Pros and Cons of Whole Life Insurance
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TAKEAWAYS IMPORTANT
- Whole life insurance is a sort of permanent insurance that can cover you for the rest of your life.
- Whole life insurance is substantially more expensive than term life insurance, which lasts for a set number of years and then expires.
- A savings component in a whole life policy can accumulate cash value over time.
What Is Whole Life Insurance and How Does It Work?
Whole life insurance, as the name implies, can cover you for the rest of your life. Term insurance, on the other hand, covers you for a set amount of time, such as 10, 20, or 30 years. If you still require life insurance after the term has expired, you must obtain fresh policy.
Another significant distinction between a whole life and a term policy is cost, with term policies being significantly less expensive. That implies you can get a term coverage with a substantially higher death benefit for the same money. It's hardly surprising, then, that while permanent life insurance accounts for 60% of new individual policies, it only accounts for 28% of the total face amount of all new policies.
Whole life insurance is more expensive than term insurance because it includes a savings component, known as the "cash value." A portion of your fixed yearly premium is used to purchase insurance, similar to a term policy, but the remainder is put into a reserve account that earns interest and grows in value over time. If you decide to give up, or surrender, your policy, you can take a loan against its cash value or withdraw the money. In contrast, a term policy has no monetary value and only pays out if you die.
Permanent Insurance: Whole Life vs. Other Types
There are three major types of permanent life insurance, in addition to ordinary whole life. All of them have a savings as well as an insurance component. Here's how they stack up against the rest of your life.
- Universal Life—With a universal life policy, you can increase or decrease your death benefit, which will effect your premiums. For example, a policyholder could wish to start with a low death benefit on a universal life insurance, increase it as their family expands and their income rises, and then cut it once their children are financially independent.
- Variable Life—A variable life policy allows you more flexibility over how your cash value is invested, often by allowing you to choose from a portfolio of mutual funds. With a whole life policy, the investment decisions are made by the insurance company. Your policy's cash value and death benefit might both fluctuate depending on how well your investments perform.
- Variable-Universal Life—A variable-universal life policy is, in the end, a hybrid. It allows policyholders to alter their death benefit, much like a universal life policy, while also allowing them to determine how their cash value is invested, exactly like a variable policy.
Pros
- Permanent
- Predictabililty
- Reductions in taxes
- Possibilities for loan collateral
Cons
- Expensive
- Death benefit is reduced.
- Inadequate investment control
The Benefits of Whole Life Insurance
Whether or if a whole life policy is suited for you may be as much a psychological decision as it is a financial one. Among its benefits are:
Permanency
A whole life coverage can last you for the rest of your life if you pay your payments on time. A term policy, on the other hand, lasts for a set number of years, after which you'll need to replace it if you still require coverage. Due to your age or health conditions, you may have more difficulty getting insurance—or receiving it at a reasonable price—by then. It's worth mentioning, though, that consumers whose term policies are about to expire typically have more options than they realize for keeping insurance.
Predictability
Your premiums and death benefit remain the same with a full life coverage. However, with either type of variable life insurance, you will be vulnerable to market fluctuations. People who are concerned about investment risk and desire a long-term policy may benefit from a whole-life policy.
Reductions in taxes
The cash value of a whole life policy increases tax-deferred, much like the cash value of other types of permanent insurance. If that money were invested in a regular, non-retirement account, the interest and dividends would be taxed annually. Furthermore, because life insurance proceeds (the death benefit paid to the recipient) are normally tax-free, those investment gains may be completely tax-free.
Possibilities for loan collateral
After a certain time, policyholders can borrow against the cash value of their insurance, as previously stated. This could be helpful in a financial emergency if all other options for financing have been exhausted. And, unlike other types of loans, individuals are not obligated to repay the money if they are unable or unable to do so. However, there are several important limitations here, one of which is that if they die before paying it back, the policy's death benefit would be decreased proportionally.
The Drawbacks of Whole Life Insurance
Whole life insurance, on the other hand, has some disadvantages to consider. These are some of them:
a higher price
Whole life insurance is more expensive than term life insurance, costing between five and fifteen times as much, according to Investopedia. One reason for this is that a portion of your premium is used to fund the cash value account (so it isn't completely wasted). Another factor is that insurance salespeople often earn more commissions for selling whole life policies than for selling term policies, which may explain why permanent insurance policies outsell term insurance policies.
Death benefit is reduced.
The fact that whole life insurance is more expensive means that whatever you pay on it will get you a significantly lesser death benefit than a term policy. So, if you require a large quantity of insurance, such as if you have a young family who relies on your income, whole life insurance may not be sufficient.
Inadequate investment control
The cash value portion of a whole life coverage is invested by the insurance company in any way it sees fit. If you're an experienced investor willing to take on some more risk, investing that money on your own could yield better results. That's why consumer advocates have long advised individuals to "purchase long and invest the difference." (Of course, to make that technique work, you must invest the difference rather than spend it on other things.) You have certain investment alternatives with a variable policy, but they are restricted to the funds offered by the insurance company.
Final Thoughts
Whole life insurance may or may not be appropriate for you, depending on your specific requirements. Because it is more expensive than term life insurance, your death benefit will be reduced for the same amount of money. You don't have to worry about it running out because it's yours for life. If you require additional protection earlier in life, such as for a growing family, a term policy is likely to be more appropriate. A whole life insurance policy, on the other hand, may be worthwhile if you wish to leave a legacy to your heirs.
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