Having spent 20 years on Wall Street, I was fortunate enough to meet many intelligent people – and on Wall Street, intelligent people become rich. So when I was speaking recently to my old boss, I asked him about the stock market and what he was buying. He told me he hadn’t bought a stock in 10 years.
What’s this? Everybody on Wall Street has a couple of favorite stocks that they love to brag about. So where on earth was he putting his money? His answer: “Whole life insurance.”
That answer could not have been more surprising, but after an hour he had me totally engrossed in the concept. He had done so much research and analyzed all of the components so thoroughly, I knew that he was right on the money. This is what smart, wealthy people are doing with their money, and they’re getting wealthier. Why? Because they are taking advantage of built-in savings options, tax advantages, and dividends.
What Is Whole Life Insurance?
Whole life is a type of life insurance contract that provides insurance coverage of the contract holder for his or her entire life. Upon the inevitable death of the contract holder, the insurance payout is made to the contract’s beneficiaries. These policies also include a savings component, which accumulates a cash value. This cash value is one of the key elements of whole life insurance.
Similarities & Differences to Term Life Insurance
- Just like term life insurance, beneficiaries exist in a whole life insurance policy. They receive the death benefit upon the contract holder’s death.
- The most obvious difference, at least superficially, is cost. In some cases, whole life insurance premiums are three to five times as much as term life premiums, at least at the onset. However, term life insurance lasts a “term”: a specified period, usually 10 or 20 years, before the policy expires. The younger you are and the better health you are in, the lower the cost. When the term is up, you can renew the policy, generally at a much higher premium, and depending on your age and health. Whole life insurance premiums, while higher initially, never go up – this is key. The policy is structured to last your entire life, and as long as you keep paying the premiums, the policy will be in force regardless of age and health.
- The premiums in whole life policies go towards a cash value as well as a death benefit – term life has just a death benefit.
Are the Higher Premiums Worth the Cost?
Are the higher premiums worth the cost? In a word, yes.
The first key advantage of whole life insurance is that the cost of the premiums paid to the policy never increases, as long as you make sure to pay the premiums and the policy doesn’t lapse. The reason why this is important is because with term policies, your rates rise over time. This is due to the changes in your health and age. As you get older, your chances of dying increase. Since the life insurance company takes on that risk, they increase the cost of premiums.
With whole life insurance, the premium cost stays the same as long as the policy is in force. Even if you become gravely ill, the cost never changes. It’s guaranteed – as long as you pay your premiums. In fact, as the years go by, the policy actually gets cheaper. This is because of inflation, which erodes the value of money. By having a premium that never changes, you are essentially paying for the policy with “cheaper dollars.”
The cost of term life polices, on the other hand, is only guaranteed until the end of the term – usually 5, 10, or 20 years. After this point, term policy premiums can be raised based not just on your age and health, but also on the rise in inflation.
Cash Value, Taxes, and Dividends
In whole life policies, the premiums paid go toward increasing the cash value and, if you are willing to pay more, increasing the death benefit. Further, your cash value earns interest similar to a savings account.
Your cash value and death benefit can never decrease in value unless you start withdrawing the cash value from the policy, or unless you stop paying your premiums. In this way, your whole life policy is akin to a savings account: When you pay your premium, part of the money goes toward the insurance costs, while the rest goes towards increasing your cash value. This cash value earns interest, which is guaranteed by the insurance company, as is the death benefit. The guarantee is as strong as the company that holds your policy, so financial stability is a key element in choosing an insurance company.
When you put money into your 401k or traditional IRA, you are only deferring taxes, as you pay taxes on all of the money when you withdraw it during retirement. With a whole life insurance policy, you pay the premiums with after-tax dollars. The cash value grows without taxation. You would only be taxed if your withdrawals from the policy exceed what you put into it, and you have the ability to remove gains tax-free by taking a loan off the policy.
The whole life policy pays a dividend. The key thing here, again, is that these dividends aren’t taxed, but are considered returns of premium. So, if at the end of the year the insurance company pays out $1,000 in dividends on your policy, you don’t pay taxes on that money. You can take that money in the form of a check, reinvest it in the cash value of the policy, or use the dollars to purchase additional, paid-up insurance. Those dollars will buy more life insurance, provide a bigger death benefit, and earn interest.
Borrowing Against Your Policy
It is possible to borrow against the cash value of your whole life insurance policy. For example, if you ever find that you are in need of cash, perhaps to help pay for a child’s education, you can borrow money from the cash value of the policy. You do pay interest to the insurance company on this loan, but the loan rates are very competitive with regular bank rates on home equity lines. In most cases, the loan balance can be repaid at the time of death by deducting it from the death benefit.
Also, there’s the potential for tax-free income. By borrowing against the policy, you can take money out of the policy tax-free. Though you will pay interest on the loan, depending on your income tax bracket, it can be substantially lower than what you’d pay in taxes. This also allows individuals younger than 59 1/2 to access income for an early retirement without having to pay hefty taxes and penalties.
Lastly, and particularly appealing to the very wealthy, is the fact that in some states, all or most of the money in a whole life policy is exempt from creditors. In these states, if you are ever sued, that money is viewed as protected because it is intended to benefit someone else: the beneficiary.
The Strength of the Insurance Company
Since whole life insurance policies are a true long-term investment, your relationship with the insurance company will literally last a lifetime. Picking a company with the highest ratings both for financial stability and customer service is the key. Do your homework and make sure that you feel comfortable with your insurance broker. Remember, the guarantees offered in whole life policies are only as strong as the companies who make them.
The highest rated overall insurance companies according to ConsumerSearch.com are as follows:
Disadvantages of Whole Life Insurance
While there are many positive aspects to whole life insurance, there are also some disadvantages to consider:
- The cash value of a whole life insurance policy will not start to build until two to three years of continual premium payments.
- Whole life is much more expensive than other types of life insurance, such as term life. Make sure that the cash value and permanence of the insurance policy justify the excess premiums relative to a term policy with the same death benefit.
- Whole life policies can be extremely complicated and there are subtle differences between policies. Careful research, a solid relationship with the insurance agent, and a clear understanding of your insurance needs and priorities are keys to getting the right policy
- Whole life policies have a “surrender period”: A length of time that you must keep your money with the insurance company before withdrawing it. If you wish to withdraw it before the end of the surrender period, you pay a surrender charge, usually around 10% of the account value. Commonly a surrender period is 5 to 10 years, but you should read the policy carefully to make sure you understand how long this period is on your particular policy.
- Loans are not immediately available. Most policies have a minimum cash balance (typically at least $10,000) and a period of time you must have the policy (typically five years or more) before you can borrow against the policy. Once you have reached these milestones, you can typically borrow up to 75% of the cash value.
The key to deciding whether whole life insurance works for you is to decide why you are buying insurance. In short, if you have a long-term insurance need and you want to supplement your retirement savings and long-range financial flexibility, a whole life policy is a great product.
The key to whole life insurance is to map out exactly what your overall financial picture is before going down that road. Once you have decided to invest in whole life, commit to it and understand its benefits and limitations so you can best utilize the policy to achieve your financial goals. Also be sure to consult a financial professional who is aware of all of your needs and concerns before making this decision.
Do you have a whole life insurance policy? What are some of the benefits that you’re most attracted to?