To understand whole life insurance, you must examine every angle; weigh the pros and cons of whole life insurance, and you’ll see that it’s a vehicle that can add value to every other asset you control.
At the simplest level, whole life insurance is defined as, “a type of permanent life insurance that offers cash value.” Those with a limited understanding will write it off as “expensive insurance.” Those who misunderstand may even claim that it’s an investment, or even a full replacement for typical retirement plans.
This article will debunk those limited beliefs, and in turn expose the truth of how it works, what it does, and the benefits of having a whole life policy. It’s not a miracle-solution, but a practical financial foundation.
Back to Basics: What is Whole Life Insurance?
Before the “Pros and Cons” of whole life insurance can be properly explained, it’s important that we lay out the basics. Beyond mere permanent insurance, whole life insurance is a traditional financial product that’s existed for more than 150 years. It may be that your grandparents, or even great-grandparents, have used whole life insurance.
This type of insurance is ideal for emergencies, opportunity, and legacy: in large part due to its permanence and cash value account. In this instance, permanent means that you cannot outlive your death benefit.
It’s the cash value that leads whole life to be (incorrectly) compared to mutual funds and other investments. In reality, whole life is best considered a savings vehicle, or risk management tool, because of the following:
Your cash value is not correlated to the markets—it won’t increase or decrease due to stock market fluctuations
Gains are locked in
Policy riders can provide additional benefits to your policy, such as long term care or disability riders
As such, whole life is not an investment. Instead, it’s an asset that protects all other assets. And because it’s not correlated to the market, whole life insurance performs well no matter the state of the economy. In times of hardship, your cash value can be used to save a home, save a business, or prevent further losses in the rest of your portfolio. When times are good, your cash value can provide you with even better opportunities—allowing you to take advantage of whatever comes your way.
Whole life insurance is a must when building your financial foundation, because it grows safely and steadily no matter the economic circumstance, and often does so more effectively than banks. Whole life insurance provides certainty, and you should seek certainty wherever possible, so that uncertainty can be navigated.
Navigating the Pros and Cons
Now that a baseline has been established, let’s look closely at what makes whole life insurance stand out. We’ll examine the Pros, as well as possible Cons.
Pro: Whole Life Insurance is Permanent
Unlike term insurance, whole life is permanent, and is guaranteed to pay out as long as it stays in force (the premiums get paid). Since death is a guaranteed event, permanent insurance is 100% likely to be used.
How many other assets have those same guarantees?
In contrast, term insurance lasts for a specific term, often ten or twenty years. Like a product warranty, it expires before you’re most likely to use it. And when the term is up, the price skyrockets. Insurance companies pay claims on less than 1% of term policies, because these policies cover a low-risk term of life.
Pro: It Builds “Equity”
This is another way of understanding the cash value. Like owning a home, owning a whole life insurance policy puts you in a position of control. Over time, “equity” builds up that you can borrow against. And the longer you own it, the more that cash value continues to build, risk-free.
What’s more, is that much like owning a home, a policy is something that can be used for legacy planning, collateral, or income creation (through dividends or conversion into an annuity).
Pro: Mutual Companies
When you purchase whole life insurance, it should be done so with a mutual company. Because as a policy owner, you are also an owner of the mutual company. In this way, properly structured whole life insurance functions more like co-ops or credit unions.
Whole life is often referred to as “participating” whole life, which means that policy owners participate in the profits of the company. This happens in the form of dividends, which have historically been paid during every major economic event in the last 100 years or so. They are not guaranteed, yet history demonstrates the reliability of these dividends.
It’s because mutual companies are beholden to the interests of policy owners, that efforts are focused on long-term growth and stability over quarterly profits.
Pro: It Offers Guarantees
To recap guarantees we’ve covered: a death benefit will be paid, no matter how long you live, so long as the policy stays in force.
In addition to the above, the following is also guaranteed:
An annual dollar-amount increase to the cash value
The cash value will not decrease
A level premium—once you’ve locked in a premium on a particular policy, it won’t increase
Participation in profits—although profits are not guaranteed, you are guaranteed to participate in the profits via dividends
The guarantees alone make the case in favor of whole life insurance. So many other assets are subject to uncertainty, that any opportunity for absolute certainty should be seized! That certainty provides peace of mind, eases market-related stress, and optimizes all other assets.
“Con”: It’s Not a Get Rich Quick Scheme
Whether or not this is a con depends more on the individual. Whole life is what we consider a “savings account that shows up like a bill.” That’s because the cash value grows through consistent contributions in the form of premiums.
