If you are a higher income earner, chances are at some point you have been given a sales pitch about all the wonders of whole life insurance. It is often presented as a guaranteed investment that includes some outstanding tax breaks.
Truth be told, it is often pitched because it is among the highest commission-paying products a life insurance salesman can sell. In other words, if someone is trying to sell you whole life insurance, you should probably reconsider your relationship with that financial “professional”. They likely have their interests ahead of yours.
Whole life insurance has many flaws, of which I am going to highlight a few here.
1) It is Expensive.
When a whole life policy is sold the seller typically is pitching the investment portion of the policy to the buyer. The actual insurance portion of the policy is touched on as an added benefit or barely touched on at all.
Most buyers expect that they are getting the going rate for the life insurance part of the policy, but instead they are usually getting charged whatever the insurance company can get away with. The price is much more expensive than if you bought a comparable term life insurance policy.
Many young people cannot afford a large enough policy that will give them the life insurance coverage they need. They end up doing one of two things. Either they buy a term life insurance policy in addition to the whole life policy or they do not buy anything and remain totally uninsured.
In addition to the overpriced insurance portion of the policy, there are also the fees. A buyer does not pay the fees directly. That is, you will never see an invoice for them, but they are there. You pay them with lower investment returns.
I mentioned at the beginning that many insurance salespeople pitch whole life insurance policies over term life policies because of higher commissions. How much higher?
On a typical whole life insurance policy the commission is 100% of the first year’s premiums and then somewhere around 6-7% of the premiums every year after that.
For a term life insurance policy is around 50% of the first year’s premiums and anywhere from 2-4% of the premiums in the years after that.
The incentive is for salespeople to sell whole life insurance policies and get you to take every add on, feature, and rider they can tag on to that thing boosting up that first year’s commissions significantly.
Some might ask why commissions matter? The company pays them, right? Yes, it is true that the company is paying the insurance salesperson the commissions, but is it not the consumer that is ultimately paying for those commissions? How much cheaper would whole life insurance be if its commission structure was in line with the commission structure of term life insurance?
2) Whole Life Insurance is Too Complex.
Yes, and that is no accident. People started to catch on that whole life insurance policies may not be in their best interests. Insurance companies responded by making them so complex that most consumers do not fully understand what it is that they are buying. Heck, most insurance agents do not fully understand what it is they are selling.
They muddied the waters to make it harder to realize that these policies were mostly just a rip-off.
If you do not believe me, ask an insurance agent to explain a whole life insurance policy in full detail some time. Then ask them to explain their commission structure on that same policy. Guess which one they will know by heart?
3) You Can Invest More Money on Your Own Outside of an Insurance Policy.
This is a big one in the negative column for whole life insurance, although insurance companies and salespeople really try to advocate for the “investment” portion of the policies. When you purchase a whole life insurance policy, the insurance company invests your premiums into a relatively conservative portfolio usually consisting mostly of bonds.
Do you know what happens to your premiums before they are invested? First, the insurance company puts a percentage aside into a pool of money they have to pay the death benefits to policy holders who expire. Then they take another portion of your premium and pocket that as profit. Only after that, do they invest any of the money into your investment portfolio.
Why not just invest the money yourself? Yes, you will have to pay some service fees or maybe an advisory fee to an investment professional, but it is going to be far less off the top than you will pay through a whole life insurance policy. Your returns are going to be far greater.
4) You Lose Easy Access to Your Money.
This one really irritates me. With most of your typical investment options you can cash out at just about any time with relative ease. You can switch up your investments or use the money for a major purchase without much in the way of hoops to jump through.
With a whole life insurance policy, you have two options for accessing your money. The first is to surrender the policy. This might be a viable option if you have owned the policy for a long time. Generally, if you have owned the policy for less than 12-15 years, you are probably going to come out on the short end of the stick by surrendering it.
The second option insurance companies provide to you is to borrow against your policy. Anything you borrow against your policy is no longer a part of the death benefit for your beneficiaries, so that may cause some problems. The other problem with this option, and the part that really irritates me, is that the insurance company will charge you interest for your loan. Sometimes a portion of that interest goes back into your policy, but not always. So you are paying the insurance company for a loan on your own money. Let that sink in for a moment.
5) The Income Tax and Estate Tax Benefits Probably Won’t Benefit You.
The death benefit on a whole life insurance policy is tax free, which salespeople will be quick to point out. This can be a useful tool for wealthy people to avoid estate taxes. What the salespeople will often fail to mention to you is that you do not need to pay estate taxes until your estate reaches a value of $5.6 million for an individual or $11.2 million for a couple.
If you are one of the lucky ones whose estate is approaching that kind of value, congratulations. That is great. However, there are better options available to you to minimize estate taxes than whole life insurance.
For these 5 reasons, I would recommend avoiding whole life insurance policies.