Whole life insurance is not recommended by most pop culture financial gurus like Dave Ramsey or Suzy Orman, but that doesn’t mean that it isn’t a suitable product for some people to buy. Whole life insurance is a niche product, but it is the only type of life insurance that should be recommended to people with a certain set of needs. In addition, other people may see the value in whole life or other forms of permanent life insurance when you compare them to term life. Whole life has some distinct advantages against other forms of whole life insurance though, and it should be considered as a viable product option when people are looking to purchase life insurance. Here are some benefits to whole life.
Whole Life Insurance Has a Cash Value
One of the chief benefits of whole life insurance vs term life insurance is that it has a cash value. This cash value grows over time, eventually reaching the entire death benefit when the policy is mature. At any point, the policy can be surrendered for whatever the cash value is at that time. People can also take loans out of the policy as well as take partial withdrawals from the policy(which reduces the death benefit by the amount of the withdrawal).
The cash value of a whole life insurance policy makes it an asset, which can be used for collateral for loans. If you are preparing a personal balance sheet, it is considered an asset by law. If you take a loan or withdrawal, you can use the cash that you access from the policy for any purpose. This is true whether it is to take a vacation, make home improvements, buy a home, or help pay bills. Because tax laws give some preferential treatment to life insurance policies, you can take money out of a policy tax-free until you have withdrawn the amount of money equal to your total premium payments into the policy. This tax treatment is known as FIFO (first in first out) and it differs from other investment accounts in this way which are typically LIFO (last in first out).
Over time the growth that will happen in cash value combined with dividend payments, which we will cover next, means that whole life insurance actually has a positive expected return. This makes it an investment as opposed to an expense! Even though the return of life insurance may be lower than a stock portfolio, people should not discount the investment value of whole life insurance given how safe it can be. The oldest and largest life insurance companies have survived the great depression, among other financial crises, and many have been profitable every year for over 150 years. Whole life insurance can be as safe an AAA-rated bond, but provide a higher rate of return than anything else so safe.
Whole Life Pays Dividends
Life insurance pays dividends as a way for owners of whole life policies to share in the companies profits. Historically, most life insurance companies were organized as mutual companies. In a mutual company, the policy owners actually own the company. As owners, they had the right to get a portion of the company profits or a portion of the cash if the rate of deaths were lower than expected (meaning the life insurance company had to pay out less cash than anticipated). While not all life insurance companies are currently organized as mutual companies today, the tradition lives on, and non-mutual companies must pay dividends to whole life insurance owners in order to keep the products competitive with mutual companies.
The amount paid out for a dividend varies depending upon the age of the policy, the amount of coverage, and the amount of cash value in the policy. Each year, the company calculates a dividend rate which is then applied based on these other factors. The dividend rates are often 5% in low-interest-rate environments and historically have been above 10% which sometimes makes them competitive with stocks.
The dividend is paid out annually, and policy owners have a choice of what to do with this money. They can take it as cash (tax-free until total dividends are greater than premiums paid), they can use it to pay premiums, they can use it to purchase more paid-up life insurance, or they can store it in an interest-earning cash account. Owners can also choose a combination of these options. The dividend component of a whole life insurance policy makes owning a policy even more valuable than the insurance protection that it provides. If the dividend is used to purchase more paid-up life insurance, it acts as an accelerator as an investment because it creates compound growth for future cash value and dividends in the policy.
Whole Life Is Permanent
A key feature of whole life insurance is that it is meant to last the entire lifetime of the insured person, hence the name “whole life”. Whole life insurance is not the only permanent form of life insurance though, because universal life and variable life insurance are also both technically permanent. Those types of policies are significantly more complex than whole life and are at significant risk of lapsing without a huge amount of funding relative to whole life. They also have higher fees over time and we do not recommend them to most people.
Because it is permanent, whole life does cost more than term life insurance, because as long as the owner makes premium payments the life insurance company is obligated to pay out a death benefit whereas most people outlive term coverage.
The permanent feature makes whole life the only product suitable in certain circumstances, such as paying estate taxes, avoiding estate taxes, funding a trust, splitting up an illiquid estate evenly among heirs, or guaranteeing a legacy to pass down to heirs. Term coverage would be a waste when there is a need for these types of features because it is unlikely to still be in-force and still provide coverage when the insured person dies.
There are also special kinds of whole life policies called final expense life insurance, which is meant to cover the cost of funerals and pay final expenses. It is important that this type of policy is whole life as well because the money needs to be available to survivors so they are not left with a big bill for the funeral or settling final debts and costs.
Whole Life Can Be Sold
Because it will last for the entire life of the insured person as long as premium payments are made, there are actually investors willing to purchase whole life insurance policies in order to profit from the death benefit. They will take over paying premiums, and in exchange receive the payout when the insured person dies. This type of sale is known as a viatical settlement and may pay the owner more than surrendering the policy would. This is especially true if the health of the insured person took a negative turn since the policy was issued and they may be expected to die at a younger age than expected at policy issue. People can debate the ethics of betting on death through viatical settlements, but it is a legal option for owners to get cash for the policy before death.
Bottom Line on Whole Life’s Benefits
To sum up, the benefits of whole life insurance over term coverage are:
- It has a growing cash value which makes it a good investment.
- It pays dividends which can be used for any purpose including paying premiums or buying more paid-up life insurance.
- The coverage is permanent.
- It can be sold or surrendered prior to death for a significant sum of money.
Compared to Term
Here is a table that compares the key features of whole life insurance and term life. As you can see, there are tradeoffs with whole life insurance but also distinct benefits over term life.
|Premium Cost||High-but dividends can pay entire premium eventually.||Low and affordable in most cases|
|Coverage Length||Permanent||Between 5 and 40 years depending upon length chosen|
|Can be Sold||Yes||No|
|Suitable for Final Expenses||Yes||No|