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Is Whole Life Insurance A Good Investment

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The Statistic Whole Life Salesmen Dont Want You To Know

Is Whole Life Insurance A Good Investment For Retirement?

It takes 5-15 years for a typical whole life policy just to break even to where your surrender value equals your premiums paid If you count inflation, some policies never break even while most take decades to do so. This brings to mind an important question:

How many people are still holding their policies after 5, 10, 15, or 20 years?

Luckily, this data is tracked by the Society of Actuaries and is demonstrated in the chart below. If we use an 11% lapse rate in year 1, 9% in year two, 7% in year three, 6% in year four, and 6% in year 5, that means that 1/3 of folks have surrendered their policies within just 5 years, long before breaking even. If we continue on to 10 years then we’re down to an overall lapse rate of 50%. Using an annual 4% lapse rate for years 11-20, the overall lapse rate is 60% at year 15 and 70% at year 20. By year 30 , about the time of retirement for someone buying one of these upon residency graduation in their early 30s, 77% of those who purchased their policies no longer own them.

Should You Invest In Whole Life Insurance Or Term Life Insurance

Permanent cash value life insurance policies, such as whole life insurance, have an investment component as well as life insurance coverage. However, the primary purpose of these policies is still to pay out a death benefit to your beneficiaries when you pass away, and this benefit makes up a significant portion of the cost of buying a policy. Thats why whole life insurance policies and other cash value life insurance policies dont make sense as an investment unless one of your objectives is to have lifelong coverage.

Assuming you do need life insurance, there are four broad groups of insurance to choose from based upon your financial situation:

Type of Policy
Whole and universal life insuranceLifetimeYoure considering guaranteed universal life insurance for the permanent coverage, but have a broad portfolio of investments already and want to diversify.Through a cash value life insurance policy you can get guaranteed returns or take greater risk, such as investing the cash value in an index or actively managed portfolio.

Since guaranteed universal life insurance policies offer permanent coverage, theyre still much more expensive than term life insurance , but you save money as theres little to no investment component. Whole life insurance policies are regularly ten times the cost of term life insurance since youre paying for permanent coverage, additional administrative costs plus funding the investment account.

Take This Example From Smartmoneycom: Whole Life Premiums Are Expensive

To get a real sense of the value of term, lets compare a term policy and a universal life policy. Say a 40-year-old nonsmoking male has a choice between a $250,000 Met Life universal policy with a $3,000 annual premium and the same amount of renewable term coverage with a 20-year fixed premium of $350. At the end of one year, the universal policy, assuming it paid 5.7% per year, tax-deferred, would have a cash value of exactly zero . But say he had instead invested $2,650 in a no-load mutual fund that averaged a total return of 10% annually. At the end of the first year, hed have $2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10 years, he would have accumulated more than $46,000 in after-tax savings in the mutual fund. Over the same period, the cash value of the policy would have climbed only to $31,819.

The biggest drawback to whole life insurance is that the premiums can be more expensive than term life insurance. Assuming equivalent investment returns, because of the way the policies are written, it takes a lot longer for a whole life policy to accumulate significant cash value than if you invested on your own.

So for a young investor with limited free cash to buy insurance and invest for the future, this is why I only recommend term life insurance. In my opinion, its better to pay the cheaper premium and have savings left over to invest, use as an emergency fund, or spend as needed.

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Types Of Life Insurance: A Quick Review

  • Term Insurance: You pay low premiums to get a high death benefit for a specific period called a term. The most common terms are 10, 20, and 30 years. During the term, the cost of insurance remains the same. After the term expires, the policy either disappears or starts going up in price. The most common use for term insurance is to protect your income when you have dependents.
  • Whole Life Insurance is a type of permanent insurance where you pay higher premiums for a lower death benefit, but the coverage doesnt expire. Most basic whole life insurance are paid for 100 years, but there are other policies you only pay for 10, 20 years, or until age 65, but the coverage remains even after the premium is paid. Whole Life builds cash value that can be accessed at any point in time. The most common uses of whole life are for wealth transfer, cash value accumulation, and estate planning.
  • Universal Life Insurance is a type of blend between term and whole life policies. It can be either permanent or temporary. It can build cash value, but it needs to be designed properly because of the rising cost of insurance. However, Universal Life Insurance its outside of the scope of this article. For more info check out: Universal Life vs Whole Life

Lets go over some of the misconceptions about whole life insurance.

Benefits Of Whole Life Insurance

Is Whole Life Insurance A Good Investment?

