Why Whole Life Insurance Is a Bad Investment and How to Avoid It

Whole life insurance can be a costly and inflexible investment. It's often sold as a way to build cash value over time, but the truth is, the returns are typically low and often not enough to keep up with inflation.

The fees associated with whole life insurance are substantial, with some policies costing up to 40% of the premium in administrative fees alone. This can quickly eat into any potential cash value.

Many people end up paying for coverage they don't need, which can lead to a significant waste of money. In fact, a study found that 75% of whole life insurance policies are sold to people who don't actually need them.

Whole life insurance is a bad investment for most people. The fees and commissions associated with whole life policies are very high, with agents receiving 90%-105% of the first year's premium.

The high fees eat away at the returns on your cash value, making them far lower than what you'd get from investing elsewhere. In fact, even at modest returns of 6% per year, a brokerage account can outperform a whole life policy's cash value.

The majority of people who buy whole life insurance don't need a permanent death benefit, and they're not investing large amounts of money. This makes whole life insurance a bad investment for them.

For example, let's look at the difference in premiums between a whole life policy and a 20-year term policy. A healthy 30-year-old male would pay $10,973 for a whole life policy, compared to $896 for a 20-year term policy.

Here's a rough breakdown of the costs:

The cash value in a whole life policy grows tax-deferred, but that's not enough to make up for the high fees and low returns.

Whole life insurance policies are notorious for their lack of transparency. They include many fees that are never clearly explained to you, such as commissions to the salesman and administrative costs.

You'll struggle to find an example of a whole life illustration that breaks down these costs for you, unlike a mutual fund which has to disclose its expense ratio, sales commissions, and other fees.

With whole life, you're forced to commit to paying huge premiums year after year, no matter what happens in your life. This limited flexibility is a major drawback, especially when life happens and you need options.

Hidden fees are a major concern when it comes to whole life policies and IUL policies. They're often glossed over during the sales pitch, but they can significantly eat into the policy's cash value and overall returns.

These fees can include premium expense charges, which can be as high as 6% of each premium payment. Monthly policy fees are also common, and they can add up quickly.

Per-unit charges based on the death benefit can also be a significant expense. Surrender charges for early policy termination can be steep, and index account charges are similar to expense ratios in mutual funds.

Here are some common hidden fees associated with IUL policies:

These fees can have a major impact on the policy's performance, and it's essential to understand what you're paying for. As one example, a doctor paid $30K a year for 3 years in whole life insurance premiums, only to discover the surrender value was only $50-60K or worse.

Whole life insurance is illiquid, meaning you can't easily access your money without facing penalties or fees. For the first decade or so, you're almost guaranteed to have negative returns, making it difficult to get back the amount of money you put in.

Many policies have a surrender charge, which is essentially a fee you have to pay if you decide to cancel the policy and withdraw the cash value. This can be a significant barrier to accessing your money.

Most policies will allow you to borrow against the cash value, but you have to pay interest, even if you're borrowing only the amount of money you've put in. This can lead to a vicious cycle of debt and interest payments.

In contrast, 401(k)s and IRAs do have penalties for early withdrawal, but they also offer many other advantages, such as the ability to choose your investments, true tax deferral, higher transparency in fees, and cash flow flexibility.

Here are some key differences between whole life insurance and other investment options:

As you can see, whole life insurance is not a very liquid investment option, making it difficult to access your money when you need it.

Whole life insurance policies often promise "tax-free" withdrawals, but this claim is misleading. This is because loans taken against the policy are not taxed, but interest starts accruing from day one.

The interest on these loans can add up quickly, and if you're using the loan for retirement purposes, it's unlikely you'll pay it back. This means the interest will keep accruing, applying to all money withdrawn, including contributions that were already taxed.

Taking out too many loans can also reduce the death benefit of the policy, which may or may not be important to you. This can have significant consequences for your loved ones if you pass away.

If you withdraw too much from the policy and there's no longer enough cash value to support premium payments, you'll either need to put more money into the policy or it will lapse, resulting in tax consequences.

