Here is a secret most life insurance companies don’t want you to know. You shouldn’t buy whole life insurance. Why are we telling you this? It sounds like a strange thing for a life insurance company to say. But at Life Ant, we are more concerned about giving our clients good information than we are about making money.
Here is the truth. Whole life insurance is almost certainly not for you. I can almost guarantee it. How do I know? Because a traditional whole life insurance is only the right choice for a very selective group of people. These people fall into two categories. High net worth individuals who need life insurance for estate planning purposes, and high net worth individuals who can benefit from whole life as a conservative investment choice as a piece of their larger investment portfolio.
Why don’t you want to buy whole life? Whole life insurance is significantly more annual premium than term. It is needlessly expensive. It’s an expense that you don’t need.
Here is what you should buy instead. You need to buy a term life policy, with as long of a term as you can get for a relatively cheap price. You need a 30 year term policy, or a 40 year term policy. They will accomplish essentially the same thing for you. Here’s why.
Why Life Insurance Agents Tell you to Buy Whole Life
Life insurance agents will push you toward buying whole life. They always do. Why is that? Well the biggest reason a life insurance agent tells you to buy a whole life insurance policy is because they make more money. A whole life insurance company incentivizes agents in the form of higher commissions. Not only is the commission structure based on first year premium, and whole life insurance premiums are about 10 times to 20 times more expensive than term premiums, but the percentage of first year premium that an agent gets from a whole life policy sale is larger. They make more money because the dollars are higher, and they make more because their share is higher. On top of it, they get residual payments every year as an incentive to keep their clients invested.
But that isn’t why they tell their clients to buy whole life. They can’t appear greedy. But they do have a few reasons that sound good at first blush, but don’t necessarily hold up to scrutiny. Here are some of the common ones.
But, before I tell you about the common ones, you need to understand a certain common argument to them called “buy term and invest the difference” because it will be the rebuttal to each, in slightly different form. You should read the article we wrote about it linked above, but basically the principal says that if you buy cheaper term life insurance, and invest the amount of money equivalent to the price difference between term and whole life, the investment will result in more money in your pocket than the cash value of buying whole life insurance.
If you Outlive your Term Policy You Leave Nothing to Your Kids
You will probably outlive your term life insurance policy. That is the reason the policy is affordable, and it’s what you want. The insurance company expects you to outlive it, and you expect yourself to outlive it. It’s a win-win when you buy term and outlive the length of the policy, because your alive, and you bought a ton of life insurance coverage just in case, for a small amount of money.
If you have whole life, you can’t outlive your policy (unless you live to be 115 years old, the age of maturity of the policy). So it is technically true that as long as your whole life policy is in-force, the death benefit will go to the beneficiaries (often the children of the insured). There is a problem with this argument though. If you die with more money than the death benefit, you will leave even more to your children (as long as you stay under the estate tax limit, which is about 11 million dollars per person, or 22 million for a couple).
So if you buy a big term life policy for 30 or 40 years, and you die during your period of coverage, you will leave your children more than you could possibly have saved. If you buy a whole life policy your premium will be much higher. You may buy less coverage, or pay a much higher premium for the same coverage. Either way, if you die early in the policy, you leave your kids the same as if you had the term. If you die when you are old, you will leave them less money than if you had purchased term life instead, and saved the difference in price and invested it. Of course that logic assumes that you get a positive rate of return on your money, but over a long period of time with proper financial planning you are almost guaranteed to get a good rate of return.
So the takeaway is that either way you slice it, you can leave your beneficiaries the most money if you purchase a term life policy, and you don’t need to worry about outliving it as long as you “save the difference”.
You Can Get Life Insurance Now Because you are Young and Healthy, Later you May not be Insurable
This is technically true. You can’t argue with the veracity of the statement, but you can again argue with the logic. Term policies can provide coverage for a long time. If you buy a 30 or 40 year term policy, you don’t need to buy life insurance again. You already are covered for as long as you need. Since you are comparing term coverage to whole life, as long as you practice saving the difference, when the term coverage expires you should have enough saved to be of similar or greater value to the death benefit.