These policies offer some very attractive advantages, including:

  • Guaranteed tax-deferred growthThe cash value will continue to accrue for as long as the policy is active.
  • No premium increasesThe premium you pay will stay the same over the life of the policy.
  • Tax-free loansMoney borrowed against the cash value is not a taxable income as long as it doesnt exceed the amount paid toward the premiums.
  • Tax-free dividendsDividends are also tax-free as long as they are derived from the premiums.
  • Permanent coverageThe policy is guaranteed for the life of the policyholder.
  • No additional health assessmentsThe policy remains the same even if the policyholders health condition changes or worsens.
  • Surrender optionsThe policyholder can surrender the policy at any time to get the cash value back from the insurance company.
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    Myth : With Whole Life You Dont Need To Worry About A Medical Exam

    Indeed, some life insurance policies dont require you to take a medical exam. They are called simplified-issue and guaranteed-issue whole life policies and are often marketed to people age 50 and older to pay for funerals and other final expenses.

    But these no-exam life insurance policies offer relatively small payouts, usually less than $50,000. And theres another catch: If you die within the first few years of a guaranteed-issue policy, your beneficiaries wont get the full payout.

    Under some policies, if you die in the first year or two, your beneficiary will only get the money you paid in premiums, plus some interest or a small percentage of the total death benefit. On others, the percentage of payout is gradually increased each year the policy is in force. It may take three or more years before the policy pays the full amount to your beneficiaries.

    Considering the relatively low payout, these policies are considerably more expensive than standard policies that require you to answer health questions and take a medical exam.

    The High Cost Of Monthly Premiums

    Whole life insurance is expensive, significantly more so than term. In a study conducted by Forbes, a 30-year non-smoking male would pay 5.8 times more for a $500,000 whole life policy than for a 40-year term policy. A non-smoking female would pay approximately 6.7 times more.

    But whole life insurance isnt only more expensive than term it may also be more expensive than other investments vehicles. .

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    When Your Assets Will Be Subject To An Estate Tax

    People with particularly high net worths can benefit from permanent life insurance. If your heirs will have to pay an estate tax on your assets when you die, a permanent life insurance policy can help offset some of those costs.

    In 2022, any assets above $12.06 million are subject to an estate tax. However, the death benefit of a life insurance policy is tax-free, as long as it pays out to a beneficiary, rather than your estate. So, for example, if your estate is worth $13 million and $940,000 of that is subject to an estate tax, you might take out a permanent life insurance policy worth $1 million so that money goes directly to your heirs â tax-free â when you die.

    A permanent life insurance policy might also benefit your heirs if your estate consists largely of fixed or long-term assets, such as real estate. Your heirs will need to pay federal taxes on your estate within nine months of your death, which could be difficult if your assets arenât liquid. A life insurance policy with a death benefit large enough to cover the taxes your family will owe can ease that financial burden.

    What Is The Average Rate Of Return On Whole Life Insurance

    Is Whole Life Insurance a Good Investment for Retirement?

    The cash surrender value of a whole life insurance policy earns interest.

    This interest is a dividend payment from the insurance companyâs yearly profits. These dividends could range between five and seven percent, not annualized, and before any management and other fees are subtracted. Itâs unlikely that youâll see a policy grow five to seven percent year over year.

    The investment side of a whole life insurance policy will grow more, as there are advantages with registered accounts. However, youâll pay higher fees with universal life and whole life insurance to invest your fees in funds you could invest in more affordably on your own.

    Why do whole life insurance policies sound so attractive at first? An advisor can enter an interest rate into a life insurance calculator to illustrate a potential return to demonstrate what could be possible with a whole life insurance policy.

    However, the interest rate environment will continually change over time. Just because an advisor uses a 10% interest rate to show potential return does not mean youâll ever earn that return.

    With whole life insurance policies, knowing what the numbers mean can be tricky.And thatâs why weâre transparent that term life insurance policies with clear policies suit most people.

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    What Is Simplified Issue Whole

    Simplified whole life insurance is a type of whole life insurance or full life insurance. It lasts your entire life. It is for people 60 and older who have health problems that make them unable to get standard coverage.

    If you apply for simplified life insurance, you will not have to go through a medical exam. You may have to conduct a phone interview and only answer some health questions on an application. Because the health evaluation is not as thorough, insurers set a higher premium with less coverage.

    Without a medical check, the underwriter assumes that you will be too risky to insure. But some people cant get insured because they have disqualifying conditions. If your age and health are good, you might not be able to get insurance.

    Some simplified issued whole life accepts qualified funds such as an IRA as well.

    What About The Guarantee

    Many people take an interest in whole life insurance because they understand there are certain guarantees inherent in every whole life insurance contract. They also usually find out that these guarantees are quite a bit higher than the guarantees found in other insurance contracts, and a lot higher than most other savings/investment options.

