Building financial security for your family is achievable in numerous ways. For example, you could set up a trust, purchase real estate or create a 529 college fund. However, if you’re looking for a financial vehicle with guaranteed returns and a hefty lump sum payment for your beneficiaries, whole life insurance can be an effective investment. It provides you the ability to earn interest in a savings account and receive dividends.
You can consult with a financial advisor to better understand how whole life might work for your unique financial situation.
What Is Whole Life Insurance?
Whole life insurance is a policy that gives coverage for the rest of the policyholder’s life, meaning the death benefit never expires, unlike term life insurance. The policyholder pays a monthly premium, part of which your insurance company adds to a cash savings account. The savings account accumulates wealth over time through interest. While it can provide more protection, with longer terms, it is more expensive than other life insurance options.
How Different Whole Life Insurance Policies Build Wealth
Multiple types of life insurance behave as assets and each one offers different benefits. Here are different types of whole life insurance and how each builds wealth over time.
Whole life insurance: Your death benefit remains active as long as you pay your premiums, meaning the policy will pay a lump sum at the end of the policyholder’s life. In addition, premiums contribute to the policy’s cash value savings account, which usually grows at a rate between 1% and 2%. As a result, purchasing a whole life insurance policy earlier in life allows your savings account to grow significantly. The government doesn’t tax whole life funds until the policy distributes cash.
Guaranteed issue of life insurance: Most types of life insurance require medical exams and might not grant coverage to certain consumers based on health complications or lifestyle. However, guaranteed issue life insurance accepts all who apply. The drawback is the limited death benefit. Generally, these policies pay out a maximum of $25,000. Plus, not all policies accumulate cash value – and if they do, the funds might only be available as a loan.
Universal life insurance: Like whole life, these policies have cash savings accounts. However, policyholders of universal life coverage might be able to modify their death benefit or reduce monthly premiums if their cash value account grows to a certain level. In addition, the savings account can invest in a stock index, giving more opportunities for growth.
Is Life Insurance a Good Investment?
In terms of return on investment, life insurance isn’t the most profitable asset. For example, an individual retirement account (IRA) is expected to return 7% to 10%, and your employer-sponsored 401(k) typically grows at a rate between 5% and 8%. On the other hand, your maximum growth potential with life insurance is 2%. Therefore, it’s recommended to max out your contributions to your IRA or 401(k) before turning to other investment options.
If you have cash left after contributing the highest allowed amount to your retirement account, life insurance might be worth considering, depending on your individual circumstances. While it isn’t technically an investment, it can be a wise financial decision. Because whole life insurance has a cash value account that grows tax-deferred, it can be a potent supplement to your financial plan. In addition, the death benefit protects your beneficiaries, so you can still take care of your children or heirs even if you deplete your finances in retirement.
Plus, if you don’t have a high risk tolerance, whole life insurance can be a solid option. You will never lose value in your cash savings account, as its growth comes from interest, not the stock market. Your insurance company might also distribute annual dividends, cash payments you can spend or invest in any way you choose. Dividends aren’t guaranteed – they are more like icing on the cake. Every time you receive a payment, your investment becomes more fruitful. Lastly, because your monthly premiums never change, you can secure a guaranteed cash value savings account and death benefit at a locked-in rate (unless you purchase universal life insurance, in which premiums can change).
How to Access the Cash Value in Your Whole Life Policy
The cash value of your whole life policy is a source of money you can tap for virtually any reason. For example, you can take out the cash needed to cover 3 to 6 months of living expenses and create an emergency fund. Or, you might want to invest in other assets or even use the savings account to pay for some or all of your life insurance premium.
However, it’s a good idea to consider the drawbacks of accessing the cash value of your whole life policy. The government will likely tax the withdrawal as income for that year. Additionally, withdrawing sizable amounts may cut down your death benefit. Also, using your cash value might not be sufficient to pay premiums over the long haul, putting your policy in danger of expiring because of missed payments. As a result, if you plan to use the cash value in your policy, it’s recommended to frequently check your account to ensure your premium is paid and your death benefit is intact.
