Are you considering buying whole life insurance? Do you know how it compares with term insurance? We prepared this guide for you to learn more about whether whole life insurance is a good investment or not.
Keep in mind that with whole life, some of your premiums build cash value, but you’re also paying for lifelong insurance protection and expenses. Our team referred to the Financial Consumer Agency of Canada’s life-insurance guide, FSRA’s explanation of life-insurance policy types, and FSRA’s policy-reading guide to learn more details on how whole life insurance works.
We’ve also included information on dividends, cash value and death-benefit returns. Remember, guaranteed cash values are set out in the contract, while dividends are not guaranteed.
Is Whole Life Insurance a Good Investment?
The bottom line depends on the numbers: premiums, death-benefit guarantees, cash-surrender-value guarantees, loans, tax values and dividend assumptions.
Generally speaking, permanent insurance makes sense if you have a real need for it, believe you can sustain the premiums and value guarantees. But it’s not a replacement for other types of investments such as a TFSA, RRSP or liquid investment account.
If you’re after a liquid investment, compare the proposed permanent insurance illustration with the numbers you would get from buying term insurance and investing on your own.
Read More: Compare Term and Whole Life Insurance
Understanding Whole Life Insurance
Whole life insurance provides a death benefit for your entire life. Usually, the policy accumulates cash value. Some whole life products require premium payments for your entire life, while others allow you to concentrate required payments into a limited-pay period.
Regardless of type, whole life insurance can be altered or lapse if the policyholder fails to pay required premiums, accrued interest on policy loans or comply with other contract provisions.
Some term life insurance policies can be converted to permanent insurance. This privilege is subject to limitations, including conversion deadlines, eligible policy types and the amount of coverage. A policyholder cannot convert a policy after it has expired.
Term insurance is temporary and usually less expensive at the outset, but it doesn’t build cash value.
Read More: Explore Whole Life Insurance Options
How Whole Life Insurance Investment Component Works
Dividends on participating policies are not guaranteed and are based on the insurer’s financial results.
Premiums are not invested on a dollar-for-dollar basis. The insurer uses them for insurance protection, expenses, reserves and cash values.
How to Test Whether The Whole Life Policy is Worth It
Below are some of the monetary aspects of your policy you should check when looking into whole life insurance policy from an investment perspective.
IRR stands for internal rate of return. The death-benefit IRR isn’t an investment return you will have as liquid wealth while living.
| Checkpoint | Calculation or question |
|---|---|
| Cumulative premiums | Add mandatory premiums and any planned additional deposits through the comparison year. |
| Surrender value | Do not use the account value. Use the cash surrender value after applicable loans, charges and adjustments. |
| Guaranteed cash-value IRR | Enter premiums as negative cash flows with their dates and the guaranteed surrender value as the final positive cash flow. |
| Illustrated cash-value IRR | Label it as non-guaranteed and repeat the calculation using the illustrated surrender value. |
| Death-benefit IRR | Use the death benefit at a selected age as the final cash flow. Calculate several ages because timing changes the result. |
| Inflation | Convert future values to today’s dollars using a disclosed assumption. |
| Tax and loan effects | Ask for the adjusted cost basis, possible policy gain, loan rate, interest method and effect on the death benefit. |
Read More: See How Participating Life Insurance Works
Pros and Cons of Whole Life Insurance as an Investment
- It can be advantageous when the need for a death benefit has no expiration date, such as for estate planning, final expenses, lifelong support for a dependent or business planning.
- Participating policies may pay dividends that increase policy values. Dividends are not guaranteed, so stress testing against lower dividend scales is important.
- Guaranteed policy values can be advantageous when certainty is the priority rather than maximum potential growth.
- Permanent insurance generally has higher premiums than term insurance at the outset, leaving less money for other financial goals.
- You may lose money if the policy is surrendered.
- Policy loans or withdrawals can reduce the eventual death benefit and future cash values.
- Whole life generally offers less liquidity, flexibility and control than separate investments.
- The products can be complicated and require complete illustrations.
Compare Whole Life With Term Plus Separate Investing
Compare quotes with the same death benefit, timeframe and health classification, and note all renewal and conversion provisions. Subtract the term premium from the whole-life premium to see how much would remain to invest.
Remember to factor in behavioural risk. Can you count on making those investments? Can you maintain the higher whole-life premium without letting the policy lapse? Try various returns after fees and taxes, and make sure the comparison uses the same inflation assumptions and timeframes.
How do the term policy and investment portfolio compare with the whole-life death benefit and cash surrender value at different points? What happens if you stop paying premiums, receive smaller dividends or miss some investments?
Read More: Compare Buying Life Insurance and Investing
When Is Whole Life Insurance Worth It?
Permanent life insurance is a good pick if you have a clear long-term goal, the premiums would remain affordable on a reduced income, the guarantees support the need and the commitment does not prevent higher-priority saving.
When Is Whole Life Insurance Not Worth It?
Permanent insurance may be a bad option when:
- coverage is only needed until the mortgage is paid or the children are grown;
- accessible cash is important;
- the cost may cause the policy to be surrendered; or
- dividends are presented as guaranteed.
Read More: Compare Whole and Universal Life Insurance