If you’re trying to determine whether whole life insurance is a good investment, there are several factors you need to consider. First, what are your long-term financial goals? If you’re looking for a way to build cash value over time, whole life insurance may be a good option. Second, how comfortable are you with risk?
Whole life insurance comes with guaranteed cash value growth, but it also typically has higher premiums than other types of life insurance. Finally, what is your budget?
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Whole life insurance is a type of permanent life insurance that provides coverage for the policyholder’s entire lifetime. As long as premiums are paid, the policy will not lapse. Upon the policyholder’s death, the policy will pay out a death benefit to the designated beneficiaries.
Whole life insurance policies come with a cash value component that grows at a guaranteed rate of return on a tax-deferred basis. policyholders can borrow from or withdraw funds from this cash value. Should policyholders decide to end their whole life insurance policy, they can take its “surrender value,” which is equal to the cash value minus any surrender charge.
Moreover, if you purchase whole life insurance from a mutual life insurance company, your policy will earn dividends that can accelerate the cash value accumulation in your policy.
How Whole Life Insurance works as an Investment for Policyholders
Whole life insurance is a type of permanent life insurance that offers lifelong coverage and also has a savings account component. Your premium payments are partially invested by the insurer into a cash value account, which grows over time at a fixed rate that is guaranteed by the insurer.
The cash value account growth is tax-deferred, meaning that any interest earned on the account is not taxed as long as the funds remain in the account.
One of the great things about cash value life insurance is that you can take out loans against your policy. This can be a helpful way to access extra funds when you need them, and you don’t have to pay back the loan – it’s your money. However, it’s important to note that any outstanding loans will be deducted from the payout when you die.
When you purchase a policy from a mutual life insurance company, you may be eligible to receive dividends based on the company’s financial performance. These dividends can be cashed in, used to pay premiums, or used to purchase additional insurance coverage. Doing so will also increase the cash value of your policy.
The Difference between Whole Life Insurance and Traditional Investments
The primary difference between whole life insurance and traditional investments is that the government does not place constraints on your investment.
For example, in 2023 the total annual contributions you could make in a traditional IRA cannot exceed $6,500 ($7,500 if you are age 50 or older) and you cannot continue investing once you’ve reached age 70 ½ years old.
Additionally, if you withdraw funds from your IRA before age 59 ½ you’ll generally be penalized 10% on the withdrawal. To make things worse, the government requires IRA account holders to begin taking required minimum distributions (RMDs) after reaching age 72.
401(k)s are employer-sponsored retirement plans that allow employees to contribute pre-tax income towards their retirement savings. 401(k)s offer various investment options, which can help accelerate account growth. For self-employed individuals with no employees, there is also the solo 401(k), which functions in much the same way.
Additionally, most employers will match a percentage of the amount their employees contribute to their 401(k) account.
However, similar to an IRA, your government places constraints on investing in a 401(k):
- If you tap into your 401(k) before age 59 ½ you will be penalized 10% for your early withdrawal and you generally cannot withdraw YOUR money unless you have a “qualifying hardship.”
- Contributions are limited to $22,500 or $30,000 if you are age 50 or older.
- Since your contributions are made with pre-tax dollars, your withdrawals are considered ordinary income and are taxable.
Roth IRAs are individual retirement accounts that are funded with after-tax dollars. This means that the money you contribute to a Roth IRA has already been taxed. The advantage of a Roth IRA is that your money can grow tax-free, and you can make tax-free withdrawals during retirement.
However, like other traditional investment products, your government wants to decide how you use it:
- You cannot contribute to a Roth IRA if your adjusted gross income is more than $144,000 for single tax filers or $214,000 for those who file married filing jointly.
- Although you’re allowed to withdraw contributions, you cannot withdraw your earnings on those contributions before age 59 ½.
How is Whole Life Insurance a Good Investment for Retirement?
First of all, let’s list the benefits of whole life insurance that are not found in the traditional investments we’ve mentioned in this article.
- Your policy will provide life insurance coverage for your lifetime as long as the required premiums are paid,
- Your minimum monthly premium can never be increased by the insurance company but, you can always pay more than your minimum premium (and you should).
- Your policy will build cash value over time from guaranteed interest earnings and dividends (if available).
- You can access your cash value via tax-exempt policy loans or withdrawals.
- There are no early withdrawal penalties like with traditional investment products.
- There are no RMD (required minim distributions) requirements.
- There are no annual contribution limits, however, if you should overfund your policy you are risking becoming a Modified Endowment Contract (MEC) which could jeopardize your policy’s favorable tax treatment.
- Most importantly, policy loans are not taxable and do not have to be repaid. You decide how you want to pay the loan back and whether or not you will pay it back. If you die with an outstanding loan(s) against your policy, the balance of the loan will be deducted from the beneficiary’s death benefit.
- Whole Life Insurance policies include living benefits such as the accelerated death benefit that provides for the company to advance the insured a portion of the death benefit to help pay for expenses of a terminal, critical, or chronic disease.
- Optional riders can be added to your policy to broaden coverage and provide additional living benefits.
What about Dividends?
Purchasing your whole life insurance from a mutual life insurance company is critical in accelerating your wealth accumulation. On top of the guaranteed interest you will receive from the insurer, you will be entitled to your share of dividends (profits) that your insurer will pay out annually. Although dividends are not guaranteed, most mutual insurers have a history of paying dividends to policyholders each year.
Although you’ll have several options for how you receive your benefits, if the intent of your whole life insurance is to accumulate wealth for retirement, we will always recommend that you take your dividends as paid-up additions.
This option increases your insurance coverage by adding paid-up mini policies which will also earn interest and dividends, and increase the death benefit for your beneficiary(s).
The Bottom Line
Although we are big believers in using whole life insurance for retirement planning, our recommendation is to use it to enhance retirement plans you’re already investing in, not to cancel them and use whole life insurance only.
We certainly recognize the benefit of investing in an IRA, Roth IRA, and 401(k), but we want to remind you that retirement planning is not just about how much wealth you accumulate, but more importantly how much of that wealth you get to keep when your glorious retirement begins.