What are the Pros & Cons of Whole Life Insurance?

One-size-fits-all doesn’t work in life insurance. Even though term life insurance suits many people, it may not be the best choice for your specific needs.

If you need lifelong coverage or want to diversify your investment portfolio, whole life insurance may be a good fit.

In this post, we will share all the information that you need to know to help you decide if it meets your long-term financial goals.

How does whole life insurance work?

Whole life insurance works by providing lifelong protection and accumulating cash value. Y

our beneficiaries receive a death benefit after you pass and you may access the policy’s cash value at any time. You can use this money for any purpose, such as buying a car, covering a financial emergency, or supplementing your retirement income.

Here are the main features:

• Whole life insurance policies have level premiums, meaning your premiums remain the same over the policy’s life.
• Part of your premium payments are used for paying the net cost of pure insurance and administrative fees.
• Another part of the premium payments — referred to as excess premiums — goes toward building cash value.
• Your policy’s cash value grows at a fixed rate set by the insurance provider.
• The cash value is not subject to tax until it is withdrawn and consequently grows faster since it is not being reduced by taxes each year.
• You can access the cash value at any time by surrendering your policy, making a withdrawal, or taking a policy loan.
• A cash value withdrawal is tax-free as long as the withdrawn amount is not higher than your total premium payments. But by doing so, it may reduce the death benefit.
• If you take out a policy loan, you will not have to pay taxes on the borrowed amount while your policy is in force, but you will be charged interest.
• If you die with an outstanding loan, that amount will be deducted from the death benefit.‍
• You can access all of the cash value by surrendering (i.e. cancelling) the policy, but your policy will terminate if you do so.

Types of whole life insurance

Whole life insurance is available in many flavors. Whatever your unique needs and policy goals are, you are likely to find a plan that’s perfect for you. ‍

1. Guaranteed Issue Whole Life

Guaranteed issue involves neither a medical exam nor a health questionnaire. Hence, acceptance is guaranteed as long as you meet the age criterion. Guaranteed issue is significantly more expensive than medically-underwritten policies and has a limited death benefit — usually up to $25,000 or $50,000. But for people with a severe underlying health condition, it is often the only option for securing life insurance. ‍

2. Simplified Issue Whole Life

‍Simplified issue lets you forgo the medical exam, but you will have to answer a few simple health questions to prove eligibility. It is much more expensive than a fully-underwritten policy but has lower premiums than the guaranteed issue. The maximum death benefit available varies by insurer, with some willing to write a simplified issue policy of up to $200,000 to eligible applicants. ‍

3. Participating Whole Life‍

Alongside lifelong coverage and tax-deferred cash value growth, participating whole life polices provide you with an opportunity to earn annual dividends. Keep in mind that dividends are not guaranteed, though some insurers have an impressive track record of paying them almost every year. Participating whole life policies are available with only mutual life insurance companies and cost more than comparable non-participating plans. ‍

4. Non-participating Whole Life‍

Non-participating whole life does not pay dividends to the policyholder. Other than that, there is no difference between participating and non-participating policies.

5. Single Payment Whole Life‍

A single payment whole life plan lets you buy coverage with a lump sum payment upfront instead of regular monthly, quarterly, or annual payments. Like most other whole life plans, a single payment policy pays out a tax-free death benefit upon the death of the insured and accumulates cash value. ‍

6. Limited Payment Whole Life‍

With a limited payment policy, you pay premiums only for a set number of years rather than for your entire lifetime. The benefits, however, last as long as you live.  

Whole Life Insurance Pros and Cons

Lifelong coverage and guaranteed returns can make whole life insurance an excellent option for some, but it is not suitable for everyone. 

Knowing its pros and cons can help you decide whether it is right for your family. 

Pros 

Lifetime Protection

A whole life insurance contract last as long as you do, provided you keep your end of the bargain by paying premiums on time. With such a policy, you can rest assured in the knowledge that your beneficiary will eventually receive the death benefit, regardless of how long you live. 

Guaranteed returns

Whole life insurance takes the risk out of the equation. Your policy’s cash value typically earns a fixed rate of interest. So you have a fair idea about how much of it you will have when it is time for you to retire. 