If you’ve reached a point in life where keeping your whole life insurance policy no longer makes sense, you can surrender the policy and receive the total value of your cash savings. Remember, the death benefit only kicks in upon the policyholder’s death, so canceling your policy will only give you access to the funds in the savings account.
Other Investment Options
Whole life insurance is just one way to build wealth and increase financial security. However, as an investment, it is generally safer and less profitable. Other investments, like the following, can bring higher risk and better returns:
401(k) plans are only accessible through the workplace and make excellent investment vehicles. Funds come out of your paycheck before taxes and go into the account. Plus, many employers match contributions up to a specific level. For example, your employer might match the first 5% of your paycheck that you contribute to the 401(k). As a result, employer matches allow you to double your investment. So, it’s wise to contribute to the plan to take full advantage of the match.
Individual Retirement Account (IRA)
If your employer doesn’t offer a 401(k) or you’re a business owner, an individual retirement account can function similarly, allowing you to invest in the stock market and save for retirement. You can open an IRA through your bank or shop for one among the other financial institutions and brokerages offering accounts.
There are two kinds of IRAs: traditional and Roth IRAs. How the government taxes each IRA can make one more suitable for you than the other. Traditional IRAs are like 401(k)s: contributions aren’t taxed, but distributions during retirement are. On the other hand, Roth IRAs are post-tax investment accounts. You can only contribute money the government has already taxed, and your capital gains and withdrawals in retirement are tax-free.
If you have extra money for investing after your monthly deposits to an IRA or 401(k), a brokerage account can give you additional exposure to stocks, bonds and other assets. Brokerages are accessible through online platforms, robo-advisors and financial advisors.
Online brokerages, such as Fidelity and Interactive Brokers, allow you to set up an account and run your own portfolio. These accounts are more hands-on, requiring you to assess market data and perform trades based on your own analysis.
On the other hand, robo-advisors are automated investing tools that have low fees and don’t require nearly as much user input. When opening an account with a robo-advisor, you’ll define your investing goals and risk tolerance. Then, the robo-advisor will create an investment portfolio for you and adjust it as needed. The robo-advisor will continue allocating investments according to its algorithms until you change your investment preferences.
Human financial advisors usually cost more than online brokerages or robo-advisors, but they provide holistic financial services. When you sit down with a financial advisor, you’ll create a financial plan that includes a customized investing approach. Your financial advisor will then invest your money (in this case, through a brokerage account) according to your financial goals and meet with you regularly to ensure your financial health stays in top shape.
Is Whole Life Insurance Right For You?
If you already have high-yield investments and can afford the premiums, whole life insurance could be right for you. It’s a good idea only to purchase what you need. So, if the following benefits appeal to you, whole life could be foundational in your financial plan:
Coverage for life
Tax-sheltered savings account with a guaranteed interest rate
Potential for dividend payments
A death benefit that never expires or decreases in value
On the other hand, if premium costs are unaffordable or you won’t need coverage after retirement, term life insurance might be a better option. Term life has cheaper premiums and expires after a set amount of time.
The Bottom Line
Whole life insurance behaves differently when compared to traditional investments. It combines a savings account that accumulates interest and a death benefit that remains the same throughout the policyholder’s lifetime. Generally, retirement accounts are more effective because they offer higher potential returns and specific tax advantages. However, you might already contribute to a retirement account and want to further strengthen your financial position. In that case, whole life is a solid option if you can afford the expensive monthly premiums.
Whole Life Insurance Tips
Whole life insurance is expensive, so it’s best to only pay for the coverage you need. A financial advisor can help you define your financial priorities and pick a policy suited for you. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
As with most financial products, it’s best to shop around before making a significant financial commitment. If you’ve decided that whole life insurance is a good investment, you can get life insurance quotes online. Remember that whole life tends to be more costly, but the premiums you’ll pay can depend on your overall health, lifestyle, and the coverage options you choose.
Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/shapecharge, ©iStock.com/Hailshadow