Whole life insurance is generally a poor investment, unless you need permanent life insurance coverage. If you want coverage for life, permanent life insurance can be a worthwhile investment if you’ve maxed out your retirement accounts and have a diversified portfolio. Just keep in mind that whole life insurance is quite expensive and often takes more than a decade to start showing reasonable investment returns. therefore, it’s usually only a good consideration if you’re relatively young, have a high income, and want to leave money to your family.
Should you invest in whole life insurance or term life insurance?
Permanent cash value life insurance policies, such as whole life insurance, have an investment component in addition to the life insurance coverage. however, the primary purpose of these policies is still to pay a death benefit to your beneficiaries when you die, and this benefit makes up a significant portion of the cost of purchasing a policy. That’s why whole life insurance policies and other cash value life insurance policies don’t make sense as an investment unless one of your goals is to have coverage for life.
Assuming you need life insurance, there are four major insurance groups to choose from based on your financial situation:
Because guaranteed universal life insurance policies offer permanent coverage, they are still much more expensive than term life insurance (easily 3 or 4 times the cost), but it saves money since there is little or no insurance component. investment. Whole life insurance policies typically cost ten times the cost of term life insurance because you pay for permanent coverage, additional administrative costs, and investment account funding.
Is whole life insurance worth the cost?
If you want permanent coverage but are on the fence about the high cost of whole life insurance, you may want to get quotes for a guaranteed universal policy. you can compare this to a whole life insurance quote. You should also evaluate the guaranteed returns of the whole life insurance policy against an estimate of your returns if you were to invest the difference in cost between the two policies. just make sure that:
If you think you’d be better off financially to get permanent coverage and just invest the difference in cost, then you should. but you have to do it for real. Many people buy a less expensive term or guaranteed universal policy and simply spend the money they saved by not buying whole life insurance.
On the other hand, if you decide to invest in whole life insurance, be sure to choose an insurer that has a high financial strength rating. You may lose your coverage and investment if your insurer becomes insolvent. Also, check that the policy allows you to receive a portion of the death benefit early if you develop a serious illness. this common feature is called an accelerated death benefit.
how whole life insurance works as an investment
When you pay premiums for permanent life insurance, some goes toward the cost of insurance, some goes toward sales and administrative fees, and the rest goes toward the cash value of the policy. In the early years, the fees and cost of insurance eat up most of your premium, but over time, it contributes more and more to the cash value.
Cash value is basically an investment account within your permanent life insurance policy that grows at a guaranteed rate over time. The guaranteed rate of return is usually enough for your cash value equals the policy’s death benefit when you turn 100, assuming you make no withdrawals. A simple way to think of the cash value of your policy is that it is the amount of money you would receive in exchange for surrendering the policy to the insurer.
For the first 10 to 20 years of coverage, the cash value of a whole life insurance policy is quite small, due to the fees and cost of coverage. therefore, we would not recommend whole life insurance as an investment if you are older, as you may not live long enough to see good returns and would save money with a guaranteed universal policy.
If you buy permanent life insurance from a mutual insurance company, you can receive dividends as its cash value increases. Mutual insurers are owned by their policyholders, so profits are redistributed as dividends annually.
Although dividends are not guaranteed, the largest mutual insurers have distributed them consistently for decades. You can choose to take cash dividends, use them to pay premiums, or use them to purchase paid insurance add-ons. Paid-in insurance add-ons are a form of “rollover” as they act as a small addition to your existing permanent life insurance policy, increasing the death benefit and cash value.
The cash value of a whole life insurance policy grows tax-deferred, which is why it’s often compared to a retirement account, such as a 401(k) or IRA. however, contributions to the whole life insurance policy are not tax deductible, as they are with retirement accounts.
access the investment earnings of your whole life insurance policy
The cash value of a whole life insurance policy is not added to the death benefit if you die; the insurer keeps it, so you must “use it or lose it.” you can access and use the cash value as follows:
When you withdraw or borrow money from the policy’s cash value, the insurer will reduce the death benefit accordingly. Because of this, you might think of whole life insurance as assisted self-insurance. It pays the insurer for the benefits of tax-deferred growth, guaranteed returns, and the ability to use the money through a policy loan as it continues to grow.
The insurer, in turn, maintains the level of premiums as the difference between the cash value and the death benefit decreases over time, reducing your liability. But while your beneficiaries receive the death benefit, they also don’t get the cash value of the policy.
Also note that while permanent life insurance policies have surrender fees for the first few years of coverage, there are no restrictions on making a withdrawal or taking out a loan based on your age. this is actually a key benefit over a 401(k) or traditional ira, which carries penalties for withdrawals before age 59.5, as you can access the funds at any time as long as you have a large enough cash value .
Policy loans can be a great option if you need funds during a market downturn or other situation where it would be difficult or unwise to withdraw money from other investments. For example, if you own shares in a private company, it could take months to sell your shares and you may not want to give up the position. Permanent life insurance policy loans tend to have low interest rates, and since there are no credit checks or eligibility requirements, you can get the money almost immediately.
investing in universal life insurance vs. whole life insurance
If you’re considering whole life insurance but want more flexibility with investment options and premiums, universal life insurance might be a better option. Universal life insurance is very similar to whole life insurance with a few key differences:
Depending on how you want to invest the cash value, you can choose between traditional universal life insurance (rates determined by the insurer), indexed universal life insurance (tracks an index), and variable universal life insurance (you choose from a pool of mutual funds). Every universal life insurance policy also has a fixed-rate investment option, but these tend to have low returns.
Universal life insurance policies are essentially higher risk and higher potential return, compared to whole life insurance. For traditional and universal index policies, your cash value will generally have a guaranteed annual rate of return, but it can be quite low or 0%. (Not that 0% is a bad yearly low, it actually ensures that earnings from previous years are not affected by poor performance.) Similarly, in good years, the insurer will cap the maximum annual earnings.
Variable universal life insurance is even riskier, as its cash value may decrease and there are higher administrative fees. Plus, its investment options often come with higher expense ratios than comparable mutual funds.
However, a key benefit of universal life insurance policies is that you can pay more in cash value in the years you can afford it. doing so reduces the time it takes to build up enough cash value so that most premiums can be paid with it. You can get a similar effect by buying a whole life insurance policy that pays out over a shorter period of time, such as 20 years. But this strategy is more flexible with a universal life insurance policy, since you’re not forced to pay more in years when you don’t have the money.