Is whole life insurance a good investment?

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 as an 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.

Who is whole life insurance best for?

There are only a handful of situations where whole life insurance works as a sound investment:

• You’re a high net worth individual who’s maxed out your 401(k) plan, IRA and Roth IRA options. If you’ve already maxed out the allowable contributions to all your tax-advantaged accounts, a whole life insurance policy can be another way to save for retirement. The cash value earns interest, and you can surrender your policy and collect the cash when you no longer need life insurance. Whole life policies also suit wealthy individuals who want to diversify their investment portfolio with an automated life insurance payment. With whole life insurance, your money isn’t usually subject to stock market conditions, unless you choose an indexed universal life policy. Your cash value grows at a guaranteed rate, and if the market drops, you won’t lose any of your cash value.
• You want to protect an estate worth $11.58 million or more. If your estate hits the IRS’ threshold, it could be subject to federal estate taxes when you die — and your heirs will have nine months to pay the money. Since a whole life insurance policy grows tax-deferred, it’ll provide your heirs with the cash they need to pay the estate taxes without having to dip into their own accounts or quickly sell off other assets.
• You have a lifelong dependent — like a child with special needs. To ensure your child has the financial resources they need when you’re gone, you can set up a special needs trust. An attorney can help you connect your whole life insurance policy to the trust, and you can appoint a trustee to manage the money according to your wishes. It will also ensure they still receive federal and state health insurance as well as Supplemental Security Income (SSI).

The best life insurance companies for high net worth individuals

The downsides of whole life insurance as an investment

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:

• It takes a long time to build cash value. In the early years of your policy, administrative fees and agent commissions eat up most of your premium. It’s only after the insurer takes care of their bottom line that they start putting a portion of your premium toward the cash value component of your policy. This means that it might be a decade before you break even on your investment, and another decade before you accumulate a meaningful cash value. If you’re searching for an investment that can offer positive returns from the get-go, a whole life policy isn’t the best fit.
• The rate of return is low. While your cash value isn’t subject to the ups and downs of the market, the guaranteed rate of return is typically low. If you’re looking for a high-interest investment, you can most likely earn higher rates of return by funneling your money into other assets, like stocks, bonds, foreign exchange, commodities and real estate.
• It’s not a diversified investment. With whole life insurance, the investments are out of your control. You can’t choose the investments or decide how much of your money you’d like to invest. Basically, you’re putting all your eggs in one basket — the insurer’s — and relying on their investment managers to produce good returns for you. Plus, the insurer takes a cut of the profits they make in the form of administrative fees.
• It’s expensive. Whole life insurance is typically six to 10 times more expensive than term life. If coverage is your top priority, you’re better off purchasing a term life policy for the years that you need it — and investing your money in other investment vehicles.

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Alternative investment options

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:

• A mutual fund. A mutual fund is linked to the stock market, but it earns compounding interest — which means your money might grow at a faster rate than with a whole life policy.
• Variable life insurance. With variable life insurance, you can invest your cash value into subaccounts of your choice. Like whole life insurance, variable life offers lifelong coverage and a death benefit. But it’s subject to the market and the returns aren’t guaranteed, so it’s a more aggressive investment. If your investments do well, your cash value could increase significantly. If they don’t, you could be hit with a loss.
• Universal life insurance. Universal life insurance offers many of the same features as whole life insurance, including lifelong protection and a cash value component. It’s more flexible, though. You can adjust your premiums and coverage as needed, and select your investments from a portfolio presented by your insurer. The interest rates might fluctuate over time and your insurer will cap your cash value returns. To make sure you’re getting a good deal on your policy, ask about the “participation rate” before committing.
• Variable universal life insurance. This hybrid policy has the highest risk and highest potential return. It offers flexible premiums and the ability to choose your investments, but your cash value is linked to market performance. It also requires you to be more hands-on with your policy. If you have prior investment experience, a high risk tolerance and a healthy savings account, it could be worth looking into variable universal life insurance.

Bottom line

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.