Is Whole Life Insurance the Best Choice?
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By James Tobin, CFP ®
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Expert Review Of Whole Life Insurance
If you are wondering "is whole life insurance a smart choice for me and my family?", you have landed at a place where you will get an honest and nuanced opinion.
We make a point of saying nuanced because many, if not most, of the opinions on whole life insurance are black and white...
....On the contrary, Bequest Mutual understands that people are different and have different goals and risk tolerances.
That being said, there are specific circumstances that call for certain prescriptions and not others. The purpose of this article is to lay out a background on whole life insurance and it's pros and cons.
Of course we will also let you know how to get the best deal possible in 2017. If you have an idea what you are looking for, you can use the handy quick navigation tool to jump around.
What is Whole Life Insurance?
Whole life insurance is a level premium , "permanent" product guaranteed to inure the owner until death or the maturity of the policy.
Level premium simply means that the rates will never go up on the policy, and policy maturity is a point (age 100 or 120) where the guaranteed cash value of the policy is equal to the benefit face amount.
When deciding if whole life insurance is a smart choice for your needs, consider that whole life policies have a variety of uses and iterations, ranging from small face amount final expense policies to large low risk investment alternatives.
Regardless of what a whole life policy is used for, there are three common traits in all whole life policies.
Is Whole Life Insurance a Smart Choice?
If you are seeking life insurance solely to cover a temporary exposure like college tuition or the mortgage, the answer is clearly no. Term insurance makes much more sense in these situations.
If you are looking to cover the expense associated with a funeral these policies may well be useful. However, so called "final expense" policies tend to be priced in a manner that allows for little or no leverage.
Larger face value whole life policies tend to be "participating" or dividend paying and can be used effectively for estate planning. Life insurance is useful way to pay for taxable estates beyond the 5.4MM exemption.
Larger, participating, whole life policies are often used by individuals who have maxed out tax advantaged opportunities or simply prefer an ultra low risk return on savings.
For these policies to be considered a "smart choice" depends on the insured risk tolerance (low) and the structuring of the policy itself.The policy must be structured to minimize death benefit, and maximize cash value, to justify it as a "smart choice".
Lastly, larger whole life policies? are regularly used in business for funding buy/sell agreements and deferred executive compensation deals.
What are the positive Attributes of Whole Life?
There are several positive things to say about whole life insurance. in fact, it's biggest proponents call it the "Swiss army knife" of the financial world.
The following list provides some of the more popular selling points of whole life insurance. Note, however, that unless otherwise noted I am referring specifically to participating whole life policies.
- Level Premiums- while participating policies from strong carriers can be structured to blend term and whole life, a policy design that encourages overpaying and converting the term into paid up permanent insurance, the minimum premium never rises.
- Self completing- The option exist (at a cost) to add a rider to the policy that pays the policy in the case of disability. This option, unavailable in competing financial products, allows for the completion of the contract regardless in the event of disabling injury.
- Guaranteed cash value- While the policy illustration will provide a proposed cash value based on current assumptions, it will also provide a mid point and a guaranteed column. The guaranteed column is low risk and not subject to any market fluctuations.
- Loan availability-not subject to credit. The cash value stores in the policy are available for loan at the asking. The loan is technically not from the policy , but rather, the policy is collateral for a loan from the carrier. This matters because the policy will continue (depending on the carrier), to earn dividends on the full amount usually "washing" with the loan interest or better.
- Potential for Tax free Income- In most cases, loans from the policy are not seen as income as long as the policy remains in-force. Thus, it is a common strategy to build cash value towards retirement years , and take loans as an income stream in retirement. This must be done carefully, as the proceeds become taxable (above the basis) if the policy lapses.
What are the Negative Attributes of Whole Life Insurance?
- Initial Cost- Whole life insurance is significantly more expensive than term insurance for the same face amount. This comes about for multiple reasons. In the case of smaller final expense policies, it is because of lenient underwriting for unhealthy buyers-who likely wouldn't qualify for term. In the case of investment alternative policies, the additional expense is largely a matter of the allocation to cash value.
