Whole life insurance has benefits and even a cult-like following. Is it worth it?
Once you start to make good money, former (and current) friends, colleagues, and even family members will come out of the woodwork looking to sell you two things: financial products and Avon moisturizers. Eventually, you’ll be hit up to buy whole life insurance.
If it’s already happened, you may have heard a pitch for investing in whole life insurance that sounds something like this: It doesn’t expire, has a cash value, and pays dividends. You’ve probably also heard that the insurance company doing the policy hasn’t missed a dividend payment in 100 years. But is it actually a good investment?
What is whole life insurance?
Whole life insurance is an insurance product that pays a death benefit to a designated beneficiary when the hold of the policy dies. Additionally, the policies have a guaranteed cash value, redeemable at any time. You can also receive dividends related to the performance of the insurance company.
The cash value compounds like an investment, but you can take out a tax-free loan against the policy and never pay it back; the insurance company will just reduce the death benefit by the loan amount.
The type of whole life strategy that we’ll be using for this article is the Infinite Banking Concept, which was pioneered by Nelson Nash.
Whole life insurance vs. term life insurance: What’s the difference?
First, whole life insurance has no term. When you purchase term life insurance, you’re buying a policy that only lasts 10, 20, or 30 years, and when the term is up, you have to start a new policy and will likely need to pay far more premium for the same death benefit (premiums tend to rise as you get older).
Whole life is unique because the premium is set when you get the policy. If you start a policy at age 25, you could potentially be paying the same premium at age 75. (Whether that’s a good idea is debatable; I’ll get into that in a minute).
Whole life insurance typically has far higher premiums than term life insurance, partly due to the term factor: It costs a lot less to insure the life of someone aged 25 for 20 years than it does for what could end up being 80 years. But higher actuarial costs aren’t the only reason—whole life has high fees, including a big commission that is paid to the agent over the first few years. Agents may try to push you toward whole life, even if it isn’t great for you, because of that huge commission.
Finally, term policies do not have a cash value or pay dividends.
Benefits of whole life insurance
No term
The most significant benefit to whole life insurance is getting to lock in a low premium while you’re young and relatively healthy. Unlike a term life insurance policy, you’ll never have to reset your premium.
Whole and term policies’ premiums are set based on the actuarial likelihood that you will die and the death benefit will have to be paid. 55-year-olds who are overweight and have high blood pressure carry more risk than fit 25-year-olds, for example.
Cash value accumulation
The cash value and dividends in the whole life policy are based on the performance of the insurance company, that is, how profitable it is—the difference between premiums paid to the company and death benefits paid to beneficiaries—and the performance of its investments, which are typically in safe fixed income instruments.
For people who are skeptical about using the current banking system or anxious about the risks of tying their retirement savings to the stock market, whole life insurance is a way to either get diversification from the system or invest outside of it entirely.
There is a case to be made that if you have a career working with the stock market or in an investment bank that at least part of your savings should be outside of the system. Look at what happened with Lehman Brothers and Bear Stearns employees during the Great Recession.
Tax-free policy loans
You can take loans against the cash value of your policy and use the investment earnings without any tax liability. As long as you keep making premium payments, you could take the loan and never pay it back; the insurance company will deduct the loan and accrued interest from the death benefit.
Cons of whole life insurance
Fees
I’ve seen policies where 75% or more of the premiums paid in the first two years go directly toward paying the agent or broker. You could make a convoluted argument that the fees you pay over time for term insurance end up being close to the same amount, but it all comes back to the opportunity cost.
Opportunity cost
The most important part of investing is time to compound. When you put your money in a whole life policy, it’s possible that the cash value of the policy won’t be equal to your contributions for 10+ years after you start the policy.
That means you’ll be making huge premium payments each year with a 0% return for at least 10 years. That’s money that can’t be invested in real estate, the stock market, scrubdaddies (scrubdaddys?), or a startup.
Bond market
Insurance companies’ investments are limited by regulators. For the most part, they only invest in fixed income. That may sound good if you’re looking to limit risk, but a 2-decade bull market in bonds just ended. Insurance companies may have trouble making the guaranteed amounts if the bond market is down 20% over the next five years.
Buy term and invest the difference
Most professionals will tell you to ditch your whole life, buy term, and invest the difference. Whole life premiums are far higher than term life premiums. You can buy a term policy that covers the next 20 years, you could then put the difference between the two premiums into the stock market. Even if you hit a recessionary period, like we’re in right now, you almost certainly wouldn’t need the ten years it takes to break even with whole life. Once the 20 years are up, a new term policy will have higher premiums, but you should have a lot more money to make the payments.
