If you have ever looked up life insurance on the internet or talked to an agent about it, you will get different opinions about whole life insurance and term insurance. Lots of financial gurus will tell you to never buy whole life and always buy term. Are they right? Does whole life suck? Here are some things you might consider.
What’s the Difference between Whole Life Insurance and Term Insurance?
Let’s start with the definition of life insurance: This is from Investopedia: Life insurance is a contract between an insurer and a policyholder in which the insurer guarantees payment of a death benefit to named beneficiaries when the insured dies. The insurance company promises a death benefit in exchange for premiums paid by the policyholder.
Here’s the definition of whole life insurance from Investopedia: Whole life insurance provides coverage for the life of the insured. In addition to paying a death benefit, whole life insurance also contains a savings component called cash value. These policies are also known as “permanent” or “traditional” life insurance.
Here’s the definition of term life insurance: Term life insurance, also known as pure life insurance, is a type of life insurance that guarantees payment of a stated death benefit if the covered person dies during a specified term.
The first thing I notice from these definitions is they say life insurance is insurance. It is not an investment. I see posts from bloggers that say whole life insurance is a terrible investment. That’s like saying, a screwdriver is a terrible hammer. While the screwdriver might get its feelings hurt having someone say it is a terrible hammer, nonetheless it still does a fine job driving screws.
What Kind of Life Insurance is Best?
This is a really tough question to answer. The best kind of life insurance is the one that is in force when you die. When are you going to die? No one knows for sure, but nobody gets out of here alive.
There is No Right Answer
First off, I believe it is more important to have the right amount of insurance than the right kind of insurance. When a life insurance death claim is paid, the insurance company pays the beneficiary money. More money is better than less money. Never buy a $100,000 whole life policy when you need $1,000,000 of coverage. People buy life insurance because they love someone or they owe somebody money.
Reasons a Person Might Want to have Whole Life Insurance
There are various types of permanent life insurance. Whole life is one of them. There is also universal life, variable life and index universal life. For this short piece I’m using whole life insurance as a catch all for permanent life insurance versus term or temporary life insurance. Here are a few reasons a person might want to have whole life insurance.
- You want to leave money for a beneficiary no matter when you die. Remember, people buy life insurance because they love somebody or owe somebody money. Usually the owe somebody money is a temporary thing and can be covered with temporary insurance. Love lasts longer than a loan. I have people all the time who want to be able to leave money to their spouse, kids, grandchildren, etc. Life insurance is the most efficient way to do this.
- You want to maximize your retirement income. This one might seem weird, but it’s hard to save enough money to retire. If you use the 4% withdrawal rate, it takes $1,000,000 to generate $40,000 per year of income. Between Social Security and taking withdrawals off of their investments, most people need every nickel they have saved to maintain their lifestyle in retirement. But they also want to leave money for their kids and grandkids. Again, here’s where having some amount of permanent life insurance comes into play. With life insurance, you know there is a guaranteed amount of income tax free money that will be left to a beneficiary. If you want to make sure the kids are taken care of, yet still be able to maximize your retirement income, permanent life insurance does the trick.
- Long term care insurance is expensive. What? I thought this was about whole life insurance. It is, but many life insurance companies have long term care riders that can be added to their whole life insurance contracts. This allows you to use some of the death benefit to pay for long term care expenses. This is a whole other subject, but you should be aware of this option.
- Remember the savings component or cash value of whole life insurance? I haven’t talked too much about it up to this point, but it is an important reason a person might want to have whole life insurance. America’s IRA expert, Ed Slott, says that the single biggest benefit of the tax code is the income tax exemption of life insurance. This would require more explanation but basically, you buy whole life insurance with after tax dollars. The cash value grows tax deferred meaning you don’t pay taxes on its growth and the death benefit is income tax free.
- Life insurance gives you control. I’m not one of those advisors who says only use one product or idea. I look at all of these things, IRAs, investments, retirement plans like 401ks, life insurance, disability insurance, etc. as tools. All of them have their plusses and minuses. That being said, tools like IRAs, Roth IRAs, 401ks and other tax qualified investments have rules that reduce your control. IRAs and other tax deductible investments have limits on how much you can contribute, have required minimum distribution rules and rules for taking money out before age 59 1/2, for instance. The new Secure Act has rules on distributing money to non-spouse beneficiaries. Whole life insurance has none of this stuff. If you need money from your cash value at age 32, you’re free to take it. If you want to name your nephew as your beneficiary, you can do that too. Basically, you have a tool that is flexible, tax advantaged and has guarantees that are very unique.
There’s so much more to write about this subject. As you can guess, the answer to my original questions, “Does Whole Life Insurance Suck?”, is No! It isn’t the end all, be all, but is a valuable planning tool. Ed Slott says it should be the bedrock of any financial or estate plan. If you would like to talk more about this, feel free to reach out to me at kbrown@gatewafinancialadvisors.com. Thanks for reading. KB