Whole life insurance isn't for everyone, and that's an understatement. It's often sold inappropriately, with 80%+ of policies being surrendered prior to death.

People buy whole life insurance for the wrong reasons, like having student loans or not maxing out available retirement accounts. It's like trying to pay off a 6.8% debt with an investment that returns only 2-5% over the long term.

Whole life insurance is a bad investment for those who need cash in the short term, as it's designed for long-term use and has nasty tax consequences for surrendering policies with gains.

You can't just stop paying premiums on a whole life insurance policy whenever you need the money. If you do, the policy lapses and you'll be forced to withdraw the cash value, which will be subject to taxes and possibly a surrender charge.

A 30-40 year period is usually when you need insurance the most, but whole life insurance covers you for your whole life, including those periods when you don't have a life insurance need.

Whole life insurance returns are not guaranteed, despite what salesmen might tell you. The illustrations they present are simply projections, often overly optimistic to make a sale.

These projections are based on the company's own growth charts, but the actual performance can be far worse. For example, a policy with a "guaranteed return" of 4% might only yield less than 1% after 40 years.

Don't be fooled by the promise of a "guaranteed return". In reality, fees and interest rate application can eat into the actual returns, making them much lower than expected.

You can often get better guaranteed returns from a savings account or CD that's also FDIC insured.

Slow progress is a major drawback of whole life insurance. It takes a long time to appear, often 40 years or so, before returns reach around 4%.

If you stick with it for that long, you might eventually get into a reasonable range of returns, but you'll have spent many years getting very poor returns. This is not a possibility of bad returns, but a promise of it.

In fact, whole life is almost guaranteed to have very poor performance for at least a decade and often upwards of two decades, which is very different from stocks and bonds that might deliver poor performance over certain periods.

Whole life insurance is not the only type of permanent life insurance, but it's not the only one that comes with high costs and commissions. Other forms of permanent life insurance include term life insurance, which is actually not permanent, but we'll get to that later.

Universal life insurance is another type that combines a death benefit with a savings component. The features of universal life insurance might look attractive, but the additional costs usually outweigh the benefits.

Variable life insurance is another type that allows you to invest your policy's cash value in a variety of assets, which can be a risk. Some people might think this is a good idea, but it's not for everyone.

Variable universal life insurance combines the features of universal and variable life insurance, making it even more complex. The costs and risks associated with this type of insurance are usually not worth it.

Whole life insurance is often misunderstood as a necessary coverage for your entire life. It has a death benefit that lasts until you die, and a cash value component that grows over time.

The primary purpose of life insurance is to provide financial resources for your children to become self-sufficient, not to cover you for your entire life.

Whole life insurance is much more expensive than term insurance, often 10-12 times as expensive. This makes it less useful as a pure insurance product.

Access to insurance is limited, especially for those with poor health or engaging in high-risk hobbies. Many people can't purchase a whole life insurance policy at a reasonable price due to their health or lifestyle.

Whole life insurance policies often end up being sold inappropriately, with 80%+ of policies being surrendered prior to death. This is because the purchaser has a better use for their money, such as paying off student loans or maxing out retirement accounts.

Some individuals are sold whole life insurance policies despite having 6.8% debt from student loans, while also being sold an investment with terrible early returns and 2-5% long-term returns. This is a bad financial decision, as it would be better to use the money to pay off high-interest debt.

Salesmen often use half-truths to sell whole life insurance policies, such as describing borrowing against the policy as "tax-free income." However, this is not entirely accurate, as the proceeds are not truly tax-free.

Tiny policies can be a major issue, especially when it comes to buying life insurance on your kids. As an example, a policy with a face value of only $20K still has policy fees that make up a larger percentage of the premium, dividend, and cash value, thus lowering your returns.

Policies that small often have the same policy fees as larger policies, which can be a major drawback. This was the case with a policy I was sold as a medical student.

The policy fees can make up a much larger percentage of