Whole Life Insurance: Pros and Cons

According to the American Council of Life Insurers, "permanent insurance" is the most commonly purchased type of life insurance in the United States today, accounting for 60% of all individual policy sales. Traditional whole life is the oldest and most well-known type of permanent life insurance on the market. This article examines its benefits and drawbacks.

What Is Whole Life Insurance?

Whole life insurance, as the name implies, can cover you for the rest of your life. In contrast, term insurance covers you for a set period of time, such as 10, 20, or 30 years. If you still require life insurance after the term expires, you must find new coverage.

Another significant difference between a whole life policy and a term policy is cost, with term policies being significantly less expensive. That means you can get a term policy with a much higher death benefit for the same money. As a result, while permanent life insurance accounts for 60% of new individual policies, it accounts for only 28% of total face amount of all new policies.

Whole life insurance is more expensive than term insurance because it includes a savings component known as "cash value." A portion of your fixed annual premium is used to purchase insurance, similar to a term policy, while the remainder is invested and grows in value over time. If you decide to give up, or surrender, your policy, you can borrow against its cash value or withdraw the money. In contrast, a term policy has no cash value and only pays out if you die.

Whole Life vs. Other Types of Permanent Insurance

Aside from traditional whole life, three other major types of permanent life insurance are available. All of them include both insurance and a savings component. Here's how they stack up against the rest of life:

• Universal Life: A universal life policy allows you to increase or decrease your death benefit, which affects the premiums you pay. For example, a policyholder may wish to purchase a universal life policy with a low death benefit at first, increase it as their family grows and their income rises, and then reduce it once their children are financially independent.
• Variable Life: Variable life policies give you more control over how your cash value is invested, typically by providing you with a portfolio of mutual funds from which to choose. The insurance company makes those investment decisions with a whole life policy. The cash value and death benefit of your policy can both fluctuate depending on how well your investments perform.
• Variable-Universal Life: Finally, a variable-universal life insurance policy is a hybrid. It allows policyholders to adjust their death benefit, similar to a universal life policy, while also allowing them to choose how their cash value is invested, similar to a variable policy.

Pros of Whole Life Insurance

Whether a whole life policy is right for you may be determined by your psychology as much as your finances. Among its benefits are:

Permanency

A whole life policy can last your entire life if you pay the premiums on time. A term policy, on the other hand, is valid for a set number of years after which it must be replaced if you still require insurance. Because of your age or health issues, you may have more difficulty purchasing insurance—or getting it at an affordable price—by then. People whose term policies expire, on the other hand, frequently have more options for retaining some form of insurance than they realize.

Predictability

Your premiums and death benefit remain constant with a whole life policy. You are subject to market ups and downs with either type of variable life insurance. People who are uncomfortable with investment risk and want a long-term policy may benefit from whole life insurance.

Tax breaks

A whole life policy's cash value, like that of other types of permanent insurance, grows tax-deferred. In contrast, if that money were invested in a regular, non-retirement account, the interest and dividends would be taxed each year. Furthermore, because life insurance proceeds (the death benefit paid to the beneficiary) are generally not taxable, those investment gains may be exempt from taxation entirely.

Potential loan collateral

As previously stated, after a certain point, policyholders can borrow against the cash value of their policies. This could be helpful in a financial emergency for someone who has exhausted all other borrowing options. And, unlike other types of loans, they are not required to repay the money if they are unable or unwilling to do so. There are, however, some significant caveats here, one of which is that the policy's death benefit will be reduced if they die before paying it back.

Cons of Whole Life Insurance

Whole life insurance, on the other hand, has some drawbacks to consider. These are some examples:

Higher cost

Whole life insurance is more expensive than term life insurance, costing between five and fifteen times as much, according to TrustedInsurance. One reason is that a portion of your premium is used to fund that cash value account (so it isn't completely squandered). Another factor is that insurance salespeople typically earn higher commissions for selling whole life policies than term policies, which may help explain why permanent insurance policies outsell term policies. 

Smaller death benefit

Because whole life insurance is more expensive, whatever amount you spend on insurance will buy you a much lower death benefit than a term policy. So, if you need a lot of insurance, as you might if you have a young family reliant on your income, whole life insurance may not be enough.

Lack of investment control

The insurance company invests the cash value portion of your policy in any way it sees fit with a whole life policy. If you're an experienced investor willing to take on some additional risk, investing that money on your own could result in higher returns. As a result, consumer advocates have long advised people to "buy term and invest the difference." (Of course, to make that strategy work, you must actually invest the difference rather than spending it on other things.) With a variable policy, you have some investment options, but they are limited to the funds offered by the insurance company. 

The Bottom Line

Whole life insurance is appropriate for you based on your specific needs. It is more expensive than term life insurance, so your death benefit will be less for the same amount of money. Nonetheless, it is yours for life, so there is no need to worry about it running out. If you require more protection earlier in life, such as for a growing family, the term is probably more appropriate. However, if you want to leave a legacy for your heirs, it may be worthwhile to purchase a whole life insurance policy.