I’ve seen various television personalities and financial advice columns recently discussing whole life insurance. It seems to me that whenever whole life insurance comes up as a topic It’s been a bad thing to stay away from but they never discussed why. I’m a pretty stubborn person and I don’t just accept “because I said so.”
I decided to do a bit of my own research. This blog post aims to discuss briefly the different types of life insurance. Also I’d like to shed some light on why, for the vast majority of us, whole life insurance is a bad idea.
Life Insurance At A Glance
Life Insurance is a financial product that exists to provide security to the family/surviving spouse when someone dies. If you don’t have dependents, people who would suffer financially if you died, you don’t need life insurance.
There are two main types of life insurance: term life insurance and whole/universal life insurance.
Term insurance covers a specific period of time. For example, if I buy a term life insurance policy for 40 years and I die in that period of time the insurance company will pay out a sum of money to my family. If I don’t die in the 40 years I’ll have to buy another term policy.
Whole life insurance is designed to cover, you guessed it, the whole life. You pay monthly premiums for the rest of your life and the insurance company will pay a death benefit if you die. You may hear a financial advisor talk about universal life insurance. For our purposes here whole life and universal life are essentially the same thing. Universal life may offer more flexibility in changing death benefits or skipping premium payments but it is still a permanent life insurance policy.
The main problem I see with whole life insurance is that it’s sold as an investment. The life insurance policy has a cash value component wherein monthly premiums are invested in mutual funds and grow just like a stock market account. Let me emphasize to you that insurance should never be used as an investment strategy. You can’t control what the company decides to invest your money in. They will choose their own investments and decide how much money their customers will see in returns. There are much better vehicles for stock investing that you can actually control. Also, it takes a long time to actually get a return on your money. Insurance policies of this kind include a lot of fees, not to mention they may be invested in types of mutual funds that carry high fees. This results in crappy performance. In the majority of cases I’ve read about, the cash value of the policy is likely to be less than was paid in…even after a long period of time.
If you read up on whole life insurance you will come across this concept of “tax-free money.” Financial professionals who promote whole life often use this as a selling point: earn a return on your money tax-free while having added life insurance benefits. Of course, tax-free in this case means you don’t pay taxes on the money you take out. However you have already paid income tax on the money that goes in. A component of this structure is that you can borrow against your policy if you need the cash. If you should decide to take the money out you won’t pay taxes on it but you will owe interest. Borrowing against an insurance policy works like a loan. Interest accrues until you pay back the loan on the policy. In my view, that money is yours. You paid taxes on it so why should you pay interest to access money that’s yours?
I have also heard whole life insurance being sold as a vehicle for retirement. Again, whole life doesn’t pass the test. Both whole life insurance and retirement accounts like Roth IRAs and 401ks are illiquid. You can’t just withdraw the money whenever you want. With retirement accounts you’ll pay a penalty for withdrawing money before 65. With a whole life policy, as we discussed, you’ll owe interest on the money you take out. However, you’re likely to see returns on your money quicker with a retirement account and you can invest, in most cases, in a much wider variety of options. Something that’s great about retirement accounts like Roth IRAs is you can stop contributing for a time if you don’t have the money. With whole life you have to come up with the cash monthly; you can’t just decide to not pay in because you don’t have the money.
If my post hasn’t dissuaded you yet I’d like you to know is that whole life insurance is expensive. Monthly premiums for a whole life insurance policy may be as much as ten times as expensive as a term policy because there’s a good chance they’re actually going to have to pay a death benefit. Your financial advisor isn’t likely to mention that the commissions on selling whole life insurance are handsome. Whole life insurance is a popular offering because financial advisors stand to make more money off of them. Beyond that, the fees you pay on whole life insurance are at best unclear. Unlike a mutual fund, where they lay out the expenses you pay, whole life insurance won’t lay out the specific costs. The company may guarantee you a certain return on your money but in my view the numbers just don’t add up.
So let’s recap. Whole life insurance is expensive. It doesn’t earn returns comparable to other investments and it is often not diversified. Your money is not easily accessible. You have to pay monthly for the rest of your life if you don’t want the policy to lapse. The fees on whole life insurance are confusing and the “tax-free” gimmick isn’t quite true because it doesn’t take into account the interest you pay.
If you’re smart about your money the best thing to do would be to buy term life insurance. With the money you save monthly on less expensive premiums you can put your money in better, less complicated, more transparent investments.
As always I advise everyone to be informed. I’d like you to do your own research on the topic. You may notice that the websites that endorse whole life insurance are from the companies selling the policies and there’s a good reason for that. Companies rely on consumers not being informed. Don’t take their word for it!