When comparing whole life insurance to term, some publications and financial gurus get hung up exclusively on price. Price is, of course, a completely legitimate consideration.
But it doesn’t tell the entire story because whole life and term life are fundamentally different products and, frankly, whole life provides benefits going far beyond the conditional death benefit that comes with a term policy.
Apples to Oranges
It’s like comparing an old-school flip phone to a modern smartphone and concluding the flip phone is better because it’s cheaper.
Sure, if the only things you’ll ever do with your phone are make calls and send the occasional text, saving money with a flip phone might make sense.
But there’s a lot of supplemental value in all the additional features and functions of a smartphone. So, if price tag is all you’re looking at, you’re not getting an altogether valid comparison.
Term life is the life insurance equivalent of a flip phone. It’s intended for one purpose—to serve as a financial safety net for your loved ones in the event of catastrophe.
Whole life, though, is designed as a multifaceted, versatile financial asset. Alongside the death benefit, you also get a wealth-building cash value component that can be tapped for retirement, leveraged for access to low-interest credit, used as a tax-advantaged estate-planning tool—or some combination thereof.
Just a heads up at the outset. Many in the financial world will refer to as ordinary life insurance, but as you will see, it is anything but.
So, let’s take a more thorough look at whole life, all of its benefits and drawbacks, and how a whole life policy can be incorporated within an overall financial plan.
We’ll occasionally compare characteristics of whole life and term life to clarify a point, but, keep in mind, it’s really apples-to-oranges because the two products are designed to meet different needs.
Contractual Structure of Whole Life
When you consider the different types of life insurance policies available, the two main categories are term and permanent insurance.
Whole life insurance is permanent insurance, which means the policy is designed to remain in force for your lifetime.
When you buy a whole life policy from a mutual life insurance company, you are buying a small ownership interest in that company. It’s akin to purchasing shares in a corporation or becoming a member of a credit union. Like shareholders, policyholders have a right to share in company earnings and even to vote on some matters of corporate governance.
The best whole life insurance companies periodically issue policyholder life insurance dividends, which are fractional interests in the company’s profits. When you receive a dividend, you’re free to use it however you like, including accepting it in cash or investing it back into the policy.
By contrast, term insurance is a simple, arms-length contract between you and the insurance company. If you die during the policy’s coverage term, the company pays the death benefit to your beneficiaries. And that’s about it—there are no ancillary financial benefits like with whole life.
Fixed Whole Life Premiums
Whole life premiums are set in stone when a new policy is issued and fixed at that same rate for the policy’s entire duration, regardless of how long that ends up being. You don’t have to worry about the insurance company jacking up the premiums as you get older.
And, especially if you buy a policy relatively early in life, you know you’ll have affordable life insurance coverage for the rest of your life.
The budgeting certainty provided through fixed premiums is particularly valuable for retirees living on a fixed income.
Whole Life to 100
The majority of whole life policies calculate premiums through age 100. That is, premiums are calculated so that the policy is paid in full around the time of the insured’s 100th birthday—which typically means premiums are due through the end of the insured’s life.
Limited Pay Whole Life
“Limited pay” is an alternative premium structure that results in payments that are a little higher but that are calculated to end earlier in life. Once the end-date is reached, the policy stays in place, retaining its full value, but no additional premiums are owed.
Most policies include a “reduced paid-up” (RPU) option that gives you the right to accept a lower death benefit in exchange for relief from any further obligation to pay premiums.
By way of example, you might buy a whole life policy with a $50,000 death benefit and keep it in place until your children have moved out and no longer rely on you financially.
At that point, you could exercise an RPU option reducing the death benefit to $30,000 but letting you keep the coverage without paying any additional premiums.
The Typical Argument Against Whole Life
Compared to term coverage, whole life requires higher premium payments (or you receive a lower death benefit for the same premiums—however you want to look at it).
Indeed, higher payments is the number one objection to whole life voiced by celebrity personal finance pundits like Dave Ramsey and Suze Orman.
Instead, they tell you to “buy term and invest the difference,” a marketing slogan created by billionaire Arthur Williams, Jr., who made his fortune selling term life insurance.
