Expert weighs in on who should – and shouldn’t – get whole life insurance

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Many people have questions about whole life insurance. But these policies are easier to understand by first understanding how insurers charge for whole life  insurance and how they invest policy account values.  

Whole life insurance is a type of cash value life insurance that has a fixed premium calculated by the insurance company. As long as those premiums are paid, either by the policyowner or by excess policy account values, the insurer will pay out the death benefit when the insured passes away.  

But note, the premium is not the cost of the insurance, and instead is the level amount the insurer guarantees will cover all the costs of the policy over the life of the policy.  

Like all forms of cash value life insurance, insurers deduct cost of insurance (COI) charges from the premium payments. The insurer also deducts policy expenses for placing and administering the policy. What’s left over is deposited into the policy account.  When an insurer of a whole life policy pays out death claims that are less than the COI charges collected and/or incurs operating expenses less than policy expenses collected, the insurer refunds these differences in the form of a dividend.  This dividend can also include interest the insurer earned that exceeds the minimum interest guaranteed in the policy contract.  

While these COI charges and policy expenses are generally not disclosed in whole life products, the lower the COI charges and policy expenses, and the greater the interest, the greater the dividend, and the more the cash value grows in the policy account.  

There are other benefits as well

Like all forms of cash value life insurance, a significant benefit of whole life products is the growth of cash value over time. Compared to other types of cash value life insurance, the most significant benefit of whole life policies are the premium and death benefit guarantees. As long as the policyowner pays the premium listed in the policy contract, the insurer guarantees will pay out the death benefit.  

However, while it’s guaranteed that the premium won’t increase, the number of premiums that will be required from the policyowner to ensure death benefits are paid is generally not guaranteed.  For instance, while whole life premiums must be paid one way or another for the whole life of the policy, when dividends become sufficient to pay the premium, the policyowner is then relieved from paying the premium. However, if dividends decrease, as has often happened over the past 30 years, the policyowner again can become responsible for premium payment.  

Some agents, brokers and insurers “blend” term insurance into whole life policies, which reduces the cost of the “quoted” premium, but also means that the premium you’re quoted is no longer guaranteed. Make sure to understand whether or not the premium you’re quoted or paying is guaranteed to stay the same over the course of the policy, as well as the number of premiums required to guarantee your beneficiaries receive the death benefit.  If the amount of the premium is not fully-guaranteed, then be sure to understand just how high premiums can be increased.  

How whole life insurance policy can increase and protect wealth

Whole life products, like all forms of cash value life insurance, offer several tax advantages useful for increasing and protecting wealth. For instance, cash values grow tax-free, and can be withdrawn tax-free up to the amount of premiums paid – even the otherwise taxable gains can be borrowed tax-free.  

In addition, death benefits are also received by the beneficiaries tax-free, and can be used to repay any policy loans. In other words, the taxation of a whole policy is similar to the taxation of a Roth IRA, which is often used to increase and protect wealth. However, the rules governing what you can be charged and what you’re permitted to invest in are dramatically different for a Roth IRA than a whole life policy.

Whole life policies and Roth IRAs also have dramatically different rules governing what you’re required to be told about costs and performance. As such, beware life-insurance-based wealth accumulation programs which promote the above tax benefits, but fail to disclose the costs you will be charged and the performance that’s reasonable for you to expect. 

If your advisor isn’t already providing you with a benchmarking of costs and performance, ask them for a Veralytic report or click here to connect with a Veralytic advisor.  

So who should and shouldn’t get a whole life insurance policy?

Invested assets underlying whole life products are required by regulation to be allocated predominantly to high-grade bonds and government-backed mortgages. In other words, assets underlying whole life cash values are required by regulation to be allocated to conservative investments, which generally include stable-value and fixed-income assets that offer lower rates of return in exchange for greater security of principal and greater certainty of return. 

Because of this, whole life products are most appropriate for consumers with a conservative risk profile (i.e., a low risk tolerance).  Also, consumers seeking an easy-to-manage type of life insurance should consider whole life, but be sure to confirm both that the amount of the premium is guaranteed, and the number of premiums required to guarantee that the death benefit is paid out.  

On the other hand, because assets underlying whole life products are required by regulation  to be invested predominantly in high-grade bonds and government-backed mortgages, whole life products are not appropriate for consumers with a moderate-to-aggressive risk profile who are comfortable allocating their wealth among various different asset classes. While whole life products could serve as the fixed-income allocation of a broader asset allocation for consumers with a moderate to aggressive risk profile, consumers should ask themselves: “How is my 401(k) allocated?”and “Why would I not allocate account values in my life insurance similarly to how my other long-term accounts are allocated?”

A final thought

As discussed above, premiums for most whole life type policies must be paid every year for the entire life of the policy. While dividends can certainly be used to pay premiums, when dividends become insufficient to pay a premium (as has often been the case over the past 20-plus years), then the consumer again becomes responsible for that premium payment.  

If the consumer doesn’t pay that premium, then insurers typically borrow that premium from the consumer’s policy account, which depletes the policy cash values and erodes policy death benefits, often without the consumer understanding they are then also responsible for paying back that loan. When such loans to pay premiums exceed the amount otherwise available in the policy account, the consumer is then required to pay both premiums and interest on that loan, which can be many times greater than the original premium.  

If the consumer decides against paying those higher amounts, then the policy will lapse, resulting in a total loss of both all premiums paid and policy death benefits.  In addition, the consumer will be required to pay income taxes on the forgiveness of that premium loan, and the amounts of those taxes can actually exceed the original policy death benefit (e.g., instead of receiving a $1,000,000 death benefit, they could be required to pay $1,000,000 to the IRS).  To prevent this from happening, consumers must understand for how long premiums must be paid, how they are being paid, and if the insurer is paying premiums via loan against the policy account.  

Barry Flagg

Expert Advisor

 

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Barry D. Flagg is the inventor and founder of Veralytic®, the leading online publisher of life insurance pricing and performance research and product competitiveness ratings. Veralytic is the result of his unique background in both the fiduciary investment business where he became the now oldest, youngest Certified Financial Planner (CFP®) in history, and as a life insurance expert consistently recognized in the top 1% of the industry. He’s renowned for applying Prudent Investor Principles to life insurance product selection or retention and portfolio management. As a result, he serves as sub-advisor to thousands of irrevocable life insurance trusts (ILITs) as well as RIAs and wealth managers, is a regular contributor to Forbes for articles about life insurance, leads curriculum development and instruction for Applied Fiduciary Practices involving life insurance for The Center of Board Certified Fiduciaries at Wake Forest University, and serves as a volunteer to the CFP Board Professional Standards and Legal Department for complaints involving life insurance. Barry has authored numerous articles for national publications on managing life insurance as an asset according to established and proven asset management principles and frequently teaches continuing education courses about the same to attorneys, CFP®s, CPAs, and CTFAs.