Cash value grows tax deferred

Your policy’s cash value is not taxed during the growing years. As a result, it grows faster because it is not subject to taxes each year. Also, if you withdraw this money when you are no longer earning a paycheck, it will likely get taxed much less than when it was first contributed to the account. 

Access cash value at any time

Once you have accumulated a certain amount of cash value, you could access it at any time without a credit check. Also, if you take a policy loan, you can choose to not pay it back. While the death benefit will be reduced, not repaying the loan can be an option if you require less coverage in later years.

Multiple uses

Whole life insurance is more than a nest egg for your family to fall back on after you are gone. You can also use it for retirement planning, estate planning, leaving a charitable legacy, or funding a buy-sell agreement. 

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Cons

Expensive

A whole life insurance plan is 5 to 15 times more expensive than a comparable term life policy. 

Cash value grows slowly

Even though the cash value grows tax deferred, it usually takes several years of compound interest to grow meaningfully. 

Surrender fees can be expensive

While you can surrender your policy at any time, surrender fees can be as high as 10% of in the first few years.   

Lower returns

The rate of return on cash value is on the lower side. Whole life insurance offers an annual rate of return of anywhere between 1% and 3.5%. Other investments, like mutual funds, stocks, and bonds, may offer better returns.  

How much does whole life insurance cost? 

In life insurance, there are no one-cost-fits-all policies. That is because insurance companies base premium rates on a number of personal factors. 

Here are 7 factors that can either raise or lower your whole life insurance cost. 

1. Age

‍Age is one of the main factors that life insurance companies look at. Generally, younger policyholders receive lower rates and vice versa.  This is so because statistically, the younger you are the more time you have to pay premiums. 

2. Health

‍To get approved for a whole life insurance policy, you will likely have to undergo a paramedical exam. If you have a pre-existing condition, like diabetes or heart disease, you may have to pay higher premiums than someone with a clean medical history. ‍

3. Gender

‍Women usually pay lower life insurance premiums than men. That’s because they tend to live longer than men, on average. ‍

4. Lifestyle

‍Life insurance companies reward people with a healthy lifestyle with lower premiums. On the other hand, if you smoke, your rates can be significantly higher. For example, a healthy, non-smoking male of age 50 can expect to pay roughly $70 a month for a $25,000 whole life plan. The same plan for a smoker would cost approximately $90 a month. 

5. Occupation

‍A high-risk job, like firefighting, might have an adverse impact on your health and consequently raise your insurance cost. ‍

6. Hobbies

‍A life less ordinary might lead to higher premiums. If you enjoy intense and thrilling activities, such as skydiving or mountain biking, life insurance providers will consider their potential impact on your health before writing you a policy.  

7. Coverage amount

‍The greater the death benefit of a whole life insurance policy, the more it will cost. 

What is the rate of return on whole life insurance?

Whole life insurance has an average rate of return of 1% to 3.5%. Compared to other traditional investment vehicles, whole life policies give lower returns, despite their tax-deferred growth. The average rate of return for RRSPs, the Canadian stock market, and high dividend index funds are 19%, 4.8%, and 4.5%, respectively. 

Is whole life insurance a good investment?

The main benefit of whole life insurance, according to its proponents, is that it offers you a way to grow your money in a tax-sheltered way. All that sounds good, but the real question is – how does it stack up against other traditional investment vehicles? 

There is no sugarcoating this: Whole life insurance gives much poorer returns compared to an RRSP, a high divided index fund, or a stock market. As such, it is generally not a good investment choice unless you need permanent life insurance coverage. 

Here are some reasons why: 

• It usually takes over a decade to earn reasonable investment returns. This means if you surrender the policy within the first 10 years, you will struggle to get back the total premiums you have paid, let alone make a profit.
• Buying a term life plan can save you money, which you can then invest in an investment vehicle with a greater earning potential, like an RRSP, a mutual fund, or stocks.
• If you do not utilize all of the cash value before you pass, the remaining amount goes to the insurance provider, not your beneficiaries.

However, in some specific situations, it is worth the cost:

• You are a high earner and have maxed out your RRSP and other tax-advantaged investment options.
• You want to invest funds in an account that requires minimal involvement from you and promises a guaranteed minimum return.

Can I cash out my whole life insurance?

Yes, you can withdraw cash from your whole life insurance policy once it has accumulated a usable sum. There are three main ways to do this. 