    Lots of time, the guaranteed column on a whole life ledger looks a tad blah because it makes the almost guaranteed to not be true assumption that the insurance company will never pay a dividend to the policyholder. I always found people who focused on this ledger to miss a much greater point about how compounding guarantees work, when we know some degree of non-guaranteed benefit was practically guaranteed to happen.

    What I mean by this is, all the major insurance companies that actively sell manufacture and sell dividend paying whole life insurance plan to pay a dividend to policyholders this year. I’m also approximately 99% certain that they all plan to pay a dividend next year. Understanding this, we know that the fundamental assumption of the initial guaranteed ledger is untrue. I’ve written about this subject in the past, but something interesting came up regarding this guaranteed assumption as I was looking over the above mentioned whole life policy.

    On top of all this, the policyholder avoids complicated and annoying tax consequences associated with other investment options.

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    Goal: Setting Aside Funds For Emergencies

    As we mentioned, accumulated cash value in a whole life policy can be used for whatever you want. That means cash value can serve as a tax-advantaged portion of emergency funds. According to the Federal Reserveâs 2017 Report on the Economic Well-Being of U.S. Households, 40 percent of Americans would struggle to cover an unexpected $400 expense. Whatever that surprise may be, you could tap into your accumulated cash value to help cover the cost.

    The added value: We recommend setting aside enough money in an emergency fund to cover 6 months of household expenses to avoid borrowing money to cover costs. Typically, youâll put that money in an ultra-safe place, such as a savings account. However, the interest earned in a savings account may not even keep pace with inflation, which means it technically loses value over time. Cash value, on the other hand, will typically grow at a higher rate and is very safe. As you accumulate cash value, you may be able to put a portion of the money that you saved for an emergency to work as investments, knowing that you could tap your cash value if you need it.

    Pros: Convert To Permanent Insurance

    Life Insurance: Is It Really A Good Investment Plan?

    If you decide you want to extend your term life policy indefinitely, you could convert it to permanent life insurance coverage. Doing so may increase your premiums but it may be a worthwhile investment if you want to have coverage for life. Converting could also give you the opportunity to accumulate cash value.

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    Goal: Financial Protection For Your Family

    Letâs start with the basics. Unlike term insurance, which only provides a death benefit if you die within a predetermined coverage window, a whole life insurance policy will provide a death benefit to your family no matter when you pass away.

    The added value: In addition to the peace of mind you get when youâre young, your death benefit can give you more freedom with other financial assets during retirement. For instance, people who want to leave a legacy are sometimes hesitant to spend down their assets in retirement for fear there will be nothing left for their heirs. Knowing that youâll always have the death benefit of a whole life insurance policy can free you to spend down other savings, so you can conquer that bucket list and still leave a financial legacy.

    Is Life Insurance A Smart Investment

    Using permanent life insurance as an investment might make sense for certain high-net-worth individuals looking to minimize estate taxes. But for the average person, buying term and investing the difference is usually the better option.

    Even if you’re purchasing life insurance primarily for investing purposes, it’s still important to research the best life insurance companies to ensure you’re getting the most beneficial policy possible.

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    Is Whole Life Insurance A Bad Investment

    Unless you require permanent life insurance coverage, whole life insurance is usually a poor investment. If youve already used up all of your retirement accounts and have a diverse portfolio, whole life insurance may be a smart investment if you need lifelong coverage.

    Consider that whole life insurance protection is expensive and takes many years to begin generating adequate investment returns. As a result, its usually only a viable option if youre young, affluent, and wish to leave money to your relatives.

    Whole Life Insurance Defined

    Is Whole Life Insurance A Good Investment For Retirement?

    Term and permanent are the two types of life insurance policies. Term policies are only in effect for up to thirty years and must be renewed if the policyholders outlive them. They provide death benefits if the policyholder dies within the term that the insurance policy is active. These policies are relatively inexpensive, but they have no additional benefits or use for investing.

    Permanent policies include all policies that dont expire. This means the policyholder will never outlive these policies as long as they continue to make their premium payments. Universal life insurance, indexed universal life insurance, and whole life insurance are all kinds of permanent life insurance.

    In addition to providing a death benefit, whole life insurance policies have a savings component called the cash value. Part of your insurance premiums go to the cash value part of the policy. This money can be withdrawn or borrowed against.

    The cash value also earns interest. You can end up covering all of the insurance premium costs if you earn enough interest. The interest that accumulates is tax-deferred, so you wont pay taxes on the interest as long as you dont withdraw more money than youve paid into the cash value.

    Whole life insurance is sometimes called straight life insurance. When

  • overfunded whole life insurance
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