DO YOU REALLY NEED WHOLE LIFE INSURANCE?
I was asked earlier whether a person should purchase a whole life insurance policy. I strongly believe that whatever financial decision a person makes, there are always pros and cons. The closest thing to a perfect financial decision you will make, is the one that best suits your needs. Life insurance is no different.
TERM LIFE INSURANCE VS WHOLE LIFE INSURANCE
There are two primary categories of life insurance: Term Life Insurance and Whole Life Insurance. Think of Term Life Insurance vs Whole Life Insurance in terms of renting vs purchasing a home.
When purchasing a term life insurance policy, you do not own it. It acts as a lease with a specified end date. However, if you were to pass away or become chronically ill, the death benefit would either go to your dependents or go towards paying off your medical expenses so that your quality of life would not be impacted.
Whole Life Insurance is different in that you own the policy. Some of the money paid into your whole life policy accumulates “cash value” in the form of a tax-sheltered account that the policyholder can borrow against. Returns on these investments tend to be lower and fees higher than with other savings or investment vehicles. You pay premiums into the policy for a specified duration until it is “paid up”.
I recommend most people get term life insurance for a very good reason. Most people within the US population do not have complex tax needs, estates, or assets in excess of $5M. Term life insurance — one of the most inexpensive life insurance options that only covers a certain number of years and does not contain an investment or savings component — is a better fit for most people. If your only consideration is the death benefit (leaving money for your dependents) then it does not make sense to purchase a whole life policy.
WHO REALLY BENEFITS FROM WHOLE LIFE INSURANCE?
So, who can benefit from whole life insurance and the cash value accumulated in this type of policy?
- Top 20% of income earners or those making $100k+ annually and have maxed out their 401(k) plans, IRA and Roth IRA options. Although folks living in San Francisco or New York City may disagree vehemently when I say 100k is a top income earner, for the sake of this argument, I have used the average salary of high-income earners across the US (Household income in the United States – Wikipedia).
- Those with complex estates. This is primarily for individuals with an estate worth $5.6M+ or couples with an estate worth $11.2M+.
- Continued care considerations for a disabled child or dependent.
- Liquidity held for a private business.
- Those individuals needing protection from litigation and creditors.
- Those in a high tax bracket, are risk-averse and are interested in conservative returns that are protected from market corrections.
If you are going to purchase a whole life policy, make sure you work with an honest advisor who has experience in structuring policies to maximize cash value. Also, consult your tax preparer or CPA to ensure a whole life policy is in line with your tax strategy for the coming years.
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