Don’t use Whole Life Insurance as an Investment
Some of our other articles have pointed out that we prefer term life insurance over whole life insurance, because life insurance should not be involved in any way, shape or form with your investments. We like to dig deeper into the subject.
Most insurance agents will try to sell you whole life insurance. Your CPA may try to sell your whole life insurance. Even your stockbroker might want to get in on the action. Why are people so eager to sell an insurance policy that is so much more complex than the less expensive and easier to understand term life insurance policy? You know the answer: commissions.
These salespeople will tell you that the investing component of whole life insurance serves as a “forced savings plan.” They’ll tell you that what they call the “cash value” will grow tax-deferred. They’ll tell you about the dividends you can receive. But wait. An IRA or a 401(k) also can be a disciplined savings plan, can grow tax-free, and can pay dividends. And on top of that, you can make your own investment decisions or seek out and change your money managers at will.
They will not tell you that your cash-value insurance is generally a very poor investment. The majority of mutual fund managers and other money managers do not beat the general market. Why would anyone think that an investment arm of an insurance company would do any better, especially when they don’t disclose their performance? They could be just as good, but what happens if they’re not? You can’t fire them. You can’t tell them to go to cash when you fear a financial crisis coming. You have no say whatsoever despite how poorly they may perform.
And whole life insurance is a very expensive way to invest. You’ve got annual investment fees which may not be broken out in your statements, you’ve got marketing fees built into your premiums, you’ve got a sales commission you paid to your broker that you didn’t even know about. In policies that do break out investment fees, you will see that they can be 3% or even higher. By comparison, index mutual funds have annual expenses under .5% and many very good actively managed mutual funds come in under 1%. If you are schooled at all on the principle of compounding interest, you’ll know that a 2-3% difference, year in and year out, can make a huge difference – perhaps by as much as hundreds of thousands of dollars over decades.
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Furthermore, most insurance companies will not disclose the rate of return in the cash value of your policy, so you will not be able to compare it to other investments. And of course insurance counties have been opposed to any and all legislation that seeks to require such disclosure.
Another downside to whole life insurance is that premiums in the early years of the policy are so much higher than the premiums of a term life policy. This is money that could be put away early into a 401(k) or IRA account, and as any investor will tell you the more money you can put in earlier the better, vastly better, your eventual nest egg will be. Not only that, the insured could buy so much more coverage for the money. For example, a 25-year-old could buy almost 10 times the coverage with term life insurance that he could with whole life insurance for the same premium payments.
Thankfully, with freely available information on the Internet, and consumer advocates rallying against whole life insurance, whole life policy sales have been declining. To try and maintain interest in these profitable types of policies, they have been inventing all sorts of new types of whole life insurance. Steer clear of them, unless you need whole life insurance for some specific estate planning needs. They all share the same problems, and are all difficult to understand by the average person.
The bottom line is simple: life insurance and investing are two vastly different things. If you want life insurance, by term life insurance; if you want to invest for retirement, do so within IRAs or 401(k)s.
{ 4 comments… read them below or add one }
Hi, I have read your above article and I feel it is very dangerous that you can express your opinion and attempt to sound expert, while excluding any fact or figurative analysis to demonstrate what you are saying. From a common sense position you are wrong. Term life insurance pays nothing back to you and ends after a period living you unprotected. Whole life insurance is for life and guarantees something back and in some companies what you get back in 20 years is 25% more than what you put in. If one has the need to protect his family with a dollar amount then a combination of whole life and term can be packaged. You obviously are not qualified in finance or anything financial to speak on those matters. If a company gives a client a contract guaranteeing a return that means the client can sue. The point is whole life insurance is not a high yielding immediate return investment, but is a supplemental retirement plan, that is beneficial to the client over a long period of time not immediately. In conclusion the client makes a profit which will catch up to inflation and may surpass it or any interest a bank may pay in a 25 year period and add up to much more thereafter. Therefore, the catch is one has to be committed for a long time, while the company invests your money, makes theirs, and pays yours later. Much later. That is why an expert would advise that the amount put in must be very affordable and never a burden, because its for the long haul.
Signed An Expert.
Hi Janice, I just wanted to know, how would you be able to get a good investment out of the Whole Life Insurance if it costs really high? The projections usually given out by “Financial Advisors” that 12% is the usual earnings specially if it is invested in TSX or NYX dwarfs the Standard and Poor’s chart performance for Mutual funds at roughly 6-8%. Not to mention the huge commissions that the agent gets as well as the Cos of Insurance, I guess it would be safe to say that the actual money would only get about 3% given the equation before fund management fees and such. By borrowing huge sums later as part of the retirement fund given the 3% actual rate that this Whole Life will actually take away the money from the Cash Value of the plan thereby makin it collapse on its own and having the client pay for their own Insurance. How many people at age 60-65 have any kids still living at their roofs? Why not just get a term, invest the difference in a stronger mutual fund that can actually get you YOUR own money, guaranteed, pay minimal fees on investment income and minimal tax fees on it as well?
As a financial advisor what I tell clients is that the main purpose of a life insurance policy is to provide a death benefit. Whether term, some sort of permanent life insurance, or a combination of the two is most appropriate depends on a number of factors including the insured’s age, income/cash flow, their stage of life, and how long they anticipate needing the coverage. Permanent insurance can have its place. I do agree that purchasing life insurance as an investment vehicle is generally a poor idea.
Walt Disney funded Disney World by using the cash value in his whole life policy. You can’t say that was a mistake. Buy term for a specific need/period and buy whole for a permanent need or if you need your life insurance past age 65.