1. Surrender your policy

You can cash out the policy entirely by surrendering it. If you do so, the insurer will pay you the cash surrender value (CSR). It is calculated using the following formula: 

CSR = (gross cash value) – (surrender fees + any outstanding policy loan)

Most people surrender the policy when they retire, but no rule says you cannot do it before. That said, during the initial few years, cash value growth is slow and the surrender fee is very high. For these reasons, surrendering a policy makes sense only if you have had it for some time, say 10 years. Otherwise, much of the cash value would go towards paying the surrender charges.

Keep in mind life insurance coverage ends the moment you surrender your policy. So if you have people in your life who depend on you for their financial well-being, a policy loan or cash withdrawal may be a better option. 

2. Withdrawal

Once your policy has accumulated a certain amount of cash value, you can take a cash withdrawal from it. However, your death benefit will likely be reduced. Also, you will pay tax on any amount that exceeds the adjusted cost basis (ABC) of your policy. 

Your policy’s ACB = Total premiums paid – the net cost of pure life insurance

So if you withdraw $20,000 from your policy’s cash value and your policy’s ACB is $18,000, you will pay tax on only $2,000 (not the entire withdrawn amount). 

3. Loans

You can borrow money from the insurer by offering your policy as collateral. Policy loans include interest payments, but the interest rate is typically lower than those of personal loans or home equity loans. You do not have to repay the loan, but in that case, the insurer will deduct the outstanding loan amount from the death benefit when you pass. 

For example, let’s assume you have a $120,000 whole life insurance policy. To meet a financial emergency, you took a policy loan of $30,000. Unfortunately, you passed away before you could pay back any of it. Since the outstanding loan amount at the time of death was $34,000 (principal amount + interest), your beneficiaries would receive a payout of $116,000. 

If you would rather keep the death benefit intact, treat a policy loan as any other loan and repay it as soon as possible. 

What are the alternatives to whole life insurance?

If whole life insurance does not fit your needs, you may want to consider these life insurance products.

Universal Life Insurance:

Apart from offering lifelong coverage, universal life insurance lets you decide how your cash value is invested. It also offers premium and death benefit flexibility. But it comes with more risk and responsibility than whole life insurance or term life insurance.

Term Life Insurance:

It provides life insurance protection for a limited period only, like 10, 20, or 30 years, and does not build cash value. On the upside, term life policies are significantly more affordable than comparable universal life or whole life plans.

Whole life vs. universal life vs. term life insurance

Is whole life insurance for me? 

You should buy life insurance if you: 

• Are a business owner and need life insurance to secure a business loan, fund a buy-sell agreement, transfer assets to your beneficiaries tax-free, or ensure you leave an equitable inheritance to all your heirs
• Are a high-net-worth individual who has maxed out other traditional investment vehicles and is looking for new tax-free investment opportunities
• Support a lifelong dependent, such as a special-needs child
• Want life insurance to offset your tax liability after death 
• Want to leave a charitable inheritance

Conclusion

Whole life insurance provides lifetime coverage and builds cash value. Even though it is more expensive than term life insurance, it can be a worthy option for people with unique life insurance needs. 

Still not sure what is better for you: term or whole life? Let Dundas Life help you. Our insurance experts will evaluate your financial goals and budget to determine which type of life insurance policy would be a better fit. We will also help you find the right coverage at a great price. 

Frequently Asked Questions

Why do people choose whole life insurance?

Whole life insurance provides permanent coverage and accumulates cash value at a fixed rate, making it an attractive option for many people. You may want to consider it if you have a lifelong dependent (such as a special-needs child), need help with estate planning or business succession planning, or are looking for a tax-sheltered investment vehicle. 

Are whole life insurance policies a scam?

Whole life policies are not a scam. Lifelong protection and guaranteed cash value growth can make it a good choice for people with unique needs. However, as a standalone investment vehicle, whole life insurance just doesn’t cut it. Other traditional investment options, like RRSP, mutual funds, and bonds typically offer much better returns. 

When do you stop paying for whole life insurance?

Generally, people buying whole life pay the premiums for as long as they live. However, some whole life policies allow you to fund the entire cover in 10, 15, or 20 years. If you buy such a policy, your premium payments will end after a certain period.