- Opportunity Cost- Critics of permanent policies in general and whole life in particular, use comparisons to the S&P500 index as a rationale to discredit life insurance as an alternative savings vehicle. The criticism is somewhat misguided as critics often use the guaranteed column compared to a non guaranteed equities return. Moreover, the comparison is not risk adjusted.
- The answer to the question about whether whole life is a smart choice has everything to do with your goals and risk tolerances. Tax advantaged accounts like a 401k or traditional IRA will be subject to an unknown % of ordinary income tax at withdrawal. This may limit some interest in these accounts beyond an employer match.
- Agent Compensation- This is interesting and the answer depends on how the question is framed. Term insurance pays a much higher percentage of premium to the agent. However, because permanent insurance is considerably more expensive, in real dollars the commission is higher for many whole life policies. Where this gets really in the weeds is when you compare a properly blended policy against the Assets Under Management (AUM) fees of equity advisors for comparable periods (say 20 years) and the early expenses of whole are overtaken by AUM fees overtime.
Positive and negative attributes are often summed up as "beauty is in the eye of the beholder" .
In that vein, here are the some of the "negatives' of whole life insurance.
How is Whole Life Insurance Underwritten?
Underwriting for whole life policies is often very dependent on the type of whole life being analyzed.
Final expense type policies - small face amount, non participating policies are usually simplified issue or guaranteed issue with no exam requirements.
Additionally, these policies allow for considerable health issues included in the pricing. When health issues are serious enough the carriers will offer a graded product.
These policies pay the Fbenefit out on a graded basis. This simply means that if the policy is not in force prior to death for longer than the graded period (usually 2-3 years) the payout will be commensurate. This is usually 33% after year one, 67% after year two,100% after year three.
Underwriting on larger policies from strong (often mutual) carrier, tends to be along the lines of term underwriting with some leniency thrown in.
This leniency is usually accomplished with so called Table shaving credits that help boost n underwriting grade to no worse than standard.
This is simply a way for carriers to "buy" the profitable business they want.
Use an Experienced Independent Agent when Shopping for Whole Life
Because different carriers have different appetites for various risks, and view each case on an individual basis, it is imperative that you have as many options as possible.
This is true in both final expense and so called "investment alternative" policies. In the former, you need many carriers because, they don't all take the same illnesses and they are not all available in most states.
With larger participating policies, underwriting niches certainly matter. however, the really big deal is that unlike term insurance where you can simply check quotes, whole life is entirely dependent on policy design.
Getting an affordable policy from a great company is not enough, in fact it's how whole life gets a bad name.The policy needs to be designed properly for whole life insurance to be a smart choice.
What are the Alternatives to Whole Life Insurance?
Alternatives to whole life are limited in the final expense segment of the market. There are a few simplified issue term policies for seniors, but they are inherently weak as final expense policies.
People seeking larger permanent policies can choose several iterations of universal life insurance. These include:
- Current assumption UL- an interest bearing policy that allows some flexibility in premium options.
- Indexed UL- a policy run on the same chassis as current assumption UL but having interest crediting tied to equity indexes.
- Guaranteed UL - This is a hybrid term/perm policy that last until a guaranteed age as long as premiums are paid, but lacks a significant cash value side account. These policies are often the best choice for budget conscious folks who want permanent insurance.
In the beginning of this article we said that our position on whole life was nuanced, hopefully this article has born out that statement.
Whole life clearly has uses and depending on the needs and wants of the person seeking advice, it can be an excellent fit.
As to the people who take black and white positions in either direction, I would ask what their financial motive is?
Do they take assets under management, do they sell term insurance exclusively?
Are they simply engaging in a controversial subject to get clicks on a blog? All of these things happen on a regular basis.
Ultimately, the client needs to decide what their risk tolerance is for the goal they seek to accomplish. Whole life insurance is super competitive on a risk adjusted basis with most bond portfolios. That is it will never 18% gains, nor will it ever have a 2009 type year.
If competitive risk adjusted returns on super low risk savings vehicle, with several bell and whistles, is what you are looking for then whole life is probably a good fit. Just make sure the policy design accomplishes your goals.
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