9 Things to Consider When Buying Whole Life Insurance

If you're looking for a way to leave money to your children, other family members, or friends, a whole life insurance policy is a nice way to do that.

In addition to leaving money as an inheritance, the policy's death benefit can be used to take care of funeral costs and any other debt.

Whole life insurance is expensive. However, its premiums are fixed, so they will not increase or decrease over time. Whole life insurance also offers coverage for a lifetime (as long as you pay premiums) and accrues cash value that you can use as an asset while living. 

As you consider buying whole life insurance, here are nine things experts say to evaluate before you make a purchase:

1. Advice from your financial adviser
2. Your purpose
3. Cash value growth
4. Policy loan options
5. Dividends
6. Riders
7. Coverage amount
8. Affordability and sustainability
9. Universal life insurance

Advice from your financial adviser

Whole life insurance is a major purchase with continual monthly fees, so you'll want to carefully evaluate how a whole life insurance policy fits into your overall financial plan.

"ALWAYS seek the counsel of a qualified financial advisor. This does not describe most life insurance agents, who do not possess the knowledge or skill to provide comprehensive financial advice," advises Rob Drury, Association of Christian Financial Advisors executive director.

Discussing your financial goals, current budget constraints, and why you want a whole life policy with your trusted financial adviser will help you determine if whole life insurance is a good fit and how much you should buy.

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Your purpose

The second thing you should think about is why you're buying life insurance.

"Individuals need to ask themselves what goal they are trying to achieve with the purchase of life insurance. For most, the goal is to provide for their dependents should they pass away prematurely. In those cases a term life insurance policy would make more sense. They are less expensive than whole life policies because they only have a death benefit component to them," says Alan Schoenberger, CFP® and Endeavor Financial Planning founder. 

If your coverage needs are short-term, then a term life insurance policy may be a better fit. However, if you want to have an asset to borrow from or leave a tax-free inheritance, a whole life insurance policy can be a good fit.

Keep in mind, however, that while the death benefit is not subject to tax, it can be taxed as part of an estate.

For more tips on choosing between term and whole life insurance, read: "Term Life Insurance vs. Whole Life Insurance".

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Cash value growth

One advantage of whole life policies is that they typically have a guaranteed growth rate for the cash value of the policy. As you compare whole life policies, consider the rates of return offered by different insurers.

Zhaneta Gechev, One Stop Life Insurance founder, also recommends looking at other investment options:

"What is the interest rate that the carrier is guaranteeing you? Are you able to have a greater rate of return with a different investment tool?"

In some cases, it may make more sense to increase your investment in a retirement plan because of the rates of return, like a 401(k) or IRA.

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Policy loan options

As you consider investing more of your money in retirement accounts versus investing in a whole life insurance policy, realize that retirement accounts typically have tax penalties for early withdrawals in addition to paying taxes on the withdrawals. In contrast, there are no tax penalties for borrowing from your insurer with your whole life insurance policy as collateral. However, you will need to pay taxes on the loan amount you receive. If you do not repay what you borrowed, the insurer will take the balance from your life insurance policy.

Before you buy a whole life policy, you also need to understand the insurer's terms for taking a loan from your policy:

"What are the policy loan option details? Different companies have different loan provisions, so it is very important to understand the loan details. One option may be more favorable in certain market conditions, while another option may be more suitable for other conditions. It is important to understand the details and draw out multiple scenarios so that you are not caught by an unexpected surprise in the future," advises Henry Hoang, CFP® Bright Wealth Advisors, LLC.

Reviewing these terms with your financial adviser will help you think through multiple scenarios and find a policy that best meets your needs.

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Dividends

If you're buying a whole life insurance policy, there's an advantage to choosing a mutual insurer over a public insurer because mutual insurers are owned by the policyholders instead of stockholders.

Mutual ownership means two things: 

1. The insurer only answers to policyholders, so it will make decisions focused on what's best for policyholders without needing to consider stockholder interests.

2. When the insurer's investments do well, it pays dividends to its policyholders.

"Because of the guarantees offered by whole life policies, they are underwritten very conservatively; therefore, premiums paid are typically far in excess of the amounts necessary to pay death claims. The excess premium collected by non-participating companies simply becomes additional profit to the insurer. 

For participating companies, particularly mutual companies that are literally owned by their policy owners, these excess amounts are distributed back to policy owners — either directly in cash, in the form of paid-up additions (additional death benefit), or applied directly toward future premiums," says Drury.

If you're going to spend money on expensive premiums, you're better off choosing a mutual company because you'll get any excess back in dividends.

