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Is Whole Life Insurance a Good Investment?


Okay guys, it’s time to get all sexy and talk about life insurance. I know, I know. Keep your shirts on.

Until recently I had only written this brief primer life insurance because it doesn’t apply to a lot of people under 30. But as some of us reading (and writing) this blog get older, I’m getting asked more often about the topic. In particular, people want to understand what whole life insurance is and whether whole life insurance is a good investment.

These readers—mostly in their late 20s or early 30s and starting families—are beginning (rightly so) to think about life insurance. And at some point, an agent has mentioned whole life insurance and the concept—getting guaranteed cash value that you can access while you’re still alive—seems appealing.

But maybe you’ they’ve also read something warning against whole life, and they’re confused.

Today I want to clearly explain whole life insurance as well as reiterate when you need (and don’t need) life insurance.

When You Need Life Insurance

If you’re like most, you won’t need life insurance until you have kids.

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After all, the purpose of life insurance is, in the event of your death, to replace your income for the people who depend on it. In some cases, you may want to get life insurance for your spouse before you have kids. But there are few cases when young, single people need life insurance. Still, some insurance agents will try to sell it to you.

There’s one interesting possible exception: If you’ve graduated with big student loan debts that a parent cosigned, you or your parent may want to get a life insurance policy on you to cover the balance of the loans.

In this case, opt for just enough term life insurance to cover the outstanding debt. In your early 20s, this policy should be dirt cheap. Avoid insurance products designed only to pay off your loans, and remember that you only need this insurance if your loans have cosigners. If you are the only signer on your loans and you die, a parent cannot be held legally responsible for those debts.

What is Whole Life Insurance?

In the confusing world of insurance, there are two primary types of life insurance: 

  • Term life insurance
  • Permanent life insurance (further divided into whole and universal)

With term life insurance, you pay premiums for a specified term (usually 20 or 30 years), and if you die within that term, the insurer pays your survivors a benefit. But term insurance is like car insurance: if you stop paying premiums, you lose the insurance.

With permanent life insurance, your insurance remains in force as long as you’re paying premiums. In addition, some of the money you pay in premiums accumulates as a cash value. You can use this cash value to save for retirement, or even take loans against it throughout life.

The big difference between whole life insurance and universal life insurance is that whole life insurance premiums are fixed for life while universal life insurance allows you to adjust the premiums and death benefit as you go. I’ll talk about whole life insurance here, but understand that where I say “whole”, this could apply to a universal policy as well.

With whole life insurance, after a number of years some of the money you’ve paid is yours to keep—even if you stop paying premiums. This is called the policy’s cash value. After several years, you’ll even see a guaranteed return on that cash value like you would in savings account.

For insurers, whole life insurance can be an easy sell. Nobody likes “throwing money away” on life insurance, so the prospect of combining life insurance policies with a way to save tax-deferred money for retirement is attractive.

But here’s the rub:

  • Whole life premiums are expensive
  • Because of fees, whole life is a mediocre investment
  • Only an expert can tell if a whole life policy is a good deal
The Pros and Cons of Whole Life Insurance
The pros and cons of whole life insurance for young savers.

Whole Life Premiums Are Expensive

Take this example from SmartMoney.com:

To get a real sense of the value of term, let’s compare a term policy and a universal life policy. Say a 40-year-old nonsmoking male has a choice between a $250,000 Met Life universal policy with a $3,000 annual premium and a same amount of renewable term coverage with a 20-year fixed premium of $350. At the end of one year, the universal policy, assuming it paid 5.7% per year, tax-deferred, would have a cash value of exactly zero (cash value is the amount you would get back if you canceled the policy). But say he had instead invested $2,650 (the difference between $3,000 and $350) in a no-load mutual fund that averaged a total return of 10% annually. At the end of the first year, he’d have $2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10 years, he would have accumulated more than $46,000 in after-tax savings in the mutual fund. Over the same period, the cash value of the policy would have climbed only to $31,819.

The biggest drawback to whole life insurance is that the premiums are way more expensive than term life insurance. Assuming equivalent investment returns, because of the way the polices are written, it takes a lot longer for a whole life policy to accumulate significant cash value (often 12-15 years) than if you invested on your own.

So for a young investor with limited free cash to buy insurance and invest for the future, this is why I only recommend term life insurance. It’s better to pay the cheaper premium and have savings left over to invest, use as an emergency fund, or spend as needed.

Whole Life Is a Mediocre Investment

With whole life cash accounts often paying around five to six percent interest before fees, conventional wisdom has been that you could do better investing on your own in a mutual fund for the long run. I still think so, but the market’s poor showing in recent years understandably has some investors doubtful.

