Are you contemplating whether to dive into the realm of whole life insurance? Navigating the plethora of insurance plans can be a daunting task, especially with insurance agents often playing the role of assertive salespeople, keen on earning commissions.
Fear not! In this article, we’ll delve into what whole life insurance entails and its major drawbacks. By the end of this piece, you’ll have a clear understanding of whether whole life insurance aligns with your financial objectives.
Understanding Whole Life Insurance
Whole life insurance is a form of permanent insurance that remains effective throughout the insured’s lifetime, as long as monthly premiums are paid. It guarantees tax-free death benefits to the policy’s beneficiaries upon the insured’s demise.
A distinctive feature of whole life insurance is the accumulation of cash value over time. This cash value eventually morphs into an asset, and in some policies, policyholders can withdraw funds or use it as collateral. Therefore, a whole life insurance account acts as both an investment or savings account and an insurance account.
In whole life insurance policies, your monthly premiums remain fixed throughout the policy’s lifespan, regardless of market conditions. This affords predictability in budgeting over your lifetime but makes whole life insurance substantially more expensive than other life insurance policies.
Applicants for whole life insurance often need to undergo a medical examination, a requirement that may or may not be present in term life insurance.
Whole life insurance comes with a significantly higher price tag compared to term life insurance or other life insurance alternatives. While the exact price difference varies, whole life insurance can sometimes be 10 to 15 times more expensive than term life insurance with a similar death benefit.
Insurance agents justify the higher cost of whole life insurance with two primary reasons. Firstly, whole life insurance provides coverage for the entire lifetime of the insured, ensuring a death benefit is paid regardless of when death occurs, whereas term life insurance has a fixed term. However, term life insurance is notably cheaper and allows for renewal after the term ends.
For instance, a term life insurance policy with a $250,000 death benefit might cost $25 per month, whereas a whole life insurance policy with the same death benefit could cost $250 per month. The extra $225 per month, if redirected, could be used for investments, vacations, other assets, or covering bills over the years.
The second reason is the permanent nature of whole life insurance, assuring a death benefit payout whenever the insured passes away, unlike term life insurance policies with a fixed term. Nevertheless, term life insurance is significantly more affordable, allowing for renewal after the initial term.
Overestimation of Cash Value
Whole life insurance policies attempt to serve dual purposes: acting as both an insurance account and an investment account. However, the result is that whole life insurance fails to excel in either role compared to accounts focused solely on one function.
While whole life insurance policies build cash value, this cash value often grows at a sluggish and limited pace when compared to investments or retirement accounts. As mentioned earlier, this is primarily because only a small portion of your monthly premium goes into your cash value account. Investing the same money into an IRA, 401(k), or other common retirement accounts usually yields better returns.
Returning to the earlier example of a $250,000 death benefit, a whole life insurance plan costing $250 per month and a term life insurance plan costing $25 per month, you could opt for the $25 per month term life insurance and invest the extra $225 in a retirement account, potentially achieving superior returns.
The straightforward reason is that the investment account of whole life insurance is not as efficient as other retirement accounts, and it only receives a small portion of the monthly premium.
Inability to Transfer Cash Value to Beneficiaries
An often overlooked concern is what happens to the cash value of your whole life insurance plan if left unused. Many assume that the cash value would transfer to the beneficiaries.
However, this is not the case. The cash value of a whole life insurance policy does not transfer to the beneficiaries upon the death of the insured. The beneficiaries are entitled only to the amount of the death benefit.
The cash value is only accessible by the policyholder during the policy’s duration. Upon the death of the policyholder, any remaining cash value is used to pay the death benefit, and if there’s a surplus, the insurance company retains it.
The predicament lies in the fact that the cash value of a whole life insurance policy often becomes substantial only in the later stages of the policy. At that point, most policyholders possess multiple retirement accounts, savings, and investments, making the additional funds less crucial. Consequently, policyholders are coerced into using their cash value at a specific point to ensure that the accumulated funds and appreciation over the policy’s length aren’t misappropriated by the insurance company.
If you have no intention or likelihood of utilizing the cash value portion of a whole life insurance policy, opting for term life insurance or other life insurance policies might be more prudent.
Cancellation Before Reaping Benefits
Indeed, due to the hefty premiums and modest death benefits associated with it, a considerable percentage of individuals who purchase whole life insurance end up abandoning their policies before deriving any benefits.
The exorbitant premiums linked to whole life insurance often make it financially burdensome over the long term. During financial hardships, bearing the brunt of high monthly premiums might become an unbearable strain, leading policyholders to opt for temporary relinquishment.
Another common reason for canceling whole life insurance policies is that, with changing ages and life circumstances, protection needs frequently evolve. Whole life insurance policies typically lack the flexibility that other life insurance plans offer.
For example, an individual may require adjustments to their death benefit later in life, either increasing or decreasing it. With whole life insurance, the death benefit is fixed once the policy commences and cannot be altered.
The combination of steep costs, inflexibility, and the permanent nature of whole life insurance often renders it challenging for individuals to sustain throughout their entire lives.
Ideal Only When a Beneficiary Need Arises
Another reason whole life insurance might not be the most suitable choice is that it’s beneficial only when there is a need or desire to provide a death benefit for beneficiaries. Without beneficiaries, purchasing a whole life insurance plan might be entirely unnecessary.
In the absence of beneficiaries, you might have only a few reasons to consider whole life insurance. If you lack beneficiaries and are contemplating whole life insurance solely as an emergency savings account, there are better options available to serve this purpose.
To ensure you have a savings account or safety net during challenging times, you can invest your funds in other retirement accounts that offer superior returns.
False Allure of Indexed and Variable Life Insurance
Our exploration today might be perceived as an attempt to disparage all insurance agents. That’s not the case. There are many excellent professionals in the insurance field who prioritize your needs and recommend products you genuinely require. Unfortunately, they are a minority in this field and often don’t last long in the business as earning commissions through high premiums is the primary motivation.
This is not the first time the truth about whole life insurance has been unveiled. The insurance industry responded by introducing variations of whole life insurance. Unfortunately, these are not necessarily better than the basic product and can be likened to applying new paint to a consistently malfunctioning old car. It might look better, but it still won’t take you where you want to go.
One such variation is indexed whole life insurance. Funds designated for the cash value are invested in index funds, providing policyholders with an opportunity for better returns. However, this cash value cannot persist beyond your demise and a significant portion is used for your death benefit. Additionally, you’ll pay higher premiums for indexed whole life insurance.
Another option is variable life insurance, empowering policyholders to decide the investment direction for cash value funds. However, it’s not entirely unrestricted as insurance companies provide a list of funds to choose from and charge exorbitant fees to manage the investment account. Like most whole life insurance, it’s not a winning solution.
Inevitably, doctors contemplating not purchasing whole life insurance policies based on the viewpoints highlighted in this article will likely encounter another pitch – this time for universal life insurance. Agents will use terms like “permanent” and insist that cash value life insurance should be an “integral part of family financial planning.” Don’t believe any of it.
Introduced in 1979 when rising oil prices and the Fed’s inability to control inflation led to an economic downturn, universal life insurance might sound familiar today, considering recent market fluctuations, rising interest rates, and consumer price inflation. The flexible premiums and death benefits made it attractive in that environment, offering more control to policyholders while still providing the “advantages” of permanent life insurance.
Like whole life insurance, universal life insurance comes in many forms. An appealing feature is that policyholders can withdraw or borrow from the cash value while still alive. However, in savings-focused universal life insurance, funds in the savings account depend on fluctuating interest rates. Hence, indexed universal life insurance policies are affected by market fluctuations.
Term Life Insurance vs. Whole Life Insurance
A crucial decision you might face is choosing between term life insurance and whole life insurance. It’s worth noting that insurance agents, aware of the high net worth of doctors, often target this demographic, aiming to sell more expensive, higher-commission whole life insurance due to its cash value and permanent insurance characteristics.
Understanding Term Life Insurance
Term life insurance is a straightforward life insurance with a fixed coverage period. If you die during the policy’s term, your beneficiaries receive the death benefit. Once the term ends, your beneficiaries no longer receive the death benefit.
Upon the term’s expiration, you can choose to renew your life insurance for a new term.
Unlike whole life insurance, term life insurance doesn’t build any cash value. It is simple and direct. You pay monthly premiums for the coverage term, and if you die during that time, your beneficiaries receive the tax-free cash death benefit established at the policy’s commencement.
Term life insurance is generally much cheaper than whole life insurance. Depending on the insurance company, comparisons often reveal that term life insurance is typically 10 to 15 times cheaper for the same death benefit.
Exploring Other Investment Alternatives
Let’s take a holistic view of your investment portfolio. An insurance agent or broker might tell you that insurance should be a part of your investment portfolio. They might even suggest annuities to “enhance” your retirement income. Evaluate the costs and returns of each scheme. There are several superior alternatives available that allow you to invest your funds.
Despite market volatility, rising interest rates, and consumer price inflation in the fourth quarter of last year, the S&P 500 index still achieved a 7.5% return in the first quarter of 2023.
Its 10-year average return is 12.15%. The Nasdaq, at the time of writing, has gained a remarkable 9.6% year-to-date and an astounding 17.13% over the past decade.
Let’s do the math. The average cost of a $5 million whole life insurance policy is $2,280 per year. If you invest this money in the market, assuming a 10% return, you would have over $450,000 in ten years. Moreover, this money is entirely liquid. If you need these funds, there’s no need for loans, and upon your death, your loved ones inherit the entire amount. Whole life insurance cannot guarantee this.
Before deciding whether to purchase whole life insurance, carefully weigh its pros and cons. Whole life insurance can be an expensive choice, and the returns on its cash value and investment components are relatively low. In contrast, term life insurance might be more affordable and straightforward, albeit lacking cash value after the policy term ends.
Additionally, explore other investment alternatives that may offer better returns and greater flexibility. It’s advisable to consult with professionals to understand your specific circumstances and needs, enabling you to make informed decisions.
Most importantly, don’t succumb to excessive sales pitches. Ensure you comprehend the insurance product you are buying and understand the pros and cons of its various aspects. This will help you make decisions aligned with your financial goals and family needs.