"This is why most participating policies can become self-sustaining (no further premium payments needed) at about the 12–15 year point. It is important to note that dividends are dependent upon the actual amounts paid in death benefits, and are not guaranteed. However, most household-name participating companies have consistently paid dividends each and every year of their existence, many for well more than a century," he adds.

When you're comparing whole life policies from various insurers, look into their history of paying dividends. How consistently had the company paid policyholders dividends? Does the insurer offer information on how much dividends it paid last year?

As you consider potential dividends from your insurance policy, you should also pay attention to how the insurer treats dividends when policyholders take policy loans.

Insurers have two methods for treating dividends: direct recognition and non-direct recognition.

Direct recognition means that the insurer changes dividend payment rates to policyholders with outstanding policy loans.

Non-direct recognition means that the insurer does not change dividend payments if a policyholder has an outstanding policy loan.

Reviewing these terms with your financial adviser will help you understand which option would work best for you and give you a better sense of the value you can expect from dividend payments.

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Riders

You can add policy riders to further protect your policy, add additional coverage, or permit early access to the death benefit. Some insurers include some of these riders as features in their policies. Others allow you to add them to your policy for an additional premium cost.

A few valuable riders often available with permanent policies are:

• Disability waiver of premium — Allows you to maintain your policy without premium payments if you become disabled.
• Long term care — Allows you to use some of the death benefit to pay for long-term care if you need it.
• Accelerated death benefit — Allows you to receive some of the death benefit early if you are diagnosed with a terminal or chronic illness.

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Coverage amount

The most important part of any life insurance policy is how much coverage you're buying. Usually the death benefit should be enough to allow your beneficiaries to cover funeral expenses and any lingering financial obligations.

Work with your financial adviser to determine how much you should buy. Since whole life policies are the most expensive, you may want to buy what you can afford and then buy the rest of the coverage in a term life insurance policy.

Gechev offers an example:

"A father of two small children has $50,000 in whole life insurance only, and he is the primary breadwinner. It is clear that he is way underinsured, but his budget allows him to get only $50,000 of whole life insurance. In this case, he needs to supplement his coverage with a term policy."

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Affordability and sustainability

Gechev's example leads us to one of the most important factors to consider: the policy's affordability and sustainability. 

"Whole life insurance can be an expensive option for coverage, relative to other options such as term insurance, in some cases costing 10 times more. Roughly 40 percent of policies are surrendered within the first decade, largely because purchasers overestimate their ability to continue making premium payments for years to come. 

Unfortunately, due to surrender charges and earlier premiums paying for upfront costs, commissions and admin fees, surrendering a policy within the first few years will likely result in a cash value significantly lower than the premiums paid into the policy," says Jonathan Seif, The ProFolio Group founder.

To avoid surrendering your policy, follow Drury's advice while you're still in the decision-making phase:

"Prioritize financial planning objectives within your budget. This will help determine how much money is available to pay life insurance premiums. Whole life is often the most cost effective option, but if the premium is too high, it may be appropriate to purchase some or all term insurance that has an option to convert to permanent coverage when the budget allows."

If you're considering buying some whole life insurance and supplementing it with term life insurance, read "10 Things to Consider When Buying Term Life Insurance" for more expert tips.

You should also consider what would happen if you suddenly lose your job and have trouble finding a new one. Would you still be able to maintain your life insurance policy? What safeguards can you put in place through personal savings to avoid losing your policy?

Remember: you're playing the long game with these policies.

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Universal life insurance

Because whole life insurance is typically the most expensive kind of permanent life insurance, you may want to consider other permanent life insurance options.

Universal life insurance offers many of the same features as whole life insurance. However, the rate of return on the cash value is not guaranteed and the premiums are not fixed. Depending on the kind of universal life insurance you buy, you may have more control over where your insurance policy is invested. These policies are cheaper because you assume more risk.

In addition to a whole life insurance policy from a mutually owned insurer, John Hill, president of Gateway Retirement, recommends the following types of universal life insurance:

"The second recommendation is a Fixed Indexed Universal Life insurance policy, which is designed to grow your money without loss because of the market and could become tax-free income later in life. This is the 7702 policy from the IRS tax code.

You want to spend your money wisely. For seniors, I would recommend a GUL, guaranteed universal life policy. It is like a term to 100. With some companies, you can take money out of the face amount for critical and/or chronic illnesses."

Gechev also recommends a guaranteed universal life policy.

"A guaranteed universal life insurance policy is a type of product that could be designed to give you guaranteed coverage up to age 121, the same as whole life insurance. The key differences are that it does not build much of cash value but oftentimes could cost a third of a whole life policy," she says.

As you evaluate your options in the context of your financial situation and long term goals, be sure to get the advice of a financial planner. Taking your time through this process will help ensure that you make a good choice for yourself and loved ones.