But before deciding that whole life is a good investment, you have to consider the policy’s fees and commissions, which are not small. By these estimates, while an agent might make 30-40 percent of a term policy’s first-year premium, they might earn 80-100 percent of a whole life policy’s first year premium (which, remember, might have premiums that are 10 times as much as term). That’s a big incentive to push whole life.

Only An Expert Can Tell If a Policy Is a Good Deal

If you’re still on the fence about a whole life policy, consider the fact that even I couldn’t look at a whole life policy and tell you if it’s a good deal. That would take a seasoned insurance pro.

The key to understanding a whole life policy is the internal rate of return— that’s the return on the policy after taking all the fees out. But it’s not like that number is printed on your policy—deducing it would take someone with know-how and some serious spreadsheets.

Also, remember that the cash value of a whole life insurance policy only begins to earn meaningful returns after you’ve held it for 20 years or more. This can be a tool insurers use to sell policies to 20-year olds (look at the money you’ll have in the bank when you’re 40!) but for savvy savers, it should be a clue that you’re saying goodbye to a lot of money for a long time.

The Exception

Because personal finance is personal, there are (almost) always exceptions to any rule. It’s no different with whole life insurance.

For wealthy families in their 30s or 40s, whole life insurance may be worthwhile as an estate planning tool because you can create an insurance trust that can pay estate taxes out of the policy’s proceeds and then pass the trust to heirs.

Lauren and I are going through the estate planning process now with an attorney she works with, so there will certainly be an upcoming post on it when we’re done. Until then, estate planning is something to consider once you have kids and/or you have assets or life insurance policies to pass one. When the time comes, consult an attorney who specializes in the estates and trusts.

How To Buy Life Insurance

The process of buying life insurance is a bit of a headache, but it’s at least easy to start shopping. You can get rate estimates online from many insurers after a few quick questions.

If you have a local independent insurance agent you work with on home or car insurance, he or she can also help you get started.

Once you’ve identified the policy you want and filled out an application, a nurse will come to your home to give you a brief physical exam and draw blood. Life insurance companies have to make sure you’re healthy enough to insure. That means recent medical diagnoses could work against you and a good reason to get life insurance as soon as you need it while you’re young.

Have you recently bought life insurance? What influenced your decision? Where’d you buy it? Have questions about term or whole life? Let me know in a comment.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Be sure to check with your employer to see if they have an insurance policy as part of your benefits and if they offer discounted policies. I know I ignored that portion of my HR orientation since it wasn’t relavent to me at the time because I was 22 and single.

    Doing some reserach, I found that my company already pays for a basic life insurance policy for me equal to 2 years salary for as long as I am an empolyee or if I retire with them they pay it for life. If I die on the job in an accident, my beneficiary gets an additional $500,000 on top of the basic policy. They also offer discounted additional insurance, both accidental and life, that each can increase benefits up to 8 time your yearly salary.

    The point is that you may be able to get discounted insurance rates through your employer, so check first before you go out and buy on your own.

    • You need to be careful about relying on your company’s life insurance policy. If you become sick (cancer, etc) and are no longer insurable and then lose your job (perhaps because you can no longer work because of you illness), you won’t be able to get life insurance. If your company offers it for free, that’s fine as a supplement, but you really need to have your own policy that stays with you from job to job.

  2. I have a blend of term/whole worth $500,000 even though my husband and I do not plan to have kids (we’re 33). I have $100K in student loan debt, but the main factor is that my mom died of a dominantly inherited disease when she was 46, and there is a 50% chance that I have it. If that turns out to be the case, we can get me the cadillac of care when I’m fully disabled (she was quadriplegic the last 2-3 years of her life) and not worry that the medical debt will destroy my husband when I’m gone. I have long-term care insurance, too, but the limits on those can be hit pretty quickly.

  3. Thanks for the informative article. I was one of the many that have asked this question and am currently looking at life insurance options. I like the idea of the blended approach of whole and term as a means to keep costs lower than going all in on whole life. I still am on the fence with the idea of having money tied up for over 10 years before the cash value equals what amount paid into the policy however. Is it worth it to get a smaller amount of whole life to start out with or would it just be wiser to save/invest that by other means?

    • Another thing to realize is that if you die, the insurance company only pays the coverage of the life insurance…all of that extra money you put into it disappears…and chances are, you probably could have put enough extra money into to have paid off a mortgage. Only after about 30-40 years does the insurance coverage begin to exceed (initial insurance coverage + extra money paid in)….and that doesn’t include any interest that that money could have potentially earned if it had been invested for those 30-40 years.

  4. I just started training as a financial advisor after finishing my MBA so my expertise is more along the lines of other investment options, but I agree on the blend of Whole and Term Life Insurance to keep costs down and still have flexibility long term. I believe you failed to mention the importance of probably going with a Mutual Company over a Stock Company so that the Board is voted on by the policyholders (rather than stockholders) who also receive dividends on Cash Value policies. In addition, companies are now offering whats called high early cash value (80-90% of premiums in year 1) for people who want more immediate liquidity, but unfortunately it offers a lower IRR long term.

  5. “Is Whole Life Insurance a Good Investment?”

    NOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO. GOD NO.

    NO. NO.

    NOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOOO!

    Life insurance is NEVER an investment. The opposite of life insurance is a pension (insurance against living too long); pensions are investments. Life insurance is a risk management tool. And the cheapest way to fully cover your risks is ALWAYS term life insurance. Buy term, invest the difference in index funds. If you don’t die, then you’re throwing your money out the window on term, but it’s a lot less money than you’re throwing out the window for whole life.

  6. I don’t have any right now for the reason you mentioned above, no kids. Definitely something to consider in the future though.

  7. Hey good info, as I’ve been looking into this a bit lately. I know guys like Dave Ramsey hate the stuff, but most insurance salesmen love it (Good commission, like you said).

    Any idea what the difference between Indexed Universal Life and regular Universal Life? A friend and financial guy is trying to hook me up with an Indexed Universal Life policy. Said it is based on the stock market, but guaranteed to never lose value when the stock market goes down. Too good to be true? What’s the catch?

    • Brandon, the Indexed Universal Life has historically been riskier but offers more reward based on the performance of whatever market index it tracks. I’m almost positive what he means by never losing value is that there is a collar on the returns you can receive… ask him for more details or to break down the policy. If he steps around the question then say… “What is my worst case scenario here?”

      I believe a regular Universal Life policy is based on interest rates, the lower interest rates are, the lower your return and vise versa.

  8. I got life insurance recently when my son was on the way, I spent a lot of time looking around for the best deal and I found two things: First, rates are all over the place with some premiums double what others offer, it makes no sense why some people would go with the pricier options. Second, I looked at a lot of whole/universal policies, and I couldn’t find one that was even close to being a good investment, the returns are horrible. Maybe some companies have decent policies, but I sure couldn’t find them.

  9. Jamie Brewer says:

    I’m glad you’re talking about this subject. This has been a topic of discussion around our home recently. I am married and have a 2-year-old daughter. I do believe that it is a bit irresponsible to not encourage younger people to look into life insurance. It’s not just for people who are married/have kids… many people under 30 don’t have enough $$ (assets – debt) to cover their funeral costs if something were to happen. A basic will and a sufficient amount of term insurance for super cheap would be adequate to take care of this situation if it were to arise.

  10. First, if you’re under 30 and under 45 or 50 for that matter, you should be looking at a variable universal life, it allows you to invest in mutual funds and not be stuck to interest rates or 10 yr bond rates. Whole life and universal life are not good for young people because interest rates are in the basement. Companies usually only pay 1% of term policies, so if you’re Dave Ramsey, you’re going to run out of coverage at some point in your life, wouldn’t want to force my kids to self-pay for burying me and paying a 55% estate tax. Coverage is very expensive when you get over 50-55 and almost ridiculous once you get over 60. And about the different prices, you get what you pay for really. Yeah you could go with the cheapest one, but will that company be financially stable when you need them to pay out? Will the rate stay the same for the life of the contract? And do they actually pay out? Some companies have such a strict guideline for paying out that they make you jump through hoops, cheap car insurance ring a bell?

    If you’re only going to do term then look at return of premium, you get all your premiums back since only 1% of term policies ever are paid out.

  11. I did TONNNNNNS of (OCD level) # crunching research and here is what I found (just turned 24).

    The only Whole Life Insurance anyone should ever buy is from a mutual company (Northwestern, Mass, New York Life). Northwestern is hands down your best bet if you are healthy enough to get coverage with them. Mass would be your second best with NYL being 3rd.

    I got the best rating at NM and am putting about 3500 into whole life a year. Its the best use of your safe long term $’s and its cheaper to get the younger and healthier that you are(I ran the #is and it is actually cheaper in the long run to lock in the premiums now than to wait 5ish years to buy coverage).

    Hope this was helpful!

  12. To my understanding life insurance is bought and purchased with age and health. I did some googling and whole life seems to be a great long term money management vehicle. Again I only believe whole life to be a good choice as you it seems you cannot out live your term as a term policy would do.

    I know most folks say buy term and invest the rest, but key points are most folks dont beat the S&P yearly. If you invest in mutual fund or stock, then capital gains are going to get you.

    If you did the same in the a whole life policy, there are no capital gains, guaranteed percentage on your money, compounding interest, cash value and a death benefit. I honestly wish I found this with I was in my 20’s….. I have to dig deeper to understand it more, but it seems like whole life policies are the isshhhhh lol