Whole Life Insurance: Stealth Retirement Savings Tool or Waste of Money?
It may seem like everyone wants to sell you a whole life insurance policy. Is it worth it?
For years, the narrative around life insurance went something like this: Buy protection while you're young to replace your income so your family doesn't struggle if something happens to you.
And that message has clearly resonated. A good 51% of American adults say they have some life insurance coverage, according to LIMRA.
When it comes to buying life insurance, you have a choice. You could opt for a term life policy that offers limited coverage and no cash value accumulation. Or, you could buy whole life insurance, a type of permanent insurance that covers you for life and includes a cash value component. (Other forms of permanent insurance include universal and variable.)
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While term life insurance holds appeal as the less expensive option, there's an inherent risk in buying it. In a nutshell, if you don't pass away by the end of your policy's term, you'll get nothing out of all of those premiums you paid (though you'll still be alive, so there's that).
With whole life insurance, you're guaranteed a payout. You can reserve the policy's death benefit for your loved ones upon your passing or tap your cash value for supplemental income in retirement.
In fact, you'll often hear whole life insurance touted as a useful retirement savings tool. But is it worth getting for that purpose?
Financial security that comes at a price
Life insurance is an inherently useful and important financial tool. But for many people, term life insurance can get the job done at a fraction of the cost.
Policygenius says that a healthy 30-year-old who doesn’t smoke might pay an average of $26 per month for a 20-year term life policy with a $500,000 payout. That same applicant would be looking at $450 per month for a whole life policy with the same benefit.
Policy Type ($500k Coverage) | Average Monthly Premium (Age 30) | Primary Function | Accumulates Cash Value? |
|---|---|---|---|
Term Life (20-Year) | $26 | Pure income replacement | No |
Whole Life | $450 | Lifetime protection + savings | Yes |
For this reason, proponents of whole life insurance tend to look beyond the "insurance" angle and incorporate whole life policies into the retirement planning equation. But while whole life insurance can provide policyholders with retirement income, it may not be the most efficient way to get there.
Whole life insurance lacks flexibility and efficiency in retirement planning
There are some use cases for whole life insurance in retirement planning. But Alex Langan, Chief Investment Officer and financial adviser at Langan Financial Group LLC, says point blank, "For most people in most situations, whole life insurance is not the right primary retirement savings vehicle. That's not a disclaimer. That's our honest assessment after working with clients across a wide range of financial situations."
For disclosure purposes, Langan Financial Group offers whole life insurance as part of its planning work, and in certain circumstances, advisers at the firm may be compensated for those recommendations.
The reason Langan doesn't usually recommend whole life insurance boils down to what the product is designed to do versus what long-term planners actually need.
"Whole life is built first around a permanent death benefit, with a savings component attached to it," Langan says. "Retirement planning is fundamentally about growth, flexibility, liquidity, and tax efficiency over time. Those aren't the things whole life is optimized for."
As Langan explains, whole life policies tend to grow more slowly than market-based alternatives. And since the costs are significant, especially in the early years, that's money that could instead go into an investment portfolio and generate stronger returns.
Derrick Schuler, CFP at Schuler Wealth Planning, agrees.
"Using whole life insurance as a retirement savings tool isn’t necessarily a waste of money, but there are much more efficient ways to save for retirement," he says.
Schuler formerly sold whole life insurance but no longer does. He makes recommendations on whole life insurance for clients, based on how it fits into their overall financial plan.
Schuler says that while whole life insurance accumulates a cash value that grows tax-deferred over time, "there are a lot of insurance costs, administrative expenses, and commissions built into the policy that can reduce the overall return on the cash value."
If retirement savings is the primary goal, says Schuler, then most people are usually better off first maximizing contributions to employer retirement plans, IRAs, and HSAs.
"These accounts generally offer lower costs, greater flexibility, and higher long-term growth potential than a whole life policy," Schuler insists.
Accessing funds from a whole life policy can be complicated
Another issue with using whole life insurance as a retirement savings tool, says Langan, is that accessing the cash value through policy loans or withdrawals comes with real trade-offs.
"Policy loans accrue interest and reduce the net death benefit while the loan is outstanding," he says. "If the loan is repaid in full, the policy can be restored to its original state. If it isn't repaid, the outstanding balance plus accrued interest is deducted from the death benefit paid to your beneficiaries."
Withdrawals work differently. They permanently reduce both the cash value and the death benefit and don't need to be repaid.
But, Langan cautions, "neither option works the way a straightforward account withdrawal does, and that matters when you're planning for retirement income flexibility."
There's also a timing issue Langan raises.
"Because of the way commissions and insurance costs are structured in permanent policies, it can take a meaningful number of years before the cash value exceeds what you've paid in," he explains. "That lag represents a real cost compared to other vehicles where contributions are working from day one."
When can whole life insurance actually make sense?
Langan says there are some scenarios where whole life insurance does make sense in the context of financial planning.
"The first is someone who has genuinely maximized every other tax-advantaged savings option available to them and is looking for additional ways to grow assets in a tax-efficient structure," he says. "At that point, the comparison set changes and whole life becomes more competitive relative to fully taxable alternatives."
Langan also says whole life insurance can fit into estate planning and legacy situations where a permanent death benefit is the actual objective.
"If someone needs a guaranteed death benefit regardless of when they die, and wealth transfer is a primary goal, permanent insurance makes structural sense because it's doing exactly what it was designed to do," he says.
Additionally, Langan says that whole life insurance could make sense as part of business planning. In that context, there are situations in which the guaranteed nature of the policy serves a specific functional purpose.
Of course, there's also a behavioral use case for whole life insurance.
"Some people know themselves well enough to recognize that they won't invest the difference between a term premium and a whole life premium," Langan says. "If the realistic choice is between a whole life policy that forces consistent contributions and builds cash value over time versus doing nothing because the money will otherwise be spent, a whole life policy is better than nothing."
But, Langan says, it's important to recognize that this still doesn't make using whole life insurance as a retirement savings vehicle an optimal financial strategy. Rather, he says, "It's a reasonable solution to a real behavioral challenge. There's a difference, and clients deserve to know which one applies to them."
Ultimately, Schuler says, it's important for savers to understand what life insurance is supposed to do — protect income, pay off debts, and provide for loved ones if something happens to them during their working years. Term life insurance can often provide that coverage at a fraction of the cost.
"For the average person looking to build wealth for retirement," Schuler says, "term insurance combined with disciplined investing will typically provide more insurance protection, more flexibility, and a larger retirement nest egg over time."
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