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Whole life insurance is one of the most controversial financial products. While whole life insurance offers permanent coverage for your entire life with a cash value you can borrow against, it’s also very expensive. Term life insurance is the far more popular option that can be up to 20 times less expensive with the coverage you want during the period when you will most likely need it the most.

Here’s what you should know about the issues surrounding whole life insurance.

Whole vs Term Life Insurance

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Whole life and term life insurance are very different products. Whole life insurance covers you for your entire life and it includes a cash value account. This means you can borrow money against the cash value of your policy or surrender the policy for its cash value. The value of the policy grows slowly over time and is tax-deferred with a minimum rate of return that is guaranteed. The main downside is whole life insurance is very expensive with annual premiums that can be up to 20 times more expensive than a 20-year term life insurance policy.

Term life insurance, on the other hand, offers temporary coverage. You select a term, such as 5, 10, 15, 20, or 30 years, and the policy will pay out if you die within the term. If you outlive the term you selected, you receive nothing. Term life insurance policies have no cash value, but they can be very inexpensive.

Another difference many consumers are not aware of is insurance agents make more money in commissions when they sell whole life insurance rather than term policies. This can create a great deal of pressure on agents from some companies to push whole life insurance policies, even when they do not make sense for the customer.

The Problem With Whole Life Insurance as an Investment

Some agents advertise whole life insurance as an investment, a concept that can be problematic for customers who can’t afford premiums. It’s true that a whole life policy comes with a minimum rate of return and cash value, but if you can’t keep up with payments, your coverage will end. If this happens in the early years of the policy, it means receiving little or no cash. Over 25% of whole life insurance policies get terminated within the first 3 years, according to Society of Actuaries and LIMRA.

Most people will be better off maximizing contributions to tax-advantaged retirement accounts like 401(k)s and IRAS before investing in a whole life policy. During this time, far cheaper term life insurance can be used for protection.

Is Whole Life Insurance a Smart Move?

Whole life insurance can make sense for some people, including those who have already capped out on retirement contributions and want a safe, conservative investment vehicle. It’s also a good move for people looking for permanent coverage and the guarantee of a whole life product.

For most people, however, a term life policy is the best choice for several reasons. Whole life insurance:

  • Costs a lot of money. You can expect to pay around 20 times more for a whole life policy than you would for a 20-year term life insurance policy.
  • Has high costs. The agent who sells a whole life insurance policy usually receives a 100% commission on the first year’s premiums and 6% on premiums after that compared to 50% of the first year’s premiums and 4% afterward for term policies. That’s a lot of money that will not be invested for you.
  • Takes a long time to pay off. Most whole life policies have a decent return if you hold them long enough. Unfortunately, most policies need to be held for about 20 years before they build up a cash value that’s worthwhile.
  • There is no liquidity. When you consider a whole life policy from an investment standpoint, remember that stocks, mutual funds, bonds, and most other investments can be cashed out easily. This is not true with a whole life policy. You can only get the money out by surrendering your policy or borrowing it from the policy. Borrowing against your life insurance policy can add extra complexities though.

The bottom line is you shouldn’t assume that a whole life insurance policy is a good investment, regardless of the projections the agent shows. There are definitely situations in which a whole life policy can be a great thing, but most people do better with term life insurance.