For most people, surrendering a whole life insurance policy for a term life insurance is a good idea.  Term life insurance provides the same death benefit as whole life insurance for a tiny fraction of the cost.  While there are benefits to whole life insurance that are not available with term life insurance, most people can obtain the protection they need at a much more affordable price when they make the switch to term life insurance.

Why Switch From Whole Life To Term

Term Insurance is Considerably Less Expensive than Whole Life

There are many reasons someone might surrender a whole life insurance policy for term life insurance (or using term life insurance instead of whole life insurance).  The number one reason that people make the trade from permanent insurance to term insurance is that term life insurance is much less expensive that permanent forms of life insurance.  A whole life insurance policy may cost hundreds, or even thousands of dollars per month.  Oftentimes this expense becomes a burden, or at best is downright unnecessary.  A term life insurance policy may be as little as 1/10 the cost of a whole life policy annually, for the same death benefit coverage.

A whole life insurance policy may become too much of a burden to pay every year, or every month.  A family on a restricted budget often will need life insurance to provide for the family and/or pay off the mortgage in the case of a death, but their budget doesn’t allow for them to outlay a significant portion of their earnings for this one form of insurance coverage.  Especially when a family needs so many different kinds of insurance such as home insurance, health insurance, mortgage insurance, car insurance, and possibly flood insurance.  To ask a family on a tight budget to pay hundreds of dollars a month for a life insurance policy simply is not feasible.

Term insurance fits the need perfectly for this situation.  The family can still obtain hundreds of thousands, or even millions of dollars of life insurance coverage, and the cost is usually less than they pay for any other form of insurance.

People May Want To Access the Cash Value Of Their Whole Life Insurance

People may also make the switch because they have built up a significant cash value, or cash reserve in their whole life insurance policy.  For people who have owned their policies for a long time, the amount of available cash value in their whole life insurance policy can be thousands or even tens of thousands of dollars.  This money can be used for a a lot of life events such as a wedding, purchasing a home, providing income during retirement,  taking vacations, paying for college educations, or to provide for living expenses during times of unemployment or other hardships.

If a person needs the cash surrender value of the policy but they also need the life insurance protection, term life insurance is an excellent replacement.  Someone could hypothetically surrender a whole life insurance policy, purchase a term life insurance policy with the same or even a much higher death benefit as a replacement for the surrendered whole life policy, and they will pay a small fraction of the cost of their old policy for the new term coverage.  This is understandably a very attractive option for people who would like to access the cash value of their whole life insurance policy.

Account For Surrender Charges

One charge that many people are not aware of on their life insurance policy is known as a surrender charge.  This is the charge against your cash value that the life insurance company takes when a policy is surrendered during the first few years of it being opened.  Please account for any surrender charges before you remove cash from a whole life insurance policy.

Whole Life Insurance as an Investment Vs. Buying Term and Investing The Difference

You may have heard the phrase “buy term and invest the difference“.  But what does this really mean?  Is it really a better investment to give up your whole life insurance policy for term life insurance?

How Whole Life Insurance Can Work as an Investment

Whole life insurance is often sold as an extremely low risk investment vehicle.  The reason it can be considered an investment is because of the dividend payment paid to the owner of the policy every year.  The idea is that over time, the owner will save a significant amount of money in the cash value portion of a life insurance policy.  As this cash value grows, the dollar amount of the dividend paid should hypothetically also rise over time.  If someone owns a whole life insurance policy long enough, and they don’t take the money out via withdrawals or loans, they will have more money in cash value than they paid.  When you consider the fact that they client also enjoyed the insurance coverage of this period of time, it doesn’t sound like a bad deal for the owner of the policy.

The return on a whole life insurance policy depends on different factors, mostly the financial performance of the life insurance company it was purchased from, and current market interest rates.  While it can vary, it is not unusual for owners to make 5% or more on their money over time.  When you adjust for  the fact that the financial risk of having money in a life insurance policy is relatively low, the return is attractive.  There are also other benefits, such as the “first in first out” taxation of life insurance policy withdrawals, and the fact that loans are not usually taxable events (unless the policy lapses with a gain or the policy is a MEC).

The Rate of Return is Hypothetically Higher For Someone Who Buys Term and Invests the Difference

Buying term and investing the difference refers to the concept of taking the total cost of a whole life insurance policy, using a small portion of it to purchase an equivalent death benefit term life insurance policy, and using the amount saved by using term life insurance coverage over whole life coverage to invest in the market (as opposed to investing the entire sum in a whole life insurance policy).

Historically speaking, the stock market has returned about 12% a year on average.  Because the hypothetical return of even a conservative investment portfolio is much higher than the dividend payments on a whole life insurance policy, over time this is a much more lucrative strategy than putting the money in a whole life insurance policy.  The owner would still enjoy the life insurance coverage (for the length of time of the term policy) and make more from the cash value savings in an investment account.  This hypothetically makes it worthwhile for an owner to surrender their whole life insurance policy for term, and invest the cash value in the market.

Ideally speaking, the investment account will grow greater than the life insurance coverage death benefit, making the term life insurance policy superfluous.

The Difference Is Risk

The downside to buying term and investing the difference is the difference in the amount of risk assumed.  While the stock market has historically grown over time, the market moves both up and down.  Sometimes the swings in the stock market are drastic, taking the investors on an emotional roller coaster, while simultaneously jeopardizing both retirement and savings accounts.

By comparison, a whole life insurance policy will grow steadily over time.  As long as loans and withdrawals are not taken from the policy, and the premiums are paid, the policy will grow in value every single year.  Life insurance companies are held to extremely strict capital requirements, and State governments often provide protection guarantees to both the cash value and death benefit of a policy.  The largest life insurance companies have billions of dollars in their capital reserves, and the odds of the company becoming insolvent are astronomically low.

Which Strategy Is Better?

For most people, a term life insurance policy is sufficient to meet their needs.  As long as their investment horizon is long enough (usually at least 10-20 years) buying a term life insurance policy and investing the difference in cost between the equivalent whole life policy and the term will net the owner much more money in the long run.  At Life Ant, we recommend that most (but not all) of our clients use term life insurance.  Term life insurance is incredibly affordable, and clients can afford a much higher death benefit when they use term life insurance.  Most people with a whole life insurance policy are well suited to surrender their whole life policy for the cash value, and invest in term life insurance instead.

The one thing that anyone considering this strategy must account for is that there are no guarantees in the market, and the actual portfolio performance an investor experience depends largely on their timing and portfolio construction (some stocks never go up).  For someone extremely averse to risk, a whole life insurance policy may be better.  There are also some other very niche uses for whole life insurance (such as tax advantaged estate planning) that can not be satisfied by using term.

If you are interested in comparing quotes for a term life insurance policy, enter your zip code in our quote tool above.

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