It all depends on you buying a term policy with a long enough length to cover you when you need it and allow you to save up a lot and invest the savings. Remember, an 8% rate of return roughly doubles every 8 years, so the power of compound interest is extremely valuable to you.
You Can Borrow from the Cash Value of a Whole Life Policy/ Whole Life is an Investment
Whole life is a great investment for high net worth individuals, who want to own it as a piece of their fixed income portfolio. It gives a dependable positive rate of return, that is a pretty good return on investment given the low risk. However, it takes a long time to give a positive rate of return, and it is ultimately not a very high return on investment.
You can take loans from a whole life policy, and you can surrender it for the cash value. But, it all comes down to saving the difference between term and whole life. If you buy term and invest the difference, you will have a much greater reservoir of money to draw from than you will with a whole life policy, as long as the money is investment wisely and conservatively.
Who Needs Whole Life?
People who need whole life insurance are generally very wealthy individuals. Not just relatively wealthy individuals, not usually people worth (just) a few million dollars. People who need whole life are usually those who are worth a lot of money. Here are a couple of valid reasons people need whole life insurance.
To Fund an Estate Worth More than the Estate Tax Exemption
Life insurance benefits are usually tax free to the beneficiary (not always, consult your CPA because tax law is complex and changes). Because the United States has a a federal estate tax, and some states have an estate tax, wealth can not be passed down to the next generation in massive amounts tax free. Life insurance can be the solution. People with a lot of money can buy big policies and pass along the money to their heirs free of tax. With a higher estate tax exemption, fewer people will require this type of policy. Keep in mind that to be worthwhile, the tax savings must be greater than the price of the life insurance.
To Add a Safe Fixed Income Investment to a Large Portfolio
Life insurance doesn’t really make sense as someone’s only investment, because the rate of return is much lower than the expected rate of return from the stock market. As a risk adjusted rate of return, life insurance can be a good investment because the risk is very minimal when it is purchased from a highly rated financially secure company. Many companies such as Northwestern Mutual and New York life have survived multiple recessions, the great depression, and have massive financial security. Depending upon a number of factors, the expected rate of return from a whole life insurance policy can be decent, given minimal risk.
If a client has a large well diversified portfolio, or they have a specific need in which whole life insurance fits, it can be a great investment. The problem is it takes a very specific type of client for it to be the optimal investment choice, and not too many people fit into this specific demographic.
To Break up an Illiquid Estate Among Multiple Heirs
Sometimes when an estate is tricky to divide evenly (like when the main asset is a house) among multiple people, whole life insurance can guarantee a way to fill a void. Instead of forcing the sale of something like a house, or valuable artwork, or something else of both monetary and sentimental value, someone can leave the item to one heir, and life insurance representing approximately equal value to the other.
While technically you could probably still solve this problem by buying term and investing the difference, some people don’t want to take a chance on the value of the investments either growing too large or not large enough. Life insurance is an easier way to pass on a highly predictable value to an heir.
Life Insurance for a Baby
Children’s life insurance, also called baby life insurance, is a questionable yet potentially useful gift for a newborn or young child. It guarantees that they can have life insurance coverage because there is no real underwriting to qualify through. It can give them an asset for their whole lives that they can use to collateralize to borrow against, take loans from, or take money as dividend payments. While morbid to consider life insurance for a baby, a whole life policy is one way to set them up for financial success.
A Combination of Factors Including “Living Benefits”
Life insurance policies can come with many riders. Whole life insurance policies especially have the ability to provide disability income, waiver of premium, accelerated death benefits, retirement income, and the ability to take cash value loans. For some people, given the relative price, predicted return, and all the benefits of whole life added together, it makes sense for them.
Conclusion- Buy Term
While exceptions do exist, at Life Ant we recommend term policies to almost all of our clients. For a very affordable price, you can get a term policy with a length of 20 to 40 years. For almost everyone, this provides plenty of cheap coverage and gives them a chance to save and invest the difference in cost. In the end, the term buyers almost always win.