You’ll often hear that if you have people in your life who are financially dependent on you, or who will suffer financially should you die prematurely, then having a life insurance policy is a must. And that’s solid advice. But not all life insurance is created equal, and if you’re shopping for a policy, it’s worth considering term life insurance instead of whole life insurance. while the latter may be a reasonable option for some people, for most, signing up for whole life insurance is a decision you’re more likely to regret.
term life versus whole life
Let’s start by laying out the key differences between a term life policy and a whole life policy. Term life insurance, as the name implies, covers you for a specific period of time – your term. thirty years is a common duration. during that time, you pay your premiums (monthly, quarterly, or yearly, depending on which policy you have), and in return, your heirs are guaranteed a predetermined death benefit in the event of your death.
Reading: Why not to buy whole life insurance
Whole life insurance, on the other hand, covers you indefinitely, as long as you keep paying your premiums. Plus, a portion of each premium goes toward the cash value of your policy, which builds up over time.
It’s that cash value that makes whole life insurance attractive. you can borrow against it, withdraw funds from it, or surrender your policy and collect that cash value, less the policy surrender fee.
Please note that the cash value of your policy is not the same as your death benefit. the latter is the amount of money your beneficiaries will be entitled to upon your death, and is an entirely separate part of the equation.
what’s wrong with whole life insurance?
If you’re not good at managing money but can change your premiums in the long run, then a whole life policy could serve as a means of forced savings, as you’ll eventually have the option to tap into the cash value of your policy. Or, to put it another way, if you don’t trust yourself to constantly put money away in a retirement plan, but you do trust setting up automatic billing so that your insurance premiums come out of your checking account month after month, then a Whole life may be a reasonable option.
But aside from that saving grace, permanent life insurance is generally not your best option if your financial goals are to secure affordable life insurance and invest your money to grow.
First, understand that for any given death benefit, your monthly premium for a whole life policy will be much, much higher than for a term life policy. Since whole life insurance offers perpetual coverage for as long as you pay, that makes sense, but that doesn’t make it affordable. PolicyGenius reports that whole life insurance can cost six to 10 times more than a comparable term policy. That greatly increases the chances that you won’t be able to pay your premiums at some point in the future. If that happens, you may have no choice but to drop your coverage, leaving your loved ones vulnerable.
Whole life insurance advocates, particularly those who sell it, will tell you it’s a good buy because it’s not just insurance, it’s an investment. Your policy’s cash value is guaranteed to grow at a certain level, and you’ll benefit from the tax-deferred nature of that growth. But tax-deferred growth is by no means a new feature. You can tap into several popular retirement savings vehicles like IRAs and 401(k)s. The difference, and it’s a big one, is that these plans tend to offer much higher rates of return over time than whole life policies, as long as you choose your investments wisely.
For example, let’s say you’re a 40-year-old man looking for coverage so he doesn’t leave his wife and children in the lurch in the event of his unexpected death. His options are a 30-year term life policy with an annual premium of $500 versus a whole life policy with an annual premium of $3,000 for the same death benefit. he takes out the term life policy and will save $2,500 a year in premiums. If he turns around and invests that sum steadily in stocks, he should have no problem generating an average annual return of 7%, which is actually a few percentage points below the stock market average. keep it up and you’ll have a little over $236,000 in 30 years.
And to be clear, that 7% average annual return is considerably higher than the likely annual return on the cash value of a whole life policy.
Even if you were to invest your $2,500 annual savings more conservatively, with an average annual return of 3%, you’d have about $119,000. And as long as you’ve invested that money in an IRA or 401(k), you’ll get the same tax-deferred growth that a whole life policy promises. In some cases, namely a Roth IRA or 401(k), that growth will actually be tax-free.
Now you may be thinking, “But what if I opt for term life insurance and my coverage runs out?” Sure, that’s a possibility. But if you sign up for a 30-year term policy in your mid-30s or older and are still alive and well when your policy expires, at that time, you’ll be eligible for Social Security and penalty-free. anger withdrawals or 401(k). And if you die, leaving a spouse behind, he or she can collect Social Security survivor benefits that, spread out over time, could easily mimic the death benefit your life insurance would pay.
But most importantly, life insurance is primarily intended to replace the financial support you provide to your loved ones in case you’re not there to do it yourself. When they’re younger, your children depend on your income, and your spouse likely does, too. By the time you’re 60 or older, you’re probably headed for retirement or already retired. you don’t need life insurance to replace income you no longer generate, and if you’ve invested properly, as mentioned above, your financial situation should be stable regardless.
Is whole life insurance always a bad idea?
As mentioned above, permanent life insurance can be a way to force yourself to build up some savings, and there’s something to be said for having lifetime coverage. But whole life insurance is so prohibitively expensive that unless you’re doing well financially, you run the risk of being forced by circumstances to cancel your coverage at some point when you can’t afford it, thus nullifying any benefits the policy gives you. would have offered to you or your loved ones.
Generally speaking, you should expect 15-20 years to pass before the cash value of a whole life policy is worth more than the premiums you paid, because during that time, a large portion of those premiums will go towards fees, commissions and the many expenses associated with providing the policy. That means if you cancel your policy at age 12, you’re out of luck.
The bottom line is this: If you have the means to pay hefty life premiums over time, you have the means to put those same funds into tax-advantaged retirement plans and invest them any way you want. And while using retirement funds early for other financial needs is generally not an ideal option, you do have some flexibility when it comes to those accounts. You can withdraw IRA funds to buy a house, for example, and you can borrow from your 401(k) if needed. As such, it makes little sense to lock your money into a whole life policy when term life insurance offers you so much more financial freedom.