Why Whole Life Insurance Is a Bad Idea

Nearly everyone can benefit from the protection of life insurance. At a minimum, your relatives may need the proceeds of a policy to pay for your funeral expenses after you die. A large enough policy can also replace your income, settle debts and fund college education for your children. The key to becoming adequately insured is to choose the policy and death benefit size that fits your needs. You may hear people say that whole life insurance is a bad idea because this type of policy isn't the best option for certain individuals. Getting the facts about whole life helps you determine if it's the right choice.

Why Whole Life Insurance Is a Bad Idea but Frequently Sold

Before you can fully understand why people claim that whole life insurance is a bad idea, you need to understand how it works and know about its most common alternative: term life.

• Whole life is permanent insurance that remains in place throughout your life if you continue to pay your premiums. Over time, the life insurance builds up a cash value.
• Term life insurance lasts for a limited period known as the term. At the end of the term, the policy expires. To continue to enjoy the protection of life insurance, you must renew or apply for a new policy. Term life doesn't build cash value.

Insurance agents often push clients toward whole life insurance. Agents usually receive pay based entirely on commission, and they tend to make more if they sell whole life than term. Because whole life insurance is unlikely to harm the insured, agents aren't shirking their duties by emphasizing the benefits of this type of coverage. Still, you should carefully examine both term and whole life before making a buying decision.

What Are the Disadvantages of Whole Life Insurance?

Some of the disadvantages of whole life insurance include the following.

Cost

Premiums for whole life insurance are generally much higher than what you'd pay for term life with the same benefit because a portion of the payment goes into the cash account. The main reason to buy life insurance is to pass money on to your loved ones, and with whole life, you may pay 6 to 10 times as much per month to do so.

Low Interest Rates

Whole life insurance does give you interest on the money in your cash account. However, the percentage is usually lower than what IRAs, 401(k)s and other retirement accounts pay. You also won't have a say in how the money is invested. The insurance company simply places the money in an account and pays the specified interest while they invest it elsewhere and make a much higher rate of return to bolster their profits. Generally, you'll earn more if you buy term life and put the money you save on premiums in another type of investment.

Many People Don't Need Permanent Insurance

Most insurance companies offer term life for up to 30 years, and a few now have 40-year terms available. For most people, one of these long-term policies will provide adequate insurance for the years when they have the most financial obligations.

For example, say you're 35 years old and purchase a 30-year term life policy. It will expire when you're 65. At this point, you have Medicare to help cover your medical expenses, and you're eligible for Social Security to supplement your monthly income. You can also now make withdrawals from retirement accounts. If your mortgage isn't paid off, it's likely paid down, and your children are probably financially independent. You may no longer need life insurance at all, or you could get by with an inexpensive burial insurance policy that will cover your final expenses.

Using the Cash or Borrowing Against It Decreases Your Death Benefit

Life insurance agents often stress the fact that you can withdraw from your cash account or borrow against it if you need money. These statements are true, but they leave out an important detail. Life insurance companies reduce the death benefit when you withdraw funds, and if you take out a policy loan and don't pay it off, the money you owe will be subtracted from the face value. Using the cash to secure a loan or cover expenses means passing on less money to your loved ones.

You Can't Pass on the Cash

If you have a retirement account or another type of investment, your beneficiaries can inherit it when you die. With whole life insurance, any cash value remaining in the policy doesn't go to your loved ones. The insurance company takes it back. A separate investment account and a term life insurance policy allow you to pass more money on to your heirs.

Cash Value Takes Time to Accumulate

Another supposed advantage of whole life insurance is that if you surrender your life insurance policy, you can receive money back. Under most circumstances, the cash value won't become significant until you've had your life insurance policy for 15 to 20 years. If you cancel before then, you likely won't recoup the total amount of premiums that you paid in.

What's Better: Whole Life or Term?

Life insurance isn't one size fits all. Term is the better option for many people, but whole life is the right fit for others. You may want to consider a whole life policy if:

• You have problems saving money on your own. A whole life policy will force you to save by crediting a portion of your monthly premiums to a cash account.
• You have an adult dependent who will need care after you die. If you have a child or other dependent who relies on you for financial support due to a disability, you may benefit from whole life insurance because it lets you pass on a large payout to cover their care.
• You have a high risk for future medical problems. Your health is usually better when you're young than it is when you get older. For those with a family history of serious medical problems, it may make sense to lock in the coverage of a whole life policy for a lower rate when you're young. Should your medical problems interfere with your ability to work in the future, you may not have a retirement account or big enough Social Security payment to fall back on.