Is Whole Life Insurance A Good Investment? – Forbes Advisor
Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors’ opinions or evaluations.
A life insurance policy can be a solid addition to a well-rounded financial plan. If something happens to you, your life insurance will provide a death benefit to your loved ones that they can use to pay final expenses, clear debts or cover everyday living expenses.
Whole life insurance is one possibility if you’re shopping around for life insurance. This type of policy combines lifelong coverage with a cash value component. The cash value accumulates at a fixed rate, so you know exactly how much cash value you’ll build over time.
But is whole life insurance a good investment?
What Is Whole Life Insurance?
Whole life insurance is permanent life insurance that can cover you for as long as you live. As long as premiums are paid, the policy won’t lapse. When you pass away, the policy pays out a death benefit to your life insurance beneficiary.
Premiums for whole life insurance won’t change over time. And part of each payment is deposited into a cash value account where it earns interest.
The cash value portion grows at a guaranteed rate of return on a tax-deferred basis. You can borrow from the cash value or withdraw funds from it. If you decide to end a whole life insurance policy, you can take the “surrender value,” which is the cash value minus any surrender charge.
The current average dividend interest crediting rate for whole life insurance is 4.65%.
Is Whole Life Insurance a Good Investment?
Whole life insurance should generally not be considered an “investment” vehicle.
“Investments are traditionally a balance of risk and reward,” says Michele Lee Fine, founder and CEO of Cornerstone Wealth Advisory in Jericho, New York. It’s better to think of whole life insurance as a tax-favored, strategic allocation of cash flows.
In the early years of the policy, the bulk of what you pay in premiums goes toward funding the death benefit, with some of the amount allocated to administrative costs. What’s left goes into your cash value account.
As time goes by, more of your premium goes into the cash value account. The money in this account grows at a guaranteed rate of return. Life insurance companies themselves generally have investments in bonds and government-backed mortgages.
Most sellers of whole life insurance are mutual insurers that pay dividends, which you can add to your cash value account periodically. The longer you pay into the policy, the more cash value you can build up over time.
The predictability of cash value growth in whole life insurance can be less stressful than other investment options. “Unlike any other asset class, whole life provides guaranteed year-over-year, tax-free growth of cash values without any market risk or volatility,” says Fine.
On the other hand, if you need life insurance mainly to provide a death benefit and nothing else, whole life insurance is not a good use of money. Universal life insurance can generally provide a death benefit at a lower cost.
Pros and Cons of Using Whole Life Insurance as an Investment
Whole life insurance can offer both advantages and disadvantages. Here’s a quick rundown of the main pros and cons.
- Whole life insurance builds tax-deferred cash value.
- Accumulated cash value can be used toward premium payments.
- Being able to borrow against a policy’s cash value, or take a withdrawal, can be valuable if you don’t have other financial resources to rely on.
- Your beneficiaries do not receive the cash value when you pass away. They receive the face value of the policy (minus withdrawals and outstanding policy loans), regardless of how much cash value you have built up. The cash value reverts back to the insurance company.
- It can take several years of paying premiums to begin accruing a significant amount of cash value.
- Whole life policies can underperform compared to the level of returns you might be able to get with other investments.
- Withdrawing money or taking a policy loan and not paying it back will reduce the death benefit that’s paid out when you pass away.
Whether the pros outweigh the cons for you, or vice versa, depends on what you’re looking for, says Howard Sharfman, senior managing director at Chicago-based NFP Insurance Solutions.
“If you’re looking for stable, predictable long-term returns from a tax-advantaged vehicle with an extremely low risk profile, then whole life is a fantastic investment,” says Sharfman. “If you’re looking to maximize returns regardless of risk and you have a short time horizon, then it’s probably not the right choice.”
When Is Whole Life Insurance Not a Good Investment?
While there are benefits associated with whole life insurance, it’s likely not the right choice if you fit any of these descriptions:
- You only need life insurance for a specific length of time. If you only need life insurance for 10, 20 or 30 years, then paying higher premiums for whole life insurance probably doesn’t make sense. A term life insurance policy is the better choice for pure life insurance at a good price.
- You have a high risk tolerance for investments. Whole life insurance tends to appeal to people who have a low risk tolerance or want a safe, guaranteed way to build cash value.
- You want control over your investments. Whole life insurance offers a fixed rate of return on cash value, with no investment choices. You won’t benefit from the potential highs of the stock market.
- You’re looking for a higher rate of return. The interest and dividends earned with a whole life policy can lag far behind the returns you can likely get elsewhere.
Whole life insurance also requires a certain amount of patience, as it can take time before you start to see the cash value add up. Sharfman says those who seek market-beating returns or have short-term liquidity needs may want to consider other savings and investment options.
When Is Whole Life Insurance Worth It?
Whole life insurance can be attractive if you:
- Want to leave money to beneficiaries no matter when you die. Whole life insurance can ensure that you’re able to leave a death benefit to loved ones, without seeing your premiums increase over time.
- Want a conservative investment. Whole life insurance can offer stable returns if you’re willing to play the long game. Cash value grows slowly year after year, but isn’t affected by market volatility.
- Max out retirement accounts each year. A 401(k) or an Individual Retirement Account (IRA) may factor into your long-term savings plan. If you’re able to max out the contributions to those plans each year, you might look at a whole life insurance policy to squeeze out a few more tax benefits since the cash value grows tax-deferred.
- Would like to have cash to tap later. Building cash value in a life insurance policy makes sense if you intend to use the cash value. For example, you could tap cash value to supplement retirement savings or put your kids through college.
Don’t confuse cash value with a death benefit. Building cash value does not build wealth for your life insurance beneficiaries. When you pass away, beneficiaries do not receive the cash value. They receive the death benefit of the policy, which is the face amount minus your previous withdrawals and outstanding policy loans.
Compare Life Insurance Companies
Compare Policies With 8 Leading Insurers