Whole life or permanent insurance comes in various forms. It is neither the worst policy nor the best policy for all people- it is simply another variety of life insurance that can be selected to protect your family. Let’s look at some of the different types and their strengths and weaknesses.
First off, true ‘whole life’ policies can only be purchased from a mutual life insurance company. This is a company where the policyholders actually own the company through their policy and the cash value growth of the policy is return of premiums based on actual performance of the company. Any other company is only offering you policies that ‘mimic’ a true whole life policy in the form of paying interest on the internal cash value of the policy.
Understanding that- lets look at pros and cons of true whole life.
1. It’s the only policy you can buy that’s guaranteed to pay you a death benefit. It sounds silly but its true. Term policies can expire and universal life policies can lapse due to increases in cost of insurance or poor rates of return. With a whole life policy, as long as you make the premium, the contract stays in force, and the premium will NEVER go up or change. Buy it early, and assuming its a strong company, and you have a guaranteed policy no matter what happens to your health or how old you get.
2. You build equity in the policy which gradually increases over time. This cash value has two elements, a guaranteed cash value and increasing dividends. The policies cash value will always be there, can be borrowed against in good times or bad no matter your credit, and generally offers superior rates of return ( typically 4-5%) relative to other guaranteed, liquid investments. Eventually, with a true whole life policy, the cash values will begin to increase the death benefit as well- this is required by law on true whole life policies, which most people aren’t aware of. As a result there is some element of inflation protection built into the death benefit. A 100,000 dollar policy bought today, won’t be worth 100,000 in 50 years due to inflation, whereas a whole life policy may be worth 200-300k in that period of time.
3. At some point, the dividends of the policy will exceed your premium commitment. At this point you may choose to offset your premium by having the dividends pay it. The cash value and death benefit will grow more slowly at this point as a result, but your out of pocket dollars will decrease as well. This makes the policy substantially cheaper than any other type of policy late in life when your health and age will dramatically affect any other type of policy
4. The internal cash values grow at a tax-deferred rate- that means you don’t have to pay tax the gain unless you withdraw it. Loans are not taxable on the policy unless you surrender it. Combined with the income tax free death benefit (in most cases) it makes an effective estate tax planning tool for transferring wealth to the next generation of family members.
OK now lets look at weaknesses:
1. The premium commitment on a whole life policy is substantially higher than any other type of policy. The reasons for this vary from company to company but essentially this is because a true whole life policy offers the most guarantees and the insurance company will have to pay that death benefit at some point as long as you keep it in force. Even if you make to 100, the death benefit will be paid as the policy comes to maturity.
2. Bearing this in mind, a person could invest this premium in higher yielding investments and purchase a much cheaper policy -such as term- and have a greater overall net worth later in life. Since whole life policies have relative low rates of return because of their guaranteed nature, they can be easily outperformed by most equity based products.
3. You have to keep it for a very long time for it to perform substantially. Whole life policies are long term products- typically 15 to 20 years before any kind of dividend offset or substantial cash value accumulates in them. Surrendering them early often comes with high penalties (often to cover the high commission and setup costs) and low cash value return. That kind of time and money commitment is something many people don’t stick to- a whole life policy is commitment for life.
4. Many whole life policies are not true whole life- they are universal life policies. These policies typically have even lower cash value performance than a traditional whole life policy and run the risk of lapse. Make sure you read the fine print on these types of policies carefully and monitor their performance from year to year.
Again, whole life can be the best type of policy for a person or it can be the worst. Make sure you consult with a professional, shop around and compare policy performance and choose carefully.