“Long-term” thinking comes into play because of the nature of cash value. In the first few years of your policy, a large percentage of the premium goes towards the cost of the policy (mortality costs, commissions, etc). In turn, your cash value for the first few years will be less than what you’ve paid in premiums.
For those who expect overnight returns, this is a downside. And yet…
Pro: It’s Long-term
…the long-term growth is also what makes whole life an asset of certainty. Over time, the costs of your policy decrease, and within 5-10 years, the cash value can break-even and surpass what you’ve paid in premiums. These policies have a tendency to outperform banking and investment products, even when you consider the slow or negative growth of the first few years.
No other account offers such consistent growth without the risk of loss. Even banks carry a degree of risk (like the possibility of a bail-in).
Pro: Dividends
As we’ve stated, dividends are not guaranteed, but are reliable.
Dividends are declared at the beginning of the year. In 2020, most companies have paid dividends in the 5-6% range. These figures are before costs, and include policy guarantees. They are Gross rates.
The net rate will look a bit different. For example, say the net guarantee of the cash value equals 2%. If the gross dividend rate is 5.7% and the cost of the policy is 2%, the cash value is growing at a rate of 3.7%. This is still a significant rate.
Dividends can also be paid in different ways. This includes: taking dividends in cash, using them to offset premiums, or purchasing paid-up additions. The latter option is the most efficient way to reinvest dividends.
Pro: Flexibility and Control
Control is crucial to financial freedom. And whole life insurance puts you in control of your finances. One such example is with dividends. You, the policy owner, get to choose how your dividends are paid, and you have the freedom to change methods as your desires change.
Moreover, you have the ability to borrow against your cash value in the form of a policy loan, which affords you flexibility. When an emergency or opportunity arises, you’ll be positioned to seize it.
(We recommend borrowing against your value, because it allows your account to continue its uninterrupted growth.)
Unlike other lending institutions, you don’t have to give a good enough reason, or have a certain credit score to gain access. Your account acts as collateral, so you can use it to fund projects that a bank might otherwise deny.
Pro: Leverage
In the same vein, your cash value can be used to pursue more opportunities, make investments, and expand your other assets. Strategically using the liquidity in your policy allows you to make deals that provide a return, all while your cash value continues to grow.
Real estate investing is even better in combination with whole life insurance. The leverage of a mortgage plus a policy loan can actually increase your rate of return.
Pro: Living Benefits
Contrary to popular belief, life insurance isn’t just about death. You can benefit from it while you’re alive. We’ve discussed many of those benefits above, but there’s one benefit we haven’t mentioned.
By adding “riders” to your policy, you can actually insure other events in your life, and otherwise optimize your insurance.
Some such riders include:
Waiver of premium: in the event that you become disabled prior to age 65, the company will pay your premiums.
Accelerated DB rider: offers protection in the event of a health crisis. Terminal or critical diagnoses will trigger a portion of the death benefit to be paid. There are no stipulations to how that money must be used.
Long-term care riders: if assistance is needed to accomplish the tasks of daily living, this rider will cover costs of long-term care
Paid-up Additions riders: allows cash value to be built up faster, as well as increasing the death benefit, through “paid up” additional insurance. This is one of our favorite riders.
Policy riders incur an additional cost, although often minimal. The peace of mind they can provide is priceless.
Pro: Privacy
Insurance is more private than traditional banking and investments, keeping your money safe from the prying eyes of creditors, predators, and Uncle Sam.
The IRS is not informed of your cash value growth, nor do you pay taxes on that growth. So long as the policy is in force, you’re in the clear from capital gains taxes and income tax. Nor are policy loans reported to credit bureaus.
Except in the rare circumstance when the estate tax exemption in exceeded, proceeds from the death benefit are not taxed, making it an ideal asset in estate planning.
Pro: Protection
Perhaps one of the greatest strengths of whole life insurance, is that it protects those you love. In the event of your death, those you leave behind are provided with immediate financial relief. While money does not heal all wounds, it does take pressure off of your loved ones. And beneficiaries can use it to replace income, pay off debts, and have some certainty during an uncertain time.
Wrapping Up: The Pros and Cons of Whole Life
As you can see, whole life insurance is packed with benefits when you understand how to use it. Typical financial advice would suggest that whole life insurance doesn’t have great returns, or takes too long to be effective, yet this information stems largely from misinformation. Our hope is that the information above helps you to see the benefits for yourself, and start to get those wheels turning.