The following post is written by Brian So from Brian So Insurance
If you have ever spoken to a life insurance broker or researched life insurance online, you may have come across a type of insurance called whole life insurance. What is whole life insurance and how does it compare to term insurance? More importantly, is whole life insurance worth it?
What is whole life insurance?
Whole life insurance is a type of permanent life insurance. Its premium is guaranteed and level for the life of the insured until age 100, when the policy is paid up and no further premium is necessary.
Because the premium never increases over the life of the policy, it starts out much higher than the premium for term insurance. The premium in the earlier years is more than necessary to cover the cost of insurance. The excess is kept inside the policy as a cash reserve. As the insured ages and his mortality rate increases, the premium he pays is no longer sufficient to keep up with the mortality rate. The excess premium paid in the early stages helps supplement the policy in the latter stages.
The insured can decide to cancel the policy at any time. Since the money in the cash reserve was saved for the latter stages of the policy, it can be withdrawn when the policy is cancelled prematurely.
Whole life insurance is used primarily for long-term needs, such as funeral costs, charitable donations and for estate planning purposes. For example, some people have a significant tax liability when they pass away. In order for their beneficiaries to receive their entire estate, they purchase whole life insurance to cover the taxes. Or if they have a business to pass on to one child, they can name the other child as beneficiary of a whole life insurance policy to equalize the estate.
How does it compare to term life insurance?
Unlike term insurance, which has an expiry date and increases in premium after the chosen term, whole life insurance never expires and never increases in premium.
The benefit of term insurance is the low cost of insurance in the early years. For example, a term-10 policy for a 40-year-old male for $500,000 of death benefit can be bought for only $375/year in the first 10 years. The same person buying the same amount of insurance would have to pay $4,690/year for a whole life policy.*
However, the term-10 policy renews in year 11 for a premium of $2,300/year and year 21 at $6,010/year. Therefore, term insurance is an extremely cost-effective method for short-term protection. It should not be used for long-term planning because of the premium increases and the fact that most term policies end at age 85. If term insurance excels for short-term needs, then whole life insurance must be perfect for long-term needs, right? Well, not quite.
Is whole life insurance worth it?
Going back to the 40-year-old, there is little chance he can anticipate his long-term insurance needs when he is in his late seventies and beyond. To purchase a $500,000 whole life policy at age 40 for funeral costs, charitable donations and estate planning purposes does not make much sense when you factor in the high premium and the fact that there are so many unknown variables affecting how much insurance he needs for each of these purposes.
He can however, buy a smaller whole life policy for $50,000 of death benefit at a cost of $654.50/year, figuring that he will need at least that much for the funeral costs and charitable donations. The advantage of this is locking in lower rates while he is young and healthy. If he needs more coverage later, he can buy a new policy if he still qualifies medically. But the longer he waits, the more expensive the insurance becomes.
Another thing he can do is convert a term policy. Term insurance can be converted into whole life or another type of insurance policy before age 65-75. By buying a term policy and converting a portion of it into whole life insurance at a later age, he satisfies both his short-term and long-term obligations.
When you ask the question of whether or not whole life insurance is worth it, you must consider your life insurance goals. If you only need life insurance for short-term needs, then no, whole life insurance is not worth it. However, if you are planning for long-term needs, then whole life insurance may form an important part of your overall insurance plan.
Brian So, CFP, CHS, is an insurance broker and blogger at briansoinsurance.com . Follow him on Twitter for his musings on life insurance and why the Vancouver Canucks will win the Stanley Cup next season (Seriously).
*Rates effective May, 2018 with Desjardins Insurance.