When people think of life insurance, they initially think of the death benefit—an insurance policy only pays out if you die, right? But whole life insurance offers living benefits too. For more than one hundred years individuals have used whole life insurance as a method to grow and preserve their money, making it a unique wealth-building vehicle.
From WWII through the late 1960s whole life insurance was the most popular type of insurance. Then, as companies shifted away from pensions, more and more Americans began investing their dollars in the stock market and qualified retirement plans like 401(k)s or IRAs to build wealth, and buying term life insurance to satisfy death benefit needs.
Today, market fluctuations have investors on edge, retirement plans aren’t providing the returns they used to, and individuals are looking for more control over their financial futures.
Whole life insurance isn’t for everyone; whether or not it’s the right strategy for you depends on your financial goals. It’s not a get-rich-quick scheme, but when structured properly it can be a valuable asset to a diversified financial portfolio.
Here’s what you need to know about whole life insurance.
Whole Life Insurance 101
Whole life insurance is a type of permanent life insurance policy that never expires, as long as the premium payment is satisfied. Your premium won’t change—it remains level for the duration of your life.
Unlike term life insurance, which only pays out if you pass away within the specified term, whole life insurance pays out regardless of when you die. But the death benefit isn’t the only reason people buy it.
When you pay your whole life insurance policy premium, a portion goes toward paying for the death benefit (also called the face value of the policy) and a portion goes into a built-in savings component of the policy called cash value.
The cash value earns a guaranteed rate of return and may also earn potential dividends. This is how a whole life insurance policy builds wealth. If you want to spend your cash value, you can withdraw your cash value or you can borrow your cash value in the form of a policy loan.
So, why save your money in a whole life insurance policy instead of in a bank? Why not buy term life insurance and invest the difference?
Let’s look at the reasons why whole life insurance might make sense for you.
Do I Need Whole Life Insurance?
To help you decide if whole life insurance is right for your financial goals, ask yourself the following:
DO I NEED LIQUIDITY?
Liquidity is a financial term used to describe how easy it is to access money in an investment. Insurance references the cash value of a life insurance policy. The cash value is “liquid” because policyholders have the contractual right to access it at any time.
The ability to have cash on hand can be a great tool for business owners, to use for personal or family emergencies, or to leverage in future investments like real estate. Often, individuals can be worth a lot on paper but can’t easily access their wealth.
For example, if you own an apartment complex, you can’t easily sell it—make it liquid—and turn it into cash.
Other examples include qualified retirement plans like 401(k)s or IRAs. The money is easier to access than the equity in an apartment complex, but you’re penalized if you access your funds before age 59 1/2. In this sense, the time restriction on when you can access your money makes your funds illiquid.
Individuals who need liquidity but still want to earn a return and dividends may find whole life insurance to be an optimal solution.
DO I WANT TO MINIMIZE RISK?
Market-based investments are inherently prone to risk. While some individuals enjoy the thrill of the stock market or have a long way to go before retirement, allowing for losses to be recouped, many people prefer a safer strategy.
Whole life insurance offers guaranteed returns, plus potential dividends in the years a mutual insurance company does well. But if the company doesn’t have a good year, you won’t suffer a loss.
Many of the policyholders we work with prefer to remain invested in the market, maxing out contributions to their 401(k) or IRA, but also utilize a whole life insurance policy for a truly diversified portfolio.
This “third bucket”—savings, investments, and now whole life insurance—acts as a volatility buffer against market risk. The cash value can be used after a market downturn, allowing time for funds in qualified plans to rebound.
If you’re averse to market risk or prefer to have a more diversified portfolio, whole-life insurance can be an excellent tool.
DO I OWN (OR WANT TO OWN) A BUSINESS?
In some cases, lenders will require business owners to have life insurance policies before agreeing to a loan. Owning a whole life policy puts you one step ahead and allows you to be your bank. Whole life insurance has helped save and fund many well-known businesses.
