Chances are, if you are reading this article, some agent presented the virtues of whole life insurance to you. Or, maybe you purchased a whole life policy and having second thoughts. Truthfully, whole life insurance isn’t bad. Really, it’s not. However, it definitely isn’t for everyone. Moreover, for most people, it’s a bad deal. In this article, we discuss the 3 reasons why whole life insurance is a bad idea to buy. If an agent is telling you that you need whole life insurance without a concrete reason, run, don’t walk, away.
And contact us for our help. We can have an honest discussion and figure out if whole life insurance is right for you. Remember, we discussed how whole life insurance can be a good idea. It can be. Its purchase depends on your situation and what you are trying to accomplish.
Let’s start by giving a brief overview about whole life, and then we will dive into the reasons.
What Is Whole Life Insurance?
First, a quick lesson on whole life insurance. It is a permanent life insurance policy. This means it is designed to last for your entire life provided premiums are paid. Over time, cash value accumulates in the policy. You can borrow from the cash value and repay it back. At some point, you can even cancel the policy and receive the cash value.
Not to get into the weeds, but that cash value is yours. It offsets the death benefit. Upon death, your beneficiaries receive part cash value and part remaining death benefit. Here’s an easy example. You purchase a whole life policy of $50,000. Six months later, you die. There’s no cash value, so your family receives $50,000.
Fast forward 25 years. You die. There’s $27,000 of cash value. Your beneficiaries receive $27,000 cash value and $23,000 death benefit, for the full $50,000.
See how that works? MANY people get this wrong. Agents, too.
This structure allows carriers to offer whole life at level, guaranteed premiums. Contrast with indexed universal life, which does not offer guaranteed premiums. (In fact, nothing is guaranteed with an IUL.)
Why Whole Life Insurance Is A Bad Idea
Without further ado, let’s discuss why whole life insurance is a bad idea. Please note: whole life insurance is only a bad idea if it does not fit your situation. There are cases where it can be a good idea. We described those situations in our article about the good reasons for whole life.
#1 Reason – You Only Need Life Insurance To Cover You IF You Die
Compared to a basic term life insurance policy that will provide your beneficiaries with a death benefit IF you die, a whole life policy will pay a death benefit WHEN you die. So, naturally, the premiums of a whole life policy will be more. The carrier insures you for your entire life and expects to pay the death benefit.
This is the #1 reason why whole life is more expensive than term. The carrier already expects to pay a death benefit to your beneficiaries.
The real question is do you really need whole life insurance? Most of us do not. We just need a term life insurance policy that will pay a death benefit in case of our unexpected death.
Many people mess that up. They think they need whole life, when all they need is a cheap term life policy.
All death benefits from life insurance – whether term, whole life, or another type – is income tax-free. Your surviving family could use the money to remain in your home, continue their standard of living, establish a college fund, or a slew of other reasons.
Term life insurance, on the other hand, is cheap. For a 40-year-old woman, good health, non-smoker, she is looking at paying about $35 per for a $500,000 death benefit. However, a $500,000 whole life policy will cost around $470 per month ($5,300 annually)!
Nevertheless, if you need a $500,000 whole life policy to cover a permanent need (say to provide funding and caretaking for a disabled child upon your death), the $470 is the best money you can spend.
The decision always goes back to your needs and situation.
#2 Reason – Cash Value Takes A Long Time To Accumulate
If you were sold a whole life policy, the selling point could have been on the cash value.
Think of the cash value as a savings account. (But it is not!)
The carrier backs and guarantees your cash value. They also provide a non-guaranteed value. While the agent should have discussed the guaranteed cash values, I bet your attention focused more on the non-guaranteed values.
However, be aware. The cash in a life insurance policy takes a long time to accumulate, on average 12 to 15 years. Why? There are various reasons. The main reason is that the carrier’s operating costs – and risk of your policy forfeiture – are much greater in the early years of the policy. In other words, the carrier protects itself by keeping cash value low in the first few years to compensate for those policyholders who cancel their policies.
Generally speaking, once you hold the policy for over 12 years, you will see the cash value exponentially grow. But, it takes a long time to get there.
Moreover, do you really need it? That is the subject of our next reason…
#3 Reason – You Invest The Difference And Come Out Ahead
You may have heard about “buy term and invest the difference”. Here is what this means: if a term policy costs $300 annually, but a whole life policy costs $2,000 annually (for the same death benefit) then you have $1,700 to invest.
Let’s use our example again of the 40-year-old woman. She plans to retire at 65. In that 26 year span, she could have accumulated about $400,000 during that timeframe if she invested the “difference” – just under $5,000 annually in this case ($5,345 annual premium – $400 annual premium)- in a fund that returned 8% on average.
Contrast this amount to the whole life insurance policy illustration that the agent presented to you. Chances are, the cash value in the illustration is much less. (In fact, here is an illustration showing the cash value at age 65 – the $190k highlighted in green.) And, yes, even for those high-dividend participating policies agents like to throw around here and there.
Of course, the “difference” is subject to stock market risk. Chances are, though, you need to save – or save more – for retirement anyway! Saving through a whole life policy won’t get you to a comfortable retirement. In fact, it may cost you significantly from the effects of inflation.
Alternatives If You Need Permanent Insurance
John, you make great points. But, I do need permanent insurance like whole life insurance.
Then, whole life is right for you. You see, your situation dictates the need for whole life insurance. Maybe you need it for estate taxation or funding the care for a disabled child upon your death. Nevertheless, whole life insurance does have a place and importance with financial planning.
But, if you don’t want to pay high whole life premiums, you have a few alternatives.
One, for example, is what we just said. Invest the difference. If you were going to pay for a whole life insurance policy anyway, invest the difference. The problem is, usually, most people don’t invest the difference. They spend that difference on lifestyle wants and other material needs. Nevertheless, the money is there to invest. Be aware to weigh your options carefully.
If you feel you need permanent coverage, but don’t want to spend the money, there is an alternative called guaranteed universal life insurance. A guaranteed universal life (GUL) policy will last your lifetime, but these policies don’t have the cash value like whole life. In this case, a GUL costs much less than whole life, but more than a 30 year-term. The premium cost is usually in between these two.
For example, let’s say our 40-year-old woman purchased a $500,000 GUL. Her premiums are about $2,800 annually or $240 per month. Wow! Again, the premiums are higher because the carrier plans to pay a death benefit to your family.
Now You Know The 3 Reasons Why Whole Life Insurance Is A Bad Idea
Now you know three reasons why whole life insurance is a bad idea. You have options. Term life insurance is a type of life insurance we all pretty much need. If you feel you need lifetime coverage, look into a GUL. It is like whole life without the cash value. All things being equal, it is much cheaper than whole life and offers lifetime coverage.
However, as we described, whole life insurance does have its place. The decision depends on your situation.
What is best for you? We can help. We have the independent knowledge to assist you in the right decision. Unlike other agencies, we aren’t beholden to any insurance carrier, but we are beholden to you and making sure our recommendations fit your needs and situation.
If we feel you need whole life insurance (and some of us do), we will tell you. If something else, we will tell you that, too. Remember, there’s no risk of contacting us. If we can’t help you, at the very least, you’ll learn something new, and we’ll part as friends.
Feel free to contact us or use the form below. We are here to help.