When you start shopping for life insurance, you will come across two different types: whole life and term. Here is an objective review of whole life insurance as an investment option.

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 on 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 they’ve also read something warning against whole life, and they’re confused.

When you shop for insurance, you’ll also notice some insurers offer both term and whole, giving you some options. Many providers even offer term life insurance that requires no medical exam. While term policies are far more popular, there are some instances where a whole life policy makes more sense for a policyholder. It’s easier than ever to take out a life insurance policy, but it’s important to read up first to make sure you’re making the right choices.

Today, I want to clearly explain whole life insurance as well as reiterate when you should consider (and should not consider) life insurance.

When you need life insurance

If you’re like most, you may not need life insurance until you have kids.

After all, one of the common purposes 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.

Related: When should you buy life insurance?

Here is one example of when you should consider life insurance: 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.

Related: How To Get the Best Price on Term Life Insurance

What is whole life insurance?

In the world of insurance, there are two primary types of life insurance: term life insurance, and permanent life insurance. These are further divided into whole and universal.

Term life insurance

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 similar to car insurance: if you stop paying premiums, you could lose your coverage just like any other policy. Only paying for a specific term period is what makes term life insurance unique.

Permanent life insurance

With permanent life insurance, your insurance remains 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 supplement retirement income, and even take loans against it throughout your life.

The big difference between the two types of permanent life insurance, whole life and universal life, 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 does not necessarily apply to universal policies.

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 accumulate tax-deferred cash value is attractive.

One highly attractive option for getting permanent life insurance is with Policygenius. Since permanent life insurance is known to be more expensive, Policygenius has a team of licensed agents (who don’t work on commission) to help guide you and give advice on getting the right policy for your needs.

The pros and cons of whole life insurance

Pros

  • Guaranteed (but modest) return on money.
  • Fixed premiums.
  • Eventually builds cash value you can borrow against or withdraw before death.

Cons

  • Mediocre investment return on money.
  • Expensive premiums.
  • Can be complicated and difficult to understand.

Take this example from SmartMoney.com: whole life premiums are expensive

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 the 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 can be more expensive than term life insurance. Assuming equivalent investment returns, because of the way the policies 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. In my opinion, 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 insurance as an investment

With whole life, cash value accounts often see around 5%-6% 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 current volatility understandably has some investors doubtful.

But before deciding that whole life is a good option, you have to consider the policy’s fees and commissions. By these estimates, while an agent might make 30%-40% of a term policy’s first-year premium, they might earn 80-100% 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 avoid 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.

Whole life insurance may be a good idea for wealthy, young-ish families

There are no hard and fast rules about buying life insurance; every person has different considerations.

But in particular, for wealthy families in their 30s or 40s, whole life insurance can be worthwhile as an estate planning tool because you can create an insurance trust that pays estate taxes out of the policy’s proceeds and then pass the trust onto beneficiaries.

Consider term life insurance instead

Now that you know the pros and cons of whole life insurance, you may be thinking that term life insurance is best for you—and you’re probably right.

Related: Term Life vs. Whole Life Insurance: Which Should You Choose?

Compare life insurance quotes:

Using an insurance marketplace like Policygenius, you can get multiple term life insurance quotes from different companies in just a few minutes. They choose highly rated providers and pull personalized quotes from each to help you comparison shop more efficiently. 

One thing that sets Policygenius apart is 24/7 customer support. You can chat with a representative about your insurance options and get one-on-one help choosing the right life insurance company and coverage. When you’re ready to apply for a policy, you can click through one of your offers to get started.

Shop for life insurance through Policygenius or read our Policygenius review.

Summary

The process of buying life insurance can be 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.

Indeed, there are pros and cons to everything including whole life insurance; important to weigh the options and get educated with real quotes about how much it’s going to cost – so you can decide definitively one way or another.

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About the author

David Weliver
Total Articles: 303
David Weliver is the founder of Money Under 30. He's a cited authority on personal finance and the unique money issues he faced during his first two decades as an adult. He lives in Maine with his wife and two children.