Like all forms of insurance, life insurance helps to protect against catastrophic losses. When an insured person dies, their beneficiaries receive a significant payout to ease the financial burdens that may arise after their death.
While there are several types of life insurance, we’ll focus on whole life insurance, including what it is and its pros and cons, so you can decide if whole life insurance makes sense for you.
What Is Whole Life Insurance?
Whole life insurance provides a fixed amount of coverage that can last for as long as the insured person is alive. Unlike term policies that end after a specific number of years, whole life policies may continue to offer coverage as long as you continue to pay the costs of insurance.
When you pay premiums into a policy, the insurance company deducts the costs of providing life insurance and adds the extra money to your cash value. Over time, that cash value can accumulate inside your policy and serve as a reservoir to fund future costs. The cash value generally grows tax-deferred, and you can potentially access it by borrowing against your policy or taking withdrawals. However, policies typically have a surrender period that could last up to 20 years, during which time a fee will be charged on withdrawals from the cash value.
If you use too much of your cash value, you may owe taxes and you could lose coverage if your policy lapses. Any unpaid loans typically reduce the death benefit.
Premiums on a whole life insurance policy are often level, meaning they do not change from year to year unless you choose certain options. And depending on which of the types of whole life insurance you choose, you might pay premiums for a set number of years or for your entire life.
Is Whole Life Insurance a Good Investment?
As with any investment strategy, it depends on your needs and circumstances. Whole life insurance premiums are higher than the premiums you’d pay for the same death benefit on a term policy. So if you primarily need life insurance to protect loved ones for a specific length of time, term life insurance is usually your best bet. For example, you might only need coverage that lasts until your children are grown or your mortgage is paid off.
Whole life insurance premiums are relatively high because, unlike a term policy, this type of policy is designed to pay the costs of insurance for your entire life (this is why permanent policies have a cash value component). For most people working with limited funds, it’s smart to direct those “extra” dollars elsewhere. For example, for the same amount of money as a whole life premium, you could buy a term policy and also save for education funding, pay down debts, or contribute to retirement accounts.
Whole life insurance makes the most sense when you know you need permanent coverage—if you want to ensure that beneficiaries get a death benefit, no matter how long you or the insured person lives. For example, you might want a cash injection to help with estate taxes or to provide liquidity at death. With the proper insurance coverage, beneficiaries might not need to sell assets (possibly quickly or at an inopportune time) after an insured person dies.
Primarily as an investment strategy, whole life rarely makes sense. But if you have an insurance need, you’ve exhausted all other tax-favored savings strategies, you are not seeking high returns, and you’re willing to accept the restrictions of a life insurance policy, it can be a fit.
Whole Life Insurance Pros and Cons
- Potential lifelong coverage
- Tax-free death benefit
- Potential benefits from dividends
- Access to cash value
- Relatively high premiums
- You can’t pause premium payments
- Using cash value could reduce coverage
- Limitations on access to funds
- Potential lifelong coverage: Unlike term insurance, as long as sufficient premiums are paid, whole life is designed to provide lifetime coverage.
- Tax-free death benefit: Beneficiaries typically do not pay income tax on the death benefit from a life insurance policy, allowing them to use all of the funds to meet their needs.
- Potential benefits from dividends: If your policy pays dividends, that money can potentially reduce your required premiums, increase your death benefit, or be paid in cash to spend however you want.
- Access to cash value: If you need to access the cash value inside your policy, you may be able to tap those funds via a withdrawal or loan. But surrender charges may apply, especially during the early years of policy ownership. Discuss the pros and cons with your insurance company before doing so.
- Relatively high premiums: Because you’re funding a cash value that will pay your policy’s cost for the rest of your life, you need to pay relatively high premiums in the early years (compared to the cost of temporary coverage with term insurance). If you’re unable to pay premiums and you don’t have enough cash value to pay the internal costs, you risk losing coverage.
- You can’t pause premium payments: Whole life insurance premiums typically need to be paid on a consistent basis; if you can’t make required premium payments, the policy could lapse. This is in contrast to universal life insurance policies which are built to have greater flexibility and will draw from the cash value to cover required premiums.
- Using cash value could reduce coverage: While your cash value is available for loans and withdrawals, there’s some risk involved when you access those funds. For example, any unpaid loan balance reduces the death benefit that your beneficiaries receive. And if you withdraw too much of your cash value, your policy could lapse, resulting in a loss of coverage and potential tax consequences.
- Limitations on access to funds: Your cash value might not be easily accessible. Especially during the early years, you may have to pay surrender charges if you decide to cash out or withdraw from your policy.
Is Whole Life Insurance Right for You?
Insurance decisions require a careful analysis of your needs and your budget. The tips below may provide food for thought as you evaluate whole life policies.
Do You Need Permanent Insurance?
A need for lifelong coverage is a clue that you might want a whole life policy. This might be the case if you want coverage for final expenses no matter when you pass, or if you have dependents with special needs. Term insurance policies end after a set number of years, and there’s no way to predict exactly how long you’ll live. But if you don’t need permanent coverage, term insurance may be an excellent solution.
Do You Have Sufficient Cash Flow?
Premiums on whole life insurance policies can be quite high. If you have limited money available in your budget, buying sufficient coverage could be difficult. However, if you have plenty of excess cash each month and you don’t have anywhere else to put it, a whole life policy might be appropriate.
Do You Need Predictability?
With whole life insurance, your premiums are typically determined at the beginning of your policy. The cash and surrender values may also be set at that time, so you know what to expect in the coming years.
Alternatives to Whole Life Insurance
If whole life insurance doesn’t sound like the perfect fit, you may be able to use several alternatives.
Term Life Insurance
The simplest form of life insurance is term. You select how long you want coverage and you pay premiums to keep the policy in force. For most families protecting against the untimely death of a parent, term life is an affordable solution.
Other Permanent Life Policies
If you have your heart set on buying permanent insurance, other alternatives exist.
- Universal life offers greater flexibility but less predictability. Premium payments must be sufficient but can be flexible, and the cash value grows at a rate that depends on your insurance company’s investment performance, so you won’t know how much you’ll earn in advance.
- Variable life insurance allows you to select a variety of investments similar to mutual funds for your cash value, and it’s possible to gain or lose money with those investments.
If your goal is to grow your assets, you don’t need to use an insurance policy to do it. For example, you can buy term life insurance for the coverage you need and do your investing in other accounts. Retirement accounts, including workplace retirement plans and IRAs, can potentially provide tax benefits. Taxable brokerage accounts may also be useful, and they don’t have the same restrictions as retirement accounts.