Whole Life Insurance: A Multipurpose Financial Planning Tool

A multipurpose tool sits open on a rock in the sun.

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In my 25 years of providing financial advice, I have found whole life insurance to be one of the most important yet overlooked financial planning tools on the market.

From the guaranteed cash value to the income tax-free loans, the long-term care rider and long-term death benefit protection for my family, my whole life insurance policies have been an important part of my financial planning. Whole life insurance has many different uses. I often refer to it as the Swiss Army knife of financial planning. But before we get into the benefits of whole life, let's first review some background on how it works.

Insurance for your 'whole life'

As its name may suggest, whole life insurance is life insurance intended to stay with you your whole life. Whereas term life insurance is intended to cover only a specific number of years, say 20 or 30 years, then it goes away. Whole life insurance has a fixed level premium that does not increase in cost. It is a higher outlay than term life insurance, but with whole life, there is a savings component. Part of your annual whole life premium pays for the cost of insurance, and the balance is invested in a pool of conservative fixed income investments managed by the insurance company. This part invested is referred to as the "cash value."

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In-life benefits

The cash value inside the whole life policy has two parts. There is a guaranteed value, which basically is a return of your premium over time. There is also a non-guaranteed value, which is the guaranteed value plus dividends (more about dividends later). The cash value is your money and has several uses. You can access the cash value via a loan at any age for any reason or multiple reasons. If the loan is not repaid, it is netted against the death benefit when and if you pass.

For example, let's say I withdraw $50,000 from my cash value to help pay for college. The withdrawal is an income tax-free loan. Should I never pay the loan back, the death benefit when I pass is reduced by the unpaid loan and the loan interest. (The loan interest on withdrawals is variable but usually is similar to the interest rates on other secured loans like home equity loans.)

It's all about the dividends

With a whole life policy, the insurance carrier can credit your policy a dividend. For example, if the insurance company does a good job of managing expenses, at the end of the year they may refund some of your premium as a dividend. Dividends can be reinvested in the cash value or paid out to the policy owner. Dividends are not guaranteed and can fluctuate year-to-year but can help the performance of the cash value.

For those who fund their whole life policy year after year, there are many benefits, here are five:

Benefit #1: A disciplined way to save for the future.

Whole life can act as a “forced savings account.” The reason is the premium must get paid, unlike funding an IRA or 401(k) which is completely voluntary. Getting that bill every month forces me to pay the premium, part of which is allocated to the cash value. Many clients are grateful after 10 or 15 years of funding to wake up and see how the cash value has grown.

Benefit #2: Provides long-term life insurance protection and tax-efficient inheritance.

You may need or want life insurance for longer than your term insurance lasts. If you still carry a mortgage in your 60s, you may be grateful to have whole life even when your term insurance expired. Even if you don't need the insurance protection, the death benefit can be left to the kids, grandkids or a charity, all income tax-free, unlike IRAs and 401(k)s, and no forced distribution schedule, like the 10-year rule with IRAs.

Benefit #3: The cash value is a part of your diversified fixed-income asset allocation.

Whole life cash value is invested in a large pool of Treasury bonds, corporate bonds, guaranteed investment contracts and other conservative investments. For this reason, I view whole life as a part of my overall asset allocation.

If I want to be 80% equities and 20% fixed income, the cash value in the whole life policy should count toward that 20%.

Moreover, the cash value in a whole life policy may perform differently than other bonds I own elsewhere, like in 2022 when most bond indexes dropped by double digits, my whole life cash value continued to chug along unphased. Cash value can provide another layer of diversification.

Benefit #4: Creates another bucket of money to access tax-free in retirement.

As mentioned earlier, withdrawals from a whole life policy are considered loans and are income tax-free. This can help with retirement planning and tax planning. Withdrawing money tax-free via a loan instead of taking an additional distribution from a 401(k) may help keep you in a lower tax bracket.

The less taxable retirement income you have the better the chance you have of paying less tax on your Social Security income, pensions and retirement account required minimum distributions (RMDs).

Benefit #5: Riders can provide protection in the event of a total disability or a need for long-term care.

Whole life insurance policies can come with two optional riders. One is the "disability waiver of premium." With this rider, if the insured becomes totally disabled — the definition of total disability varies, but usually it's a severe disability — the insurance company will allow the whole life policy to continue functioning as normal. This means the premium is waived, dividends continue to accrue, and the death benefit can grow without creating a loan. Usually, there is an age limit for this rider, such as premiums are waived till age 65.

The second rider is the "long-term care rider." This rider allows the insured to borrow against the cash value a certain amount of money each month to pay for long-term care, such as home health care or an assisted living facility, without creating a loan. The benefit is no loan interest accrues. A doctor will have to certify you qualify for care. This may mean not being able to bathe or walk on your own.

The arguments against whole life

Some say you should buy lower-priced term life insurance and invest the difference in premium for what a whole life policy costs in the stock market for greater growth. This sounds like a reasonable argument on the surface, but I have two concerns:

Many don't save the difference — they spend it because something always comes up.
There are no guarantees with the stock market. The risk/return of whole life and investing in the stock market is completely different. Whole life behaves like fixed income. The stock market is riskier and, rightfully, should be more rewarding. I see whole life as the belts and suspenders to my asset allocation, and my stocks elsewhere as the growth and opportunity. In times of market stress, guaranteed cash value looks pretty good.

Some also say whole life is "too expensive." True, whole life costs more than term life insurance. But they are different products. If you buy term life insurance, you can invest the difference in cost on your own. If you buy whole life, the insurance company invests it for you. Those are two different approaches. But to say whole life is "too expensive" negates all the benefits described above. Some may value whole life's long-term death benefit protection, diversification benefits, long-term care riders and the disciplined savings.

Finding a balance

In the end, I'd say give whole life a chance. Too many pundits scoff at whole life, given the higher outlay than term life. But it's naive to make blanket statements. If you are considering life insurance, you may want to take a look at some blend of whole life and term life for the reasons mentioned earlier.

In the end, no one knows for sure what the future may hold, but at least whole life creates options for your future self with the cash value, long-term care rider and the long-term death benefit protection. The more options you have, the better prepared you are for whatever life may throw at you.

If you are interested in learning more, a good first step is to have a qualified agent or broker run a quote.

For more information, please feel free to email the author at maloi@sfr1.com.

Investment advisory and financial planning services are offered through Summit Financial LLC, an SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax. 973-285-3666. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Links to third-party websites are provided for your convenience and informational purposes only. Summit is not responsible for the information contained on third-party websites. The Summit financial planning design team admitted attorneys and/or CPAs, who act exclusively in a non-representative capacity with respect to Summit’s clients. Neither they nor Summit provide tax or legal advice to clients. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state or local taxes.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Michael Aloi is a CERTIFIED FINANCIAL PLANNER™ Practitioner and Accredited Wealth Management Advisor℠ with Summit Financial, LLC. With 21 years of experience, Michael specializes in working with executives, professionals and retirees. Since he joined Summit Financial, LLC, Michael has built a process that emphasizes the integration of various facets of financial planning. Supported by a team of in-house estate and income tax specialists, Michael offers his clients coordinated solutions to scattered problems.