Is Whole Life Insurance a Good Investment? When it's Worth it to Invest in Life Insurance
Whole life insurance is generally a bad investment unless you need permanent life insurance coverage.
If you want lifelong coverage, whole life insurance might be a worthwhile investment if you've already maxed out your retirement accounts and have a diversified portfolio.
Just keep in mind that whole life insurance is quite expensive and often takes over a decade to earn reasonable investment returns. Therefore, it's typically only a good consideration if you're relatively young, have a high income and want to pass on money to your family.
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 in addition to the insurance coverage. Still, the primary purpose of these policies is to pay out a death benefit to your beneficiaries when you pass away, which makes up a significant portion of the cost of buying a policy. That's why whole life insurance policies and other cash value life insurance policies don't 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.
Type of policy | Length | Reason for coverage | Investment suggestions |
|---|---|---|---|
| Term life insurance | 5–35 years | You have debts or pending expenses that are fairly significant (such as a mortgage or sending your kid to college). Or, you want income replacement for your family if you die. | Term life insurance is solely for risk management, not investment. Instead, contribute to 401(k), IRA and brokerage accounts. |
| Guaranteed universal life insurance | Lifetime | You want to pass on an inheritance, help your family with estate taxes or pay some other costs after your death. | Guaranteed universal policies have little to no cash value. Instead, invest in a 401(k), individual retirement account (IRA) or brokerage account. |
| Final expense insurance | Lifetime | Your family would have trouble covering bills at the time of your death, such as the cost of a funeral. | This isn't an investment option. Because this coverage is limited in scope ($50,000 max), you would be better served by prioritizing saving in an emergency fund and investing money in your retirement accounts. |
| Whole and universal life insurance (cash value policies) | Lifetime | You're considering guaranteed universal life insurance for the permanent coverage. You 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 a greater risk, such as investing the cash value in an index or actively managed portfolio. |
Because guaranteed universal life insurance policies offer permanent coverage, they're still much more expensive than term life insurance (easily three to four times the cost), but you save money, as there's little to no investment component. Whole life insurance policies are regularly 10 times the cost of term life insurance, since you're paying for permanent coverage and additional administrative costs on top of funding the investment account.
Is the cost of whole life insurance worth it?
If you want permanent coverage but are on the fence about the high cost of whole life insurance, you may want to get quotes for a guaranteed universal policy. You can compare this to a quote for whole life insurance. You should also evaluate the guaranteed returns on the whole life insurance policy against an estimate of your returns if you invested the difference in cost between the two policies. Just make sure that you:
- Compare prices between a whole life insurance policy and a guaranteed universal life insurance policy — not a term life insurance policy. If you don't need permanent life insurance, don't buy it. If you do need permanent life insurance, it will cost more than term coverage, and a guaranteed universal policy is the closest way to approximate your cost of coverage.
- Use conservative estimates for your investment returns through a brokerage account. Some critics of whole life insurance compare it to other investments with 8 to 10% annual expected returns, which is not realistic. In addition, those returns are not guaranteed, meaning you can lose the money you invest. Whole life insurance returns, on the other hand, are quite moderate, but they are guaranteed.
- Consider capital gains taxes. Investment gains in a brokerage account can be taxed at up to 20%, whereas insurance payouts are usually tax free.
If you think you'd do better financially to get term coverage and simply invest the difference in cost, you should do that. But you need to actually do it. Many people purchase a less expensive life policy and then simply spend the money they saved by not purchasing whole life insurance instead of investing it.
If you do decide to invest in whole life insurance, make sure you choose an insurer that has a high financial strength rating. You can lose your coverage and investment if your insurer becomes insolvent. In addition, check that the policy allows you to receive a portion of the death benefit early if you develop a severe illness. This common feature is called an accelerated death benefit.
How whole life insurance works as an investment
When you pay whole life insurance premiums, a portion goes toward the cost of insurance, some is put toward sales and administrative fees, and the rest goes toward the policy's cash value. In the early years, the fees and cost of insurance use up the majority of your premium, but over time, an increasing amount is contributed toward the cash value.
The cash value is basically an investment account inside your whole life insurance policy that grows at a guaranteed rate over time.
The guaranteed rate of return is typically enough that your cash value should equal the policy's death benefit when you turn 100, assuming you don't make withdrawals. A simple way to think of your policy's cash value is that it's the amount of money you would get in return for giving up the policy to the insurer.
During the first 10 to 20 years of coverage, a whole life insurance policy's cash value is quite small, due to fees and the cost of coverage. Therefore, we wouldn't recommend whole life insurance as an investment if you're older, as you may not live long enough to see good returns and would save money with a guaranteed universal policy instead.
If you purchase whole life insurance from a mutual insurance company, you may receive dividends as your cash value grows. Mutual insurers are owned by their policyholders, so profits are redistributed as dividends annually.
