Whole Life Insurance … Love It or Leave It?

Whole life insurance has several benefits. There is a guaranteed savings account (also known as cash value). Whole life also provides long-term death benefit protection. While there are many reasons to purchase a whole life policy, currently low interest rates are making it challenging for existing whole life policyowners.

If you have a whole life policy, is it still serving you well? Could you be facing additional premium payments going forward? Now may be a good time to re-evaluate your whole life policy for three reasons.

Reason #1: Lower interest rates are not good for policy dividends

Lower interest rates may be good for some companies, but generally speaking they are not good for insurance carriers. Low interest rates can negatively affect whole life dividends and policy loans. Annual dividends are a return of policyowners’ premiums. They are not guaranteed, but they are important in the performance of a whole life policy over time. Dividends are reinvested in the cash value of the policy and help the savings account grow. After 15-18 years, in most cases the dividend is usually large enough to pay for the future premium. The policy owner does not need to make any more payments and has a potentially “paid-up” policy for life. I say “potentially,” because it depends on the future performance of the dividend.

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Lower interest rates can mean lower dividends for policyowners. This is because insurers invest policy premiums largely in conservative fixed income assets. If the fixed income investments are yielding less due to low interest rates, than the insurers earn less on their money and have less to credit in dividends. If dividends remain low, whole life policy owners may have to pay into their insurance contracts for longer they initially anticipated. The dividend may not be large enough to have the policy “paid-up.”

Reason #2: Lower interest rates are not good for policy loans

Whole life insurance policyowners can borrow from their cash value while they are alive. The insurance company charges interest on the loan. This used to be less of an issue because loan rates were low and dividends were high. However, since insurance companies are earning less on their bond portfolios, they are looking for alternative sources of income. Some insurers are raising the loan rates they charge policyowners. Recently one large insurance company boosted their loan borrowing rate from 3.5% to 5%. For policyowners with an outstanding loan on their contract, this is an additional cost that will detract from the performance of the cash value. Again, this may translate into paying for longer than initially anticipated.

Reason #3: Your goals may have changed

I have a 60-year-old client who no longer needed the whole life insurance death benefit protection. His kids were older, and the mortgage was paid off. Instead, retirement income and long-term care insurance were higher priorities. We asked the insurance company for a quote on his existing whole life policy. To no surprise, they projected he needed to contribute more premium. The dividend was not high enough to put the policy in paid-up status. The time was right to evaluate other options.

What to do instead?

A good start is requesting an in-force illustration from the existing carrier. An in-force illustration projects the cash value and death benefit values. It also shows how much longer you may need to fund the policy. I usually stress test the in-force illustration by running a dividend rate lower than the current dividend. If the policy needs several more premium payments to reach the “paid-up” status, then you want to evaluate whether it still makes sense to fund. It may be time to look at other options.

In the case of my 60-year old retiree, the policy required five more payments. We concluded his old whole life policy was not going to meet his needs going forward. Instead, we did a partial 1035 tax-free exchange of his old whole life cash value into a fully paid-up long-term care insurance policy. A 1035 exchange allows taxpayers to avoid paying income tax on the gains of whole life cash value if you exchange it for another life insurance, long-term care or annuity policy. The new long-term care insurance policy has a death benefit, but more importantly for my client, it provides a pool of money to cover long-term care expenses for up to six years. This will help him maintain his other IRA and bank accounts for retirement income.

For the remaining whole life cash value, we did a 1035 exchange into a deferred annuity to provide additional retirement income. The monthly income starts at his age 65 and lasts for his lifetime. He plans on using the money to pay for Medicare premiums and other retirement-related expenses.

Other options

There are many options for policyowners concerned about paying into a whole life policy for longer than expected. Asking the insurance company to reduce the death benefit will lower the premium, help reduce insurance costs, and may shorten the premium commitment.

In some cases, a new policy makes sense. Had my 60-year-old client wanted to maintain the life insurance for his family, we may have rolled the cash value into a new life insurance policy and have it fully paid-up, i.e. no more premiums needed. This is possible because newer variable universal or indexed universal policies come with better death benefit guarantees than they did in the past.

Granted there are differences between whole life and universal, beyond the scope of this article, it is best to check with a qualified agent. Your health will also weigh into the decision of whether a new policy is possible. If you had cancer or a health event recently, that may preclude you from being medically underwritten for new insurance. If not, the newer indexed universal or guaranteed variable policies can provide greater cash value growth potential than whole life while still guaranteeing a death benefit for life. It may be worth exploring. There is no harm in evaluating your options.

Much has changed in the world. Some changes, like lower interest rates, have not been good for whole life insurance policyowners. Now may be an opportune time to evaluate how a prolonged low interest rate environment affects your future premium commitment. Other changes, such as in your employment or retirement goals, are legitimate reasons to re-evaluate an old whole life contract as well.

There may be better uses of your premium dollars or cash value going forward. Either way, evaluating your options is a good first step.