The cash value can be borrowed at any time through policy loans. Because the insurance company does not determine the payback schedules on policy loans, this gives the policyholder a very unique amount of flexibility. The cash value can be accessed for any reason—there is no approval process or waiting time.
Whole life insurance also helps business owners create a succession plan, either by insuring the owner or other key individuals and helps protect against loss. The death benefit can be used to replace personnel, facilitate buy-sell agreements, pay off company debts, and help avoid bankruptcy—especially for small businesses and family-owned companies.
DO I WANT TO PAY LESS IN TAXES?
One of the biggest reasons people opt to add whole life insurance to their financial portfolio is because whole life insurance policies are given favorable tax treatment by the IRS.
Policy premiums are paid with after-tax dollars, but the growth of cash value from interest and dividends is tax-deferred. If you withdraw cash value, you’ll be taxed on your gains—anything you’ve earned that exceeds the amount paid in premiums. But if you utilize a policy loan, you can access your gains tax-free.
This is a big deal if you’re using a whole life insurance policy as a retirement fund, also known as a life insurance retirement plan (LIRP). After-tax payment of premiums mimics Roth IRA contributions, but whole life insurance policyholders aren’t penalized for accessing funds before a certain age, aren’t subject to market-based volatility, and can spend all of their gains in retirement tax-free through policy loans.
When the policyholder passes away, the outstanding loans are deducted from the death benefit of the policy. This means less of a death benefit for any beneficiaries, but if tax-free retirement is one of your financial goals, whole life insurance is a great option.
The tax benefits of whole life insurance extend to the death benefit as well. Your beneficiary won’t owe income taxes on money received through a life insurance claim and most death benefits are also exempt from estate tax. Wealthy families often utilize whole life insurance policies to help pass on tax-advantaged wealth for generations. Irrevocable Life Insurance Trusts (ILITs)can also be arranged for even more tax benefits for families.
DO I NEED COVERAGE THAT LASTS MY ENTIRE LIFE?
If your main reason for buying insurance is a death benefit, you need to consider the length of coverage you need. There are a couple of reasons why lifetime coverage makes sense.
- Tax Advantages: If you have significant wealth that would be subject to taxation upon your passing, whole life insurance allows you to funnel some of that wealth through your policy so your family can avoid a hefty tax bill after you’re gone.
- Long-Term Care: If you have a child or spouse with a disability who will need to be cared for in perpetuity, you need a life insurance policy that will payout regardless of when you pass away.
In most cases, term life insurance is sufficient in paying out a death benefit if you pass away unexpectedly. Often, by the time a term policy expires, the insured no longer needs insurance anyway; the house is paid off, the kids are grown, and tuition bills are paid… your passing wouldn’t place any undue hardship on loved ones.
But if you’re looking for more than a death benefit out of your insurance policy, are looking for a tax shelter, or have family members who require permanent care, you need whole life insurance.
DO I WANT TO MINIMIZE OPPORTUNITY COST?
One of the best ways to minimize opportunity costs is by utilizing policy loans through whole-life insurance. Why? Because when you take out a policy loan, you still earn interest on the full cash value of your account. Essentially, you can borrow a dollar and earn interest on that dollar at the same time. This means you can recapture interest and continue to grow your wealth even as you use it.
Here’s an example:
June has $100,000 in cash value in her whole life insurance policy. She borrows $25,000 to buy a new car. Her insurance company charges her 5% interest for the loan and June repays it for a total of $26,250 ($25,000 + $1,250). Meanwhile, she earns a 4% guaranteed rate of return on the cash value in her policy—the full $100,000. She earns $4,000, bringing her cash value up to $104,000. Despite the loan, June still came out ahead by $2,750 ($4,000 – $1,250).
Meanwhile, Jake takes out a $25,000 loan from the bank for a new car. His bank charges him 5% interest on the loan and Jake repays it for a total of $26,250 ($25,000 + $1,250). But he’s not earning any interest; he doesn’t have a whole life insurance policy. Jake’s loan cost him an extra $1,250 while June continued to grow her wealth and made money.
Finally, Jarrod withdraws $25,000 cash from his $100,000 savings account for a new car. He doesn’t have to pay any interest—but he doesn’t earn any interest either. Now he’s left with $75,000 in his savings account. Whole life insurance could help Jarrod maximize his wealth.
How Do I Find the Best Whole Life Insurance Policy?
Up to 45% of whole life insurance policies are abandoned in the first 10 years due to financial hardship or because they don’t align with the policyholder’s goals. Before you go out and buy whole life insurance, make sure it’s structured properly to fit your unique financial goals and budget. Here are our tips for getting the most out of your policy:
CHOOSE A TOP-RATED MUTUAL INSURANCE COMPANY
Mutual insurance companies pay dividends, so if your goal is to increase cash value, you’ll see faster growth with a mutual insurance company. Much like a credit union, these types of companies are owned by policyholders. When the company does well, the policyholders reap the benefits.
Here we work with the nation’s top-rated mutual insurance companies to help you find the right policy for your needs. We’re experienced in finding policies for people in retirement, those who have been denied coverage before, and individuals with high-risk careers or hobbies. We only submit policies to underwriting with companies that demonstrate consistently strong financial ratings.
DETERMINE YOUR BUDGET
Whole life insurance policies are considerably more expensive upfront than term life insurance, but that doesn’t mean they’re only for wealthy individuals. Consider what you’re comfortable paying and take into account that whole-life premiums remain level for your entire life.
Younger, healthier individuals are more likely to receive favorable ratings from their insurers, which equates to more affordable premiums, but there’s another reason why it makes sense to buy young—the dividends earned can be used to pay premiums. Many properly structured whole-life policies become self-paying by the time the policyholder retires.
KNOW YOUR FINANCIAL GOALS
When buying term life insurance, it’s important to know how much coverage you’ll need to take care of your family if you were to pass away. With whole life insurance, it’s important to have clear financial goals as to how much cash value you’ll need.
A death benefit may still be an important factor, but if you’re using your whole life policy as your bank, how much do you need in the “bank” to accomplish your goals? Policies that prioritize cash value typically buy the lowest amount of death benefit possible and add on Paid-Up Additions policy riders—supplemental insurance—that allow a policyholder to “frontload” their policy, rapidly growing cash value and increasing the growth potential of the policy over time.
Common financial goals for a whole-life policy may be to fund business costs, pay for a child’s tuition, purchase real estate, or fund early retirement.
CONSIDER RIDERS
Paid-Up Additions aren’t the only type of rider to consider when purchasing whole life insurance. You can customize your whole life policy in any number of ways with riders for disability, terminal or chronic illness, family members, loan protections, and even add-on term insurance to create a hybrid policy. Some of these riders are included at no extra cost, some require annual premiums, and some only charge if you use them.
A Paradigm Life Wealth Strategist can help you determine which riders you need (and which ones you don’t) to make your policy work best for your family and your budget.
EXPLORE INSURANCE ILLUSTRATIONS
Once your Wealth Strategist or insurance agent have a clear picture of your insurability, budget, financial goals, and riders, they can provide you with an illustration from your insurance company before you buy showing you how your premium payments will break down, your guaranteed rate of return, and non-guaranteed returns with potential dividends factored in.
Examine your illustration closely and make sure to ask your Wealth Strategist or insurance agent if you have any questions or concerns. We’re here to guide you every step of the way—whole life insurance is meant to be a permanent commitment and it’s important you fully understand your insurance contract.
MAKE CUSTOMER SERVICE A PRIORITY
If you plan on utilizing whole life insurance to help you accomplish financial goals via policy loans, it makes sense that you would select an insurer and agent who value customer service. To make your policy work best, annual reviews with your agent and regular communication with your insurer are key.
We can customize a policy to fit your financial situation. As a wealth strategist we are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals.