Whole Life Insurance
Article by Ryan Frailich, Jason Metz at Forbes Magazine June 2nd, 2021
Whole life insurance is one type of permanent life insurance that can provide lifelong coverage. It provides a variety of guarantees, which can be appealing to someone who doesn’t want any guesswork after buying life insurance.
Whole life insurance combines an investment account called “cash value” and an insurance product. As long as you pay the premiums, your beneficiaries can claim the policy’s death benefit when you pass away.
Whole life insurance offers three kinds of guarantees:
A guaranteed minimum rate of return on the cash value.
The promise is that your premium payments won’t go up.
A guaranteed death benefit that won’t go down.
While it can sound like a good choice, there are often better options for individuals who want life insurance that will last as long as they live.
Cash Value Accumulation in Whole Life Insurance
Part of the premium payments for whole life insurance will accumulate in a cash-value account, which grows over time and can be accessed.
Similar to a 401(k) or IRA, the money in the cash value account grows tax-free. However, if you take out cash value that includes investment gains, through a policy withdrawal or loan, that portion will be taxable.
The accumulation of cash value is the major differentiator between whole life and term life insurance. While actual growth varies from policy to policy, some take decades before the accumulated cash value exceeds the amount of premiums paid. This is because the entire premium does not go to the cash value; only a small portion. The rest goes to paying for the insurance itself and expense charges.
Most whole life policies have a guaranteed return rate at a low percentage, but it’s impossible to know how much your cash value will actually grow. That’s because most insurance companies that sell whole life also offer a “non-guaranteed” return rate of return based on dividends. You can choose to apply your dividends to cash value every year, but you can’t know how much that will amount to over time.
In my experience, having reviewed several dozen policies, guaranteed rates of return are often 1% to 2%, with non-guaranteed rates at about 4% to 6% annually.
In one policy I recently evaluated, it would take 35 years, according to the guaranteed rate projections, for the policyholder’s cash value to exceed what she had paid in premiums. Even at the higher estimates from the “non-guaranteed” projections, it would take the client 15 years for the cash value to exceed the amount she had paid in.
It’s unclear what percentage of policyholders get returns closer to the “non-guaranteed” rates.
Using the Cash Value
You can tap into cash value with a withdrawal or a loan. If you take a loan, it’s tax-free, and you can pay it back, with interest. If you make a withdrawal, there are no taxes as long as your withdrawal is less than the portion of your cash value that’s attributable to premiums you’ve paid. If your withdrawal is greater, you’ll owe taxes on the difference because those are investment gains.
Outstanding loans and withdrawals will both reduce the amount of death benefit paid out if you pass away. That’s not necessarily a bad thing. After all, one of the reasons to buy a whole life insurance policy is to get cash value, so why let the money sit there without ever using it?
While the cash value is there, you want to be sure that you know all the ramifications of accessing it prior to making any decisions.
Picking Life Insurance Beneficiaries
When you buy a policy you’ll choose a life insurance beneficiary to receive the death benefit. You don’t have to split the payout equally among beneficiaries. You can designate the percentage for each, such as 75% to Mary and 25% to John.
It’s also a good idea to also designate one or more contingent beneficiaries. These folks are like your backup plan in case all the primary beneficiaries are deceased when you pass away.
Designating beneficiaries is an important task, as is keeping your designation up to date with your wishes. The life insurance company is contractually obligated to pay the beneficiaries named on the policy, regardless of what your will says. It’s wise to check once a year to verify your beneficiaries still reflect your wishes.
What Happens When You Die
A major selling point of whole life insurance is that it will be in force until your death, unlike term life insurance. You can’t outlive the whole life policy as long as you’ve paid the premiums.
But here’s a kicker: For most policies, the policy pays out only the death benefit, no matter how much cash value you’ve accumulated. At your death, the cash value reverts to the insurance company. And remember that outstanding loans and past withdrawals from cash value will reduce the payout to your beneficiaries.
Some policies allow you to purchase a rider that gives your beneficiaries both the death benefit and the accumulated cash value. This provision also means you’ll pay higher annual premiums, as the insurance company is on the hook for a larger payout.
Whole Life Insurance Costs
While some of the cash value features and the permanent nature of whole life insurance sound appealing, for many people, whole life insurance is simply unaffordable.
Many life insurance shoppers look at term life vs. whole insurance costs. It’s never an apples-to-apples comparison because the policies are so different. That said, we found that a $500,000 40-year term life policy from Legal & General (the longest term life policy currently available) would cost about $700 a year for a healthy 30-year-old male. A $500,000 whole life policy from American National would cost about $4,060—or 5.8 times more. Price differentials will vary according to age and coverage amount.
This cost differential makes whole life far less attractive to the majority of individuals with an insurance need.