What are the benefits of investing in a whole life insurance policy?

I'm 27 years old and have had a few insurance salesman try to sell me whole life insurance. They call themselves financial advisors, but no matter what I tell them, they continue to tell me that whole life insurance is what I need. The way I look at it is, I'm not going to need insurance at a certain point in the future. Why would I pay high fees to tie together my insurance and investments when I could just invest in my 401(k) and Roth IRA and buy cheap term insurance? I feel like these salesman have no experience and know less about personal finance than I do. What are some good reasons to buy whole life insurance?

Personal Finance, Investing, Life Insurance
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March 2017
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Whole life insurance can be a very powerful element of your portfolio for a number of reasons, but advisors can also make a lot of money by selling them and mismanaged whole life policies can wreak havoc on your financial plan. As such, I would not buy whole life if you suspect it is merely transactional and the product is not being touted as part of a diversified plan.

Whole life policies offer numerous benefits throughout your life and beyond. Death benefits are generally passed on tax-free, so the taxable equivalent rate of return on legacy value is often substantial. Because whole life policies have guaranteed cash value growth, the cash value account can be utilized like the bond portion of your portfolio, allowing your to invest more aggressively outside of the policy. Perhaps the most attractive aspect is the fact that growth in the cash account can be realized completely tax-free. Anything up to your cost basis is distributed completely tax free, and cash distributions beyond that can be structured as a loan, which is also untaxed. You can potentially take a loan on the cash value while still receiving dividends, allowing you to generate multiple returns on your dollar if you have the opportunity to invest that capital elsewhere in the future. This feature is attractive to business owners and investment property buyers.

By having whole life along side an investment portfolio, you will have the option to choose the most beneficial source of capital for things like real estate purchases, home improvement, college tuition or retirement. This is often thought of as a "tortoise and hare" approach, and it will keep you from disinvesting a the bottom of a stock market cycle (the worst time to disinvest) due to capital needs. In retirement, having a permanent death benefit that will be passed on to your spouse allows you to spend your assets more liberally because you will not need to preserve income-producing assets. This is especially attractive in the early years of retirement, which are the most active. Having a permanent death benefit also allows you to maximize your pension election, if that is relevant in your career. Without a competent and reliable advisor walking you through these features and staying in contact to help you throughout your various life stages, it might be very difficult for you to realize and execute on these opportunities, however.

Whole life certainly has disadvantages, though, especially if it is mismanaged. Opening a policy is a commitment. Contributions are higher than for corresponding term policies, and you will lose liquidity in the first years of the policy (though this impact can be reduced by utilizing paid-up additions from the start). As you pay for the mortality and expenses of the policy early on, your premium contributions will not result in corresponding increases to cash value. Your cash value will only equal your gross contributions several years into the policy, depending how it is structured, so you should understand that if it is being pitched as an investment. Historically, the growth rate on these policies has not matched that of the market, though they are considered valuable because they "never have a bad day."

Regarding the fees, I also urge you to consider the fees that you are charged in 401(k) and Roth IRA accounts. I am surprised by how much my clients underestimate the impact of these fees, which can be numerous and well-hidden. People also frequently fail to realize the magnitude of their embedded tax liability in their 401(k) and other qualified accounts, which can be disastrous down the line. It is rare that you see a genuine apples-to-apples comparison of net returns across different product categories.

Like any other product, there are trade-offs that you must consider. However, whole life absolutely has a place in the portfolios of many investors.

February 2017
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