It’s simple enough advice, but it ignores both the additional financial benefits provided by whole life and the advantages of fixed premium payments.
Term life is certainly cheap when you’re young and healthy, but term life insurance rates can (and often do) increase dramatically as you age—making it practically impossible for some term policyholders to keep coverage in place as long as they want or need it.
If you buy a whole life policy when you’re 40 years old, you’ll be paying the same rates when you’re 50, 55, 65, or any other age (and you will have built up an impressive store of cash value to boot).
By contrast, premiums for term coverage will be significantly cheaper than whole life when you purchase a policy at age 40.
But, when you’re 65, rates for the same amount of term coverage could be literally ten times as much—and the term premiums will likely run higher than if you’d purchased fixed-premium whole life coverage to begin with.
Even if you buy a term policy with an extended coverage term (which itself requires notably higher premiums), you’ll eventually reach a point where either renewal sends the premium payments through the roof or you’re no longer able to renew at all. With fixed-premium whole life, that’s never a concern.
Guaranteed Death Benefit
Of course, another reason term life is often cheaper is that there’s no guaranty a policy will ever pay out. You send check after check to the insurance company, but the insurer is more likely than not to never send one back (to you or your beneficiary).
With whole life, you know for sure that, one way or another, either your beneficiaries will receive the policy’s death benefit or you will reap the rewards of the policy’s steadily growing cash value.
Permanent, Guaranteed Life Insurance Coverage and Death Benefit
Unless it lapses for non-payment or is voluntarily cashed out by the policyholder, a whole life policy is absolutely assured to stay in place for your “whole life.” It doesn’t matter how old you get; you’ll never reach an age at which you don’t have life insurance.
Likewise, only permanent life insurance like whole life guarantees that, when you die, insurance proceeds will be available for your beneficiary or estate. The death benefit is guaranteed.
It takes effect when the policy is issued, often growing through dividends and earnings throughout the life of the policy, and then provides an income-tax-free cash legacy to your beneficiaries when you die.
A substantial source of guaranteed cash can be crucial in multiple contexts. You might be supporting a disabled child (minor or adult) and need the wealth to continue the support after death without affecting Medicaid eligibility.
As a business owner, you might need liquidity to give the business time to adjust to the loss of a key person—or to purchase a deceased partner’s share pursuant to a buy-sell agreement.
Or, you might want to protect your loved ones from the financial burden of estate administration, funeral expenses, or estate debts and taxes.
Cash-Value Savings Component (“Forced Savings”)
Along with a guaranteed death benefit, whole life’s other feature attraction is the cash value it accumulates.
Also called “cash surrender value,” a whole life policy’s cash value is basically the amount of money you’d get from the insurance company at any given time if you opted to surrender the policy (and forego the future death benefit).
Importantly, cash value isn’t just a theoretical number—it is a genuine financial asset that provides real-world value even if a policy isn’t actually surrendered.
With each premium payment, cash value increases—building slowly at first and then gaining momentum as the policy matures. It’s sometimes described as “forced savings” because you don’t have to consciously choose to contribute to cash value. It automatically increases every time you pay your whole life insurance premium.
What Happens to the Cash Value When You Die?
Critics sometimes cite as a drawback of whole life that, when an insured person dies, the beneficiary receives the death benefit—not the death benefit plus the cash value. This is because cash value and death benefit are linked but distinct, like two sides of the same coin.
More precisely, you might say a death benefit is a guaranteed right to receive a future payment upon the insured’s death, and cash value represents the amount of that future payment that’s already vested—even without the death benefit being triggered.
It’s analogous to how, with each mortgage payment, you build up equity in your home. The equity is a real asset that you can tap if needed, but it doesn’t exist independently of the actual value of the real estate. When you sell, you don’t receive the home value plus the equity—they’re part and parcel of the same asset.
Another similarity to wealth stored as home equity is that cash value is fully or partially exempt from creditor attachment in almost all states.
So, if a creditor has a judgment against a whole life policyholder, the creditor cannot seize the policy’s value to satisfy the judgment (or, depending on the relevant state, can only attach the value in excess of the statutory exemption amount).