While dividends aren't guaranteed, the largest mutual insurers have consistently distributed them for decades. You can choose to take the dividends as cash, use them to pay premiums or use them to purchase paid-up insurance additions, which are a way to reinvest. They act like a small addition to your existing whole life insurance policy, increasing the death benefit and cash value.
A whole life insurance policy's cash value grows tax deferred, which is why it's often compared to a retirement account, such as a 401(k) or IRA. However, contributions to the insurance policy are not tax deductible, as they are with retirement accounts.
Accessing your whole life insurance policy's investment gains
A whole life insurance policy's cash value is not added to the death benefit when you pass away; it is kept by the insurer, so you either use it or lose it. You can access and utilize the cash value by:
- Taking out a policy loan. The insurer holds your money and gives you a loan with the cash value as collateral. Your cash value grows according to the interest rates in the policy, and you don't actually need to pay back the loan. Instead, you pay the interest on the loan, or it is added to your outstanding balance. If your outstanding balance exceeds your cash value, your policy will lapse and you’ll have to pay taxes on the money. If you pass away with an outstanding balance, it will be deducted from the death benefit your beneficiaries receive.
- Taking dividends as cash. With a participating whole life insurance policy from a mutual insurer, you can get dividends as cash. There's no income tax, so long as the amount doesn't exceed what you've paid in premiums.
- Making a partial withdrawal. You can withdraw from the policy's cash value up to a certain level determined by the insurer. They may charge a withdrawal fee or limit when you're able to take money out, and the amount you withdraw will be deducted from your death benefit. You can withdraw from the cash value up to the amount you've paid in premiums without paying income tax.
- Selling the policy. If your spouse passes away or your children do well financially, you may no longer want coverage. Through a life insurance settlement, you may be able to sell your policy for an amount greater than its cash value but less than the death benefit. The buyer takes over premium payments and becomes the beneficiary. Any gain you make on the settlement is taxed as either income or capital gains, depending on the terms.
- Surrendering the policy. If you no longer want your policy and can't get a life insurance settlement, your cash value is the amount you would receive by surrendering coverage to the insurer. During the first 10 to 15 years of coverage, insurers typically impose high surrender fees. This is one reason whole life insurance shouldn't be considered as a short term investment.
When you withdraw or borrow money from the policy's cash value, the insurer will reduce the death benefit accordingly. Because of this, you could think of whole life insurance as assisted self-insurance. You pay the insurer for the benefits of tax-deferred growth, guaranteed returns and the ability to use the money through a policy loan as it continues to grow.
The insurer, in turn, keeps premiums level as the difference between the cash value and death benefit decreases over time, reducing their liability. But, while your beneficiaries will receive the death benefit, they won't get the policy's cash value.
Also note that while whole life insurance policies have surrender fees during the first several years of coverage, there's no restriction based on your age for making a withdrawal or taking out a loan. This is a key benefit over a traditional 401(k) or IRA, both of which carry penalties for withdrawals before age 59.5. You can access the funds at any time, as long as you have a large enough cash value.
Policy loans can be a great option if you need funds during a market downturn or other situation in which it would be difficult or unwise to pull money from other investments.
For example, if you have equity in a private company, it could take months to divest your shares, and you may not want to give up the position. Whole life insurance policy loans tend to have low interest rates and, since there's no credit check or eligibility requirement, you can get the money almost immediately.
Investing in universal life insurance vs. whole life insurance
If you're considering whole life insurance but want greater flexibility in regard to investment options and premiums, universal life insurance might be a better fit. It is very similar to whole life insurance, with a few key differences.
- You can use the policy's cash value to pay a portion (or the entirety) of premiums.
- There's a minimum and maximum premium, but you can generally pay any amount that falls within these limits.
- Premiums are not level and can increase.
- You can choose from a variety of options on how you want the cash value invested.
Depending on how you want to invest the cash value, you can choose between traditional universal life insurance (rates determined by insurer), indexed universal life insurance (tracks an index) and variable universal life insurance (you pick from a set of mutual funds). Every universal life insurance policy also has a fixed interest rate investment option, but these tend to have low returns.
Universal life insurance policies are essentially higher risk, and higher potential return, compared with whole life insurance.
For traditional and indexed universal policies, your cash value will typically have a guaranteed annual rate of return, but this can be quite low or even 0%. (A 0% annual minimum actually ensures that gains from previous years aren't affected by poor results.) Similarly, in good years, the insurer will put a cap on the annual gains.
Variable universal life insurance is even riskier, as your cash value can decrease and higher administrative fees are higher. In addition, your investment options often come with higher expense ratios than those in comparable mutual funds.
However, a key benefit of universal life insurance policies is that in years when you can afford to, you can pay more into the cash value. By doing so, you reduce the time it takes to build up enough cash value that most of the premiums can be paid with it. You can get a similar effect by purchasing a whole life insurance policy that's paid for over a shortened period, such as 20 years. But this strategy is more flexible with a universal life insurance policy, because you're not required to pay more in years when you don't have the money.