When Is Whole Life Insurance a Good Investment Strategy?

Insurance, Life Insurance
When Is Whole Life Insurance a Good Investment Strategy?

On the surface, life insurance sounds like an easy concept to grasp — you pay an insurance company a monthly or annual premium, and upon your death, the company pays out a sum to your beneficiaries.

But permanent life insurance policies such as whole life insurance also contain an investment component, and that’s where things can get confusing. Some of the money paid into your whole life policy accumulates “cash value” in the form of a tax-sheltered investment account that the policyholder can borrow against. Insurance companies tout these policies as not only a way to leave a financial legacy to your heirs, but also as a good investment tool.

Critics of this strategy point out that returns on these investments tend to be lower and fees higher than with other investment vehicles and that term life insurance — a cheaper life insurance option that only covers a certain number of years and does not contain an investment component — is a better fit for most people.

We asked financial advisors Steven Elwell, Damon Gonzalez and Brian McCann, who are members of NerdWallet’s Ask an Advisor network, for their opinions on whether whole life insurance is a smart way to round out your overall investment strategy.

Should everyone consider a whole life insurance policy as part of their retirement savings strategy?

Steven Elwell: While everyone can consider a whole life insurance policy as a part of their retirement savings strategy, for the vast majority of people there will be other, more attractive options to use first. For most, their employer’s 401(k) will be the first choice, especially if there is an employer match, which is essentially free money. After that, IRA and Roth IRA accounts should be the next consideration.

Brian McCann: There are some very important reasons to have a whole life policy, such as estate tax issues, care for a disabled child or dependent, and liquidity for closely held businesses. If you need a whole life policy for such a reason, you may also be able to benefit from the cash value that builds up in the policy for retirement. But I generally do not encourage people to save for retirement using life insurance policies. They can be an expensive way to save.

Damon Gonzalez: I don’t recommend these policies for everyone. Most Americans cannot afford to buy the appropriate amount of life insurance coverage through whole life insurance alone. The median income in the U.S. is about $54,000 per household, and I think only the top 20% of income earners should consider whole life. Term insurance is cheaper and is almost always the best type of insurance for 80% of the nation.

In what situations and for which people would whole life insurance be an appropriate choice?

Steven Elwell: For very-high-income people who have maxed out their 401(k) plans, IRA and Roth IRA options, a whole life insurance savings strategy can make sense, especially if they have a need for life insurance. Another viable option for high-income individuals could be the use of a tax-deferred, nonqualified annuity if they don’t have a need for life insurance.

» MORE: How to find the best whole life insurance policy

Damon Gonzalez: I typically recommend this strategy to people who are already maxing out their 401(k) plans, Roth IRAs (if they are eligible) and 529 plans (if they have children). The cash value is protected from creditors in many states. It also makes sense for someone who has built a good nest egg and wants to diversify part of his or her portfolio into permanent insurance. If you are in a high tax bracket, are risk-averse and will be happy with bondlike returns, you should look at whole life.

What are the main disadvantages of whole life as a retirement savings strategy?

Steven Elwell: Whole life insurance can come with high premiums and high investment costs when dealing with variable universal life insurance. Many times, an investor can find substantially less expensive investment options outside of life insurance. The longer the investment time frame, the more important these investment costs become.

Damon Gonzalez: The insurance company is expecting the premium you commit to each year, and they aren’t very flexible. Your policy could lapse if you lose your job and can’t make premium payments anymore. It is important to keep in mind that you are paying for life insurance, and the cost of insurance will be a drag on your overall performance.

Anything else consumers should keep in mind when considering this?

Damon Gonzalez: If you are going to purchase a whole life policy, there is a plethora of riders and acronyms involved, and you should hire an honest advisor who has experience designing policies to maximize cash value. The advisor will need to access different insurers’ illustration software to design the best policy for you based on your health, age and how much you want to save. You can receive drastically different illustrations from agents that represent the same company, so don’t be afraid to shop around.

Steven Elwell: Consumers should keep in mind that many people calling themselves financial advisors have a financial incentive to sell whole life insurance as a retirement strategy when other avenues have yet to be utilized. I would caution investors that “buyer beware” should apply when an advisor appears to be pushing a product without reviewing other, less-costly options.

Brian McCann: If you don’t need permanent insurance, term insurance is a very affordable option. You can invest the money you save on premiums to build a retirement nest egg. If you haven’t maximized your tax-favored accounts, such as an IRA or 401(k), then you can also get tax benefits on your contributions.

Steven Elwell is a certified financial planner and vice president at Level Financial Advisors in Amherst, New York.

Damon Gonzalez is a certified financial planner and president of Domestique Capital in Plano, Texas.

Brian McCann is a certified financial planner and principal at Bootstrap Capital in San Jose, California.