How to Get the Best Investment Value from Whole Life Insurance

Life insurance mitigates risk, but you may be surprised to learn that it can also be a form of investment. When you pay into a whole life insurance policy, you may be able to access some of the cash while you are still alive. It's not the right approach for everyone, so here's what you need to know to decide if and how to use whole life insurance as an investment.

The Basics

Let's start by recapping what whole life insurance is. Most coverage falls into two categories, "term" and "permanent," and whole life is part of the latter category.

Term insurance covers you for a specified period. If you die during this period, the policy pays out. If you're still alive at the end of the period, the policy ends, and you get nothing back.

Permanent life insurance extends your entire life. When you die, the policy pays out an amount called a death benefit.

Permanent life insurance includes a couple of options, namely whole life and universal life. With whole life insurance, you pay fixed premiums throughout your life and get a fixed death benefit. With universal life, you can alter the premiums later on, which in turn will change the death benefit.

So, where's the investment?

There's another big difference between term insurance and whole life. With term insurance, all the money you pay in premiums goes to the insurer. Essentially, it's the fee you pay to cover the risk they might have to pay out during the term.

With whole life, only part of the premium goes to cover the policy itself. The rest invests, meaning you can build up a "cash value" in the policy based on how well the investment performs. It's tax-deferred, meaning you don't pay tax until you withdraw the cash.

Depending on your policy, you may have several options for accessing the cash before you die, including withdrawing it and borrowing against it.

Who should consider whole life insurance as an investment?

Whether using whole life as a form of investment is a good option depends on your circumstances. The following is a list of situations where it makes sense. While not a comprehensive list, the more of these that apply, the more appropriate whole life insurance as an investment could be for you.

You need or want life insurance anyway

If you don't have any financial dependents, or if you've already paid off significant life costs like a mortgage or college fees, you may not need life insurance. In this case, it's unlikely the investment benefits of a whole life policy would be worthwhile.

However, if your dependents would suffer financially without your income, whole life insurance makes more sense. Whole life is particularly suitable if you are looking to cover funeral costs, provide for a dependent with lifelong issues such as disability, or manage your estate.

You're younger

The longer your whole life policy runs, the higher the investment component. It's far more likely the investment returns will outweigh the fees and other costs involved in whole life policies. An extended investment period means more chance of riding out any market downturns.

You have a higher income

In most cases, traditional retirement savings options such as a 401(k) or IRA should be the first step given the advantages such as employer matching. Whole life insurance can be a significant next step once you've maxed out these options.

You're happier with lower risk/lower reward

With a whole life policy, the investment component most commonly goes into unit-linked funds or with-profit funds. The funds are spread across multiple stocks and securities. You're less likely to get spectacular swings up or down and more likely to get smaller but steadier growth.

Making the most of the investment

If you like a whole life policy because of the insurance benefits, there are many ways to make the most of your plan.

Weigh the costs

Choosing a whole life policy will cost you in several ways, most notably:

• Considerably higher premiums than term insurance (to reflect the fact the insurer is sure to pay out eventually.)

• High administration fees, particularly in the initial years of the policy.

Compared with term insurance, or with more conventional investment, even a small variation in premiums and fees between different providers can make a significant financial difference. Indeed, it's arguably the area that will most affect the value you get from this investment.

Compare like-for-like

Don't merely compare fees and premiums across different policies: this won't always be an apples-to-apples comparison. It's essential to understand how a particular policy works. You'll need to find out exactly where the investment goes and how this fund operates. Know the proportions in which your premiums split between; paying for the policy and investing cash value. Some plans vary these proportions over time, adjusting to market conditions.

Take control

Some policies give you a degree of control over exactly how and where your money invests. If you're a confident, informed investor, this may be a good option for making the most of your cash or tweaking the risk-reward ratio.

Keep the seller's incentives in mind

Make sure you understand what options an insurance agent covers when offering you the "best" deal. Remember, you need to compare a whole life policy's investment component against other forms of investment as well as different types of insurance.

Check the seller's financial strength rating

While your whole life policy's investment element will likely be diversified, you do need to know the risk of the insurer itself going out of business. Independent agencies such as Moody's and Standard & Poor's can warn if an insurer is vulnerable.

Consider dividend options

Some whole life policies invest in "with profits" funds that pay dividends to investors at the end of the financial year rather than just growing the investment. You may have a choice between receiving this as a cash payment (usually tax-free) or reinvesting it. The latter option can be a hassle-free way to boost your policy's cash value.

In many cases, a whole life policy will guarantee a low rate of return, perhaps one or two percent, regardless of how the investments perform. You may well get more than this, but it's dependent on the dividends.

Understand how to access your cash value

Find out exactly how you can get the money from the investment element of the policy, as this will affect how worthwhile this investment is for you. Common options include:

Making a withdrawal: this will carry a fee and reduce your eventual death benefit. It's tax-free as long as it doesn't exceed the amount you've already paid in premiums.

Accelerated benefits: some policies let you take a portion of your death benefit while you are still alive, usually in specific circumstances such as being diagnosed with a terminal illness or requiring long-term care. This can affect your eligibility for Medicaid and disability benefits. Often, your ongoing premiums will decrease to reflect the decrease in the remaining death benefit.

Surrendering the policy: this gets you an immediate lump sum but cancels the policy. However, high surrender fees usually make this impractical in the first 10 to 15 years of the plan.

Taking a policy loan: this is a way to borrow money without the need for credit checks or putting up other assets as collateral, and the interest rates are usually low. However, when you die, the death benefit deducts money you haven't paid back. In some cases, missing a scheduled repayment could mean the company will cancel your policy.

CNBC notes the rates for policy loans are often lower than other forms of borrowing. It cites a customer who paid 4.29 percent for a policy loan at a time credit card rates average 17.7 percent and personal loan rates could reach 36 percent.

Selling the policy: it may be possible to sell the policy to somebody else who then takes over both the premium payments and the future benefits. For this to work, you'll need to find a sale price that's more than the current surrender value (so you're better off) but less than the scheduled death benefit (so the buyer is better off.) You'll usually have to pay taxes on any gains you make from this process.

If you are considering a life insurance policy, visit our Life Insurance page to learn how to find the best plan to fit your needs.