Spend time searching the best life insurance, and you are likely to find everybody recommending term life insurance. Even though term life stands out when it comes to coverage and cost, it does not mean whole life insurance is all-bad.
Whole life insurance also comes with its fair share of benefits that most people find exciting. Unlike term life that comes only with a death benefit, whole life insurance adds an investment component. That said, it is important to consider when Whole life insurance is a bad idea, and when it is not.
Whole Life Insurance Is a Bad Idea
Here are a few reasons you may want to avoid the whole life.
Whole life insurance can be absurdly expensive when compared to term life insurance. Given that coverage is provided as long as one is alive, whole life insurance premiums can eat into one’s finances significantly. A portion of the high premiums goes towards funding the investment component of the insurance policy even though it does not come with guaranteed returns.
One of the reasons why whole life insurance is a bad idea has to do with the fact that its investment component is undiversified. What this means is that the insured are always left exposed to a much higher risk, given that insurance companies invest their premiums on undiversified investments.
The lack of diversification is one of the reasons why whole life insurance tends to underperform most investments. For that, reason people should never consider whole life insurance, purely, for its investment component, given that there are better investments that guarantee better returns at much lower risks.
Returns Not Guaranteed
While most sales agents talk about whole life insurance returns as if they are guaranteed, that is not always the case. The long-term growth returns that the agent's tout is simply projections that often fail to come true.
Higher fees, as well as where insurance companies invest and interest applied, are some of the factors that take a toll on whole life insurance returns. While an insurance company might tout a 4% return at the start, one might end up getting a return of not more than 1% after 30 years. In contrast, 10-year treasury bonds offer investors returns of about 5% annually.
Illiquid and less cash flow flexibility
Whole life insurance as an investment is highly illiquid. What this means is that it is extremely difficult to cancel the policy at a preferred time and walk away with a profit. In the first decade, you are likely to end up with negative returns.
If you decide to cancel the policy in the second decade, you are also likely to end up with limited returns, as there is always a fee to pay in addition to income tax consequences on earnings. While you can borrow against the policy, the risk of paying interest is always high.
Whole life insurance is also a bad investment, as you cannot decide to stop paying premiums. While it is possible, such a move will only amount to termination of the policy cover, leading to taxation as well as a possible surrender charge.
Whole Life Insurance as a Good Idea
For every con, there is a pro, here some upside to whole life.
Whole life insurance stands out as a good investment in the fact that premiums are guaranteed for life. What this means is the insured always has an idea of the number of premiums they will have to pay for coverage.
In contrast, other life insurance policies such as term life insurance come with fluctuating premiums that might increase, making the policies quite expensive.
Guaranteed Death Benefit
Whole life insurance comes with the guarantee of the death benefit regardless of when the insured dies. In this case, the insured only has to pay premiums to enjoy coverage, thus ensuring lifelong protection. In contrast, term life insurance has term limits on when coverage is offered
Whole life insurance acts as an asset given the investment component it comes with. Its cash value tends to build with time as the insured pays premiums. The cash value can grow considerably to a point where the insured can take a loan. Likewise, the cash value can become part of the retirement plan.
Whole life insurance also stands out on the fact that it comes with a minimum rate of return. Conversely, even if the market dips significantly, one can rest assured of the cash value of the policy earning a guaranteed interest rate.
Whole life insurance comes with several tax benefits that can lower the insured taxable income. The death benefit is usually tax-free. The cash value is tax differed, which allows the cash value to grow faster. What this means is that the insured does not have to pay any taxes on the money or dividends earned on the policy.
It Comes Down to You
What works best for you will depend on your unique situation. Consult with an advisor and see if whole life is something you need, or need to avoid.