Depending on the jurisdiction, whole life provides a means of accumulating significant savings outside the reach of creditors and which can even survive a bankruptcy case.
Guaranteed Cash-Value Growth
Cash value doesn’t increase only because part of each premium is applied toward cash value. The money that’s already there also earns guaranteed growth at a fixed interest rate. And growth compounds over time, so you’re effectively earning interest on interest.
Critics of whole life assert that returns are below what you would see if you invested in stocks or mutual funds.
It’s true that whole life guaranteed rates are below average long-term stock market returns, but that’s not all that fair of a comparison.
In the stock market, you run the risk of making a bad investment and losing money—or the market could tank generally.
With whole life, you have no risk of loss, and you don’t have to worry about market volatility.
You can still put other wealth into more high-risk / high-reward assets, but diversifying your financial portfolio with a stable, reliable asset like a whole life policy is a good way to mitigate the risk of a bear market.
And it’s worth pointing out that policy returns often exceed amounts guaranteed by the insurance company—particularly when factoring in dividends.
Control Over and Ready Access to Cash Value
Easily accessible and highly liquid cash value allows whole life insurance to work as part of an overall wealth-building strategy. You don’t have to just leave cash value alone, earning interest throughout the life of a policy.
Rather, you can access it at essentially any time, whether by making a partial withdrawal from the policy, taking a loan against cash value, or leveraging cash value as collateral for a loan from another lender.
By comparison, accessing wealth stored in home equity is much more difficult and often expensive. Even CDs impose an early withdrawal penalty if you don’t wait out the entire term. And, of course, IRA and 401k withdrawals come with a hefty tax penalty if you haven’t yet reached retirement age.
Use Cash Value to Buy Assets
Cash value’s relatively easy and low-cost liquidity can be leveraged to facilitate acquisition of other assets. This strategy has become quite popular with a certain niche community of people who practice a concept called infinite banking.
As an example, you might use a policy loan to obtain a new, income-producing asset. You retain the interest-earning cash value and death benefit in your policy by using a policy loan, and ideally cashflow from the new asset can be applied toward paying back the loan.
An important but often-overlooked feature of whole life policy loans is that loans are tax-free but repayment is more or less discretionary.
If a policy loan isn’t repaid, the outstanding amount is paid back from the death benefit, reducing the amount received by beneficiaries.
In the retirement planning context, this feature lets you keep a policy in place but tap its value to help fund retirement through policy loans. It’s like taking an advance on the death benefit knowing that, whatever you end up not needing, will be there for your heirs when you’re gone.
Policyholder Flexibility in Allocating Whole Life Dividends
As one of the perks of being a policyholder, participating policies from mutual insurance companies receive regular life insurance dividend payments.
While dividends are not guaranteed, some insurers have nearly flawless track records in issuing them, so it’s a good idea to check out a company’s historic dividend payments when deciding on a policy.
When you receive a dividend, you have multiple options for deciding how to apply it.
For long-term wealth building, investing it back into the policy by purchasing a paid-up addition is often the best approach.
Essentially, you get a miniature policy attached to your regular policy that’s already paid-in-full. The addition increases the policy’s death benefit and cash value, and the amount from the dividend immediately begins growing, further adding to the policy’s growth potential.
Alternatively, you can take a dividend in cash and invest, spend, or save it however you see fit. Cash derived from a dividend is not considered taxable income.
Or, dividends can be applied toward annual renewable term coverage, increasing the death benefit available to beneficiaries for as long as the term coverage stays effective.
Other options include applying dividends toward outstanding policy loans, current premium payments (reducing your next premium payment), or just letting the insurance company hold onto the money in a separate account and pay you interest.
Tax Advantages of Whole Life Insurance
In general, life insurance is treated kindly by the IRS and most state taxing authorities. When a death benefit payment is received by beneficiaries, it is not taxable income, whether from a term or whole life policy.
Policy proceeds may be subject to estate taxes if the estate is large enough (2020’s federal exemption amount is $11.58 million, so most estates don’t qualify). However, there are estate-planning strategies available to keep insurance proceeds outside of the taxable estate.
