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Whole life insurance offers coverage and accumulates a cash value over time.
This type of permanent life insurance may suit high net worth individuals and parents with lifelong financial dependents.
Depending on your budget, the low rates of return might not offset the high premiums.
On the surface, life insurance is a simple concept: You pay an insurance company a premium and, when you die, the company pays your beneficiaries. But whole life insurance also features a cash value component, which is where things can get complex.
These policies earn interest in a tax-advantaged account and offer guaranteed returns, but they’re expensive and not suitable for most people.
» MORE: Whole life insurance definition
How whole life insurance works as an investment
Whole life insurance provides permanent coverage that accumulates a cash value.
When you pay your premium, the insurer invests a portion to give your policy a cash value. The cash value grows over time at a fixed rate guaranteed by your insurer. It’s tax-deferred, which means that any interest you earn isn’t taxed, as long as you keep the funds in the policy.
Once you’ve accumulated enough cash value, you can begin to take out loans against your policy. While you don’t need to pay back these loans — it’s your money — your insurer will subtract any outstanding loans from the payout when you die. You’ll want to make sure you don’t borrow too much against your policy to avoid running into issues later on.
If you choose to buy a policy from a mutual life insurance company — an insurer that’s owned by its policyholders — you might receive dividends based on the company’s financial performance. You can cash them in, use them to pay premiums or buy additional insurance to boost the face value of your life insurance policy. If you choose that option, your cash value will increase as well.
When is whole life insurance worth it?
Whole life insurance can make sense as an investment in these situations.
You’ve maxed out your retirement accounts
If you’re a high net worth individual who has made all the allowable contributions to your tax-advantaged accounts like 401(k) plans or individual retirement accounts, you could use a whole life insurance policy to top up your tax-deferred savings.
The cash value will earn dividends or interest over the years, and when your children are adults, your mortgage is paid off or you no longer need life insurance for whatever reason, you can surrender your policy and collect the cash. If you surrender the policy, be aware that you will most likely be subject to income tax on the value it has gained, and your beneficiaries won’t receive a death benefit when you die.
You have a lifelong dependent, such as a child with a disability
Life insurance can offer peace of mind to anyone with financial dependents. If you’re a parent caring for a child with a disability, a whole life insurance policy might suit your situation as it typically provides lifelong coverage, giving your family a sense of financial stability.
To ensure your child is still eligible for government benefits, like Supplemental Security Income, avoid naming them as your beneficiary. Instead, consider setting up a special needs trust. An attorney can help you place your whole life insurance policy into the trust, and you can appoint a trustee (such as a guardian) to manage the money on behalf of your child.
You want to help your family pay estate taxes
Is your estate worth $12.92 million or more? That’s the federal tax exemption limit for 2023, so the IRS might levy an estate tax on any assets above the threshold when you die.
In addition, some states charge their own estate or inheritance tax. For example, New York’s estate tax kicks in after $6.58 million.
Thanks to the cash value component, whole life insurance is a form of “forced savings.” Whether you hold the policy until you die or surrender it for cash when you retire, whole life insurance can give your loved ones the money they need to pay estate taxes without having to dip into other accounts.
You want to diversify your investment portfolio
The cash value on a whole life insurance grows at a set rate, and returns are dependable. They’re not subject to the ups and downs of the market, so you won’t lose any money if the market takes a turn.
This differs from other permanent policies, like variable life insurance and variable universal life insurance. With these policies, the cash value grows at a variable rate, meaning returns are subject to market conditions and aren't guaranteed.
» MORE: Average life insurance rates
The drawbacks of whole life insurance as an investment
While whole life insurance has its perks, it’s not the right policy for most people. Before you sign up for a policy, be aware of these downsides.
The premiums are expensive
The cost of whole life insurance tends to be much higher than term life insurance. For example, a healthy 40-year-old man can expect to pay an average annual premium of $7,028 for a $500,000 policy, while a woman of the same age might pay $5,937, according to Quotacy, a life insurance brokerage. To compare, a term life policy for a healthy 40-year-old would cost $334 for a man and $283 for a woman, on average.
If you’re purely interested in life insurance coverage, you might be better off buying a term life insurance policy and funneling the savings into other investment vehicles.
The cash value is slow to grow
For the first few years, your insurer will direct a chunk of your premiums to fees, commissions and other administrative costs. Eventually, a higher percentage of your premium will go toward your cash value. But this takes a while, so it can take 10 to 15 years (or even longer) for you to build up enough cash value to borrow against.
If you’d prefer an investment that offers positive returns quickly, you’ll want to look elsewhere. And if you are interested in the relatively low but predictable returns offered by whole life insurance, try to buy a policy while you’re young so you have plenty of time to reap meaningful returns on the cash value.
The cash value rate of return can be low
The average annual rate of return on the cash value for whole life insurance is 1% to 3.5%, according to Quotacy. While whole life insurance offers fixed, guaranteed returns on your cash value, you may earn higher returns with other investments, such as stocks, bonds and real estate. Consult a fee-only financial advisor to learn about tax-advantaged investment options that suit your risk tolerance.
You can’t control your portfolio
With whole life insurance, the insurance company declares the dividend or interest rate and professionally manages the investments for policyholders.
On one hand, this makes whole life insurance a hands-off product. But if you’re a seasoned investor, you may not like relying on your insurer’s investment managers to deliver returns for you.In that case, you could consider policies that allow you to select investment subaccounts from a portfolio presented by your insurer. These include indexed universal life insurance, variable life insurance and variable universal life insurance, which typically have the highest risk and highest possible returns for life insurance.
There can be tax implications if you withdraw cash from your policy
Generally, you only pay taxes on the cash value if you access it — and the IRS only charges a tax on the amount that exceeds the policy basis. This is the amount of money you’ve already paid in premiums, minus any dividends you’ve received.
If you withdraw less money than the policy basis, those funds are yours, tax-free. But any withdrawals over that are subject to income tax. You may also pay taxes if you surrender your life insurance policy, or if you borrow against your life insurance and don’t repay the loan. Speak to an accountant to learn more about how whole life insurance can affect you at tax time.
» MORE: Is life insurance taxable?
More about whole life insurance
Check out these additional resources about whole life insurance.