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All life insurance policies are designed to pay a death benefit to your beneficiaries when you die. But permanent policies — like whole life — are also marketed as investments. They have a cash value component that earns interest over time, but it could be years before you see a meaningful return on your investment.
Whole life insurance is a permanent policy with a savings component. When you pay your premium, a portion is invested to give your policy a “cash value.” The investment is managed by your insurer, who guarantees a rate of return. While your cash value grows tax-deferred and earns interest over time, the growth rate is relatively low compared to other investments. This is because life insurance companies have to cover the cost of underwriting and servicing policies.
One of the perks of whole life insurance is the ability to borrow against your policy once you’ve accumulated enough cash value. But thanks to these administrative fees, the cash value can be slow to grow. For the average policyholder, it can take 10 to 15 years to build up enough cash to take out loans. And though the loans are tax-free, your insurer will charge interest.
If you’re with a mutual insurer, you may also receive dividends on the company’s profits. You can choose to cash them in, use the money to pay premiums or buy paid-up insurance additions. These boost your policy’s value — and in turn, increase the cash value.
In the first 10 to 20 years of your policy, most of your premium takes care of your coverage and fees — the rest goes toward your cash value. Over time, a higher percentage of your premium contributes to the cash value.
The percentage varies between providers and policies. Typically, if you don’t make withdrawals, your cash value will equal the policy’s death benefit when you turn 100.
If you’re thinking about purchasing whole life insurance, it’s best to buy it when you’re young. Otherwise, you might not live long enough to see the returns on your investment.
There are only a handful of situations where whole life insurance works as a sound investment:
The best life insurance companies for high net worth individuals
For most people, a whole life insurance policy isn’t a solid investment choice. Before you sign up for a policy and start contributing to its cash value, keep these drawbacks in mind:
While the “forced savings” part of whole life insurance can help you to stash some cash away, there are options that can offer you a better return in the long run, consider investing in:
Is term life insurance a good investment? In terms of finances, no. A term life policy offers coverage for a set number of years, and it doesn’t have a cash value component. If you outlive your policy, you won’t get any money back. But if you die during the term, your beneficiaries will get a guaranteed payout — so in that way, it can be seen as an investment in your family’s peace of mind. However, term life might be a good alternative to whole life insurance if you’re not looking for a policy with an investment component.
Generally, whole life insurance isn’t the best investment. But if you’re in a high tax bracket and have maxed out all your other tax-advantaged accounts, a whole life policy could help preserve your money. Otherwise, the low rates of return and lack of diversification might not offset the expensive premiums.
If you decide to invest in whole life insurance, compare life insurance companies to get the strongest possible policy.
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