A whole life policy’s growth is “tax-deferred,” which means policy growth isn’t subject to income tax until it is actually received.
Favorable tax treatment makes whole life a useful tool for retirement planning—especially for people who need to catch up and have maxed out contribution limits for a traditional or Roth IRA.
If you decide to cash out a policy or make partial withdrawals, whole life gets advantageous FIFO (“first-in-first-out”) accounting treatment under IRS regulations.
As a result, you don’t owe any income tax for any funds withdrawn from a policy all the way up to the total, aggregate premium paid in.
Your combined premium payments constitute your “basis,” and any withdrawals up to that amount are considered nontaxable “return of premium.”
If you surrender and cash out a policy entirely, you’ll owe income tax for the growth but not for the rest.
A popular option for retirees is to “roll over” an existing whole life policy into an annuity through a 1035 Exchange.
The policy’s cash value transfers to the annuity, and the existing growth (which would otherwise be taxed upon withdrawal) is applied toward the annuity’s lump-sum premium.
Then, you receive the annuity payments either for a fixed number of years or for the rest of your life (depending on the specific annuity), and income taxes due for the growth are spread out over the life of the annuity.
Commissions and Fees for Whole Life
Celebrity personal finance pundits who dislike whole life occasionally point to the “high commissions” earned by agents when selling policies.
Based on your policy design, whether you are looking to maximize death benefit or cash value, can also greatly influence your agents commission. Policies focused on cash value growth, utilizing paid-up additions, may pay agents 50% less commission or more.
And commissions vary by company and the precise policy sold, but it’s not unusual for an agent to earn a higher commission for selling a more sophisticated whole life policy than for selling relatively simple term policy.
However, if when you evaluate whole life insurance rates, the coverage provided, and the guaranteed cash-value growth, a whole life policy looks like a smart decision, the commission the life insurance company pays to the selling agent doesn’t make it less so.
If you find a good deal from a car dealership, it doesn’t turn into a bad deal just because that dealership happens to pay their sales people higher commissions for selling that particular vehicle.
Along the same lines, whole life usually does have notably higher start-up costs than a simple term policy. Most of the associated fees are front-loaded—coming out of early premium payments and slowing the initial accumulation of cash value.
Before long, though, this balances out, and fees as a percentage of total premium and policy value decrease significantly as a policy matures.
Fees are definitely something to consider, and early fees can make whole life insurance less attractive as a short-term savings vehicle.
It’s important to remember, though, whole life is designed to work as part of a long-term financial strategy, offering near-term protection through the death benefit and long-term wealth-building through compounding cash value and dividends.
Living Benefits Available with Optional Riders
Life insurance riders are contractual addendums or add-ons that you can choose to incorporate within your whole life policy.
In a nutshell, riders allow policies to meet needs not met by a standard policy—often by expanding or accelerating coverage upon the occurrence of a particular event.
Riders sometimes require additional premium payments.
Terminal illness, chronic illness, and long-term care riders are three of the most popular and useful riders which can sometimes be referred to as Living Benefits.
A terminal illness rider accelerates a policy’s death benefit in the event the insured individual is diagnosed with a terminal illness (usually defined as 12 months to live or less).
Basically, the benefit is paid out early—in whole or in part—rather than waiting for the insured’s death. With most policies, terminal illness riders do not require any additional premium.
Chronic illness riders work similarly, but instead accelerate the death benefit upon a chronic illness diagnosis (typically defined as an inability to perform two of six “activities of daily living”).
Long Term Care
Long term care riders also accelerate death benefits, allowing access to policy proceeds if an insured’s condition requires long term healthcare, such as a skilled nursing facility.
For some people, whole life insurance is the better choice because it offers leveraged death benefit protection, but also cash value growth.
The point of this article detailing out the pros and cons of whole life insurance was not to may you an expert. Rather, it was to show you our expertise so that you know when you call us we can help you find the best life insurance policy for you, based on your unique goals and needs.
So what are you waiting for? Give us a call today for a complimentary strategy session and experience the IBUSA difference.