Why Whole Life Insurance Could Be a Costly Financial Misstep
Whole life insurance is frequently advertised as a dual-purpose financial product that offers life insurance protection as well as savings. That might seem like a slip of the tongue — but for many consumers, it could be an expensive mistake. But before you even think about a whole life insurance policy, you need to understand how that product works, along with the downsides.
What is Whole Life Insurance?
Whole life is a type of permanent life insurance that remains in force for the insured's entire lifetime, provided premiums are paid as required. Whole life insurance differs from term life insurance, which offers coverage for a limited time, in that it contains a cash value component that accumulates over time on a tax-deferred basis. You can borrow against or withdraw from this cash value, making for some savings or investment.
Pricey Nature of Whole Life Insurance
Firstly, the exorbitant premiums may lead to an expensive financial blunder: whole life insurance. Life polices cost much more (5x-15x) than term life insurance1, it's cheaper to buy dividends by miles. This high price tag can stretch budgets thinly, particularly for those who would likely be better off putting the premium differential to use elsewhere.
Low Returns on Investment
The cash value portion of a whole life insurance policy is often marketed as an investment. On the other hand, the returns from this investment are usually lesser compared with other investments like mutual funds or stocks. Consumer Reports states that a traditional whole life policy earns an annual return on the cash value component of only 1.5% to 4.5%2. By comparison, the stock market's average annual return, after inflation3, is around 7%.
Complicatedness and Inflexibility
Whole life policies such as this are notoriously complicated and even the average consumer has a tough time wrapping their brains around them. Apart from so many fees and charges that cut and leave little to the cash value, these policies offer little flexibility as such. For example, say a policyholder wants to lower their premium payments, it may come with a penalty or limit coverage. Another downside is that accessing the cash value via a loan incurs interest that will decrease the death benefit if it is not paid back.
Better Alternatives
For the majority, term life insurance is a less expensive option. I provides simple term life for a predetermined amount of time — increasing available options of 10, 20 or 30 years — for a fraction of the price. The plush difference in costs can be used to invest in retirement accounts and other forms of investment with higher interest returns, than on whole life. It's often said that this method is better than whole life because "you should buy term and invest the difference," but the philosophy that goes behind this approach is simply that it allows for more flexibility in guiding one's financial strategies to align with their long-term objectives.
Factors You Should Think About Before Buying
It is important to evaluate the financial situation and goals of individuals before embarking on whole life insurance. A whole life insurance policy may or may not fit into your monetary policy, which is what a financial advisor can help you figure out. Also, a cost-benefit analysis of different types of insurance can illuminate the best choice.
Overall, whole life insurance might be attractive because you get coverage along with saving, but it is important to keep in mind the expensive premiums, low IRR, and complexity. But for most people, other approaches with term life and invested money can provide improved financial results.