But there are some significant disadvantages that should be weighed before purchasing a whole life policy.
The Disadvantages
Without question, the single biggest disadvantage is cost. The actual cost of any life insurance varies based on a number of factors. These include your age, whether you smoke, the length of a term policy, the amount of insurance, and your health. But the cost of whole life insurance can easily exceed a term policy with the same death benefit by thousands of dollars a year. As a general rule, expect whole life policies to cost five to 10 times more than a comparable term policy.
Because of the excess premium funds the investment component for a whole life policy, it may seem worth the cost. There can be some tax advantages, and some view it as a forced way to save for retirement. Some insurance agents sell whole life insurance to clients by stressing that a portion of the premium is invested in bonds, money-market products, stocks, and other financial products that collectively serve mainly as a retirement fund. Again, this might sound fantastic as forced savings takes the savings responsibility out of your hands. But there are two big disadvantages to keep in mind.
First, you have little control over the investment choices made by the life insurance company. It’s not like a 401(k) or IRA where you can choose where to investment your money. And second, the fees taken out of the premiums you pay are extremely high. While I like to keep my investment expenses below 0.5%, fees for whole life insurance investments can and do exceed 3% at times. So if you are considering a whole life policy, make sure you understand the fee structure first.
The Advantages
Assuming that you are paying your monthly premiums, a whole life insurance policy will cover you for your entire life. The idea of ceaseless life insurance coverage comforts many customers. Typically, term life insurance policies won’t cover you after age 65. And once the term expires on a term policy, the premiums typically increase substantially.
Whole life insurance differs from term life insurance in its provision of both a death benefit and a savings account. A portion of your life insurance payment is set aside in a savings account often meant to serve to fund retirement. Insurance agents refer to this as “forced savings.” You can withdraw or borrow against the cash value of your savings portion of your insurance policy. In addition, if you outlive the life of the policy, you can receive cash back, which acts as another security feature to ease consumers minds.
Buyer Beware
The primary thing to understand about permanent life insurance is that it is not an investment. You’ll often hear universal life insurance described to you as “similar to an IRA” or as an investment with “guaranteed returns.” This couldn’t be further from the truth.
Permanent life insurance carries high fees, and your higher premiums can eat into your returns. Dave Ramsey put it best: “‘Cash value’ life insurance is one of the worst financial products available.” You should be maximally contributing to your 401(k) and an IRA before you even begin to consider a whole life insurance policy, and even then, it’s likely not the best fit for you.
“Permanent” life insurance is exactly as it sounds, and you’re penalized heavily if you withdraw from your policy early. This is a policy you’re taking out for life, so compare it to other common insurance commodities like car insurance. You change your car insurance as your car ages, dropping coverages or changing deductibles. Do you want to lock yourself into a policy that remains in effect until you turn 100?
Be sure to weigh all of your options before choosing a life insurance plan. And remember that the best option for you today may not be the best option for you in ten years.
Summary
Whole life insurance has both pros and cons:
- Whole life costs much more than term life insurance
- The investment portion of the policy typically charges significant fees
- The insured often has limited control over investment choices
- Ideal if you need insurance throughout your life
If you are still on the fence, perhaps the fist step is compare the cost of different life insurance options. And if you do need to seek advice, get it from a fee-based adviser, rather than somebody who stands to make a nice commission if you purchase an expensive policy.
One key downside to whole life insurance is that they usually have very large surrender fees. These surrender fees are penalties if you cease the plan or cash out early. Usually the surrender fees will cause you to lose all of your investment if you drop the policy within the first year or two. You have to stay in these plans for at least a few years just to get past the surrender period where the early cancellation penalties are in effect.
People don’t go into insurance policies with the intent or plan to cancel them early, but stuff can happen (job loss, divorce, etc.) that can make it so you have to cancel. Over 25% of whole life policies are cancelled within the first 3 years costing their owners most of their investment.
I agree with what Jim said about the surrender fees. I would also like to add one more disadvantage of having a whole life insurance. The internal rate of return in the whole life insurance policy may not be competitive with other savings alternatives available in the market.
Our goal this year is to establish a life insurance policy. We considered whole life but I think we would prefer to keep our savings a separate issue from our life insurance. Term life seems more flexible and affordable so we are going for it.
Whole Life is too expensive for the value. Perhaps for people who are well-off, Whole Life can be a convenient option to insure a business partner or loan, bequeath a charity, pay estate taxes, or leave a legacy to heirs.
But that is not most people. the typical profile of a term life insurance owner is someone who is a family breadwinner and has minimal savings. It is critical protection. If you are in this category and aren’t insured, get insured now!
Advantages of Term Life Insurance are: totally affordable, and ideal for younger families when the need for protection is greatest.
Choose Term Life Insurance for covering specific needs that will disappear with time, such as: Income replacement, Financial security for dependents, Mortgage protection, College funding, Final/burial expenses
Use a free online quote engine to compare term rates from hundreds of top-rated companies to see how affordable it is. (I’d recommend Quality Term Life’s site because they don’t ask for you phone or email to get quotes.)
I would always go with a whole term life insurance plan even though it’s less affordable you cover yourself for the short term unlikely event of an accident and when you are old an on your last legs you family can take a benefit from your investment, if something where to happen. Just my 2 cents.
I really enjoyed this article. I have had whole life insurance for the past 10 years, which started when I was 29. Throughout all my life events I have been able to retain my policy, that includes taking 1/2 a year off transitioning from one career to another. If my life span according to the calculations is correct and I don’t live past my policy then I would have paid less than my policy is for. I have never looked at this as an investment/savings route, which makes the paid up dividends additions an added value. I wanted a policy that would take me through my life because my goal was to live past 65. I have a term policy to cover paying off my house in the case of an untimely event. That is only going to be around through the next 15yrs since that is the expected pay off date of the house. I think term is great for short term insurance coverage and whole life is great for life coverage. That is just my opinion. What I find helps with investments and savings is actually investing and saving. With 3 kids and being a single mother and bread winner invest 50 a month in my retirement and learning about investments has brought me a long way. It takes discipline and diligence.
We are just over 4 years into our whole life policy. Would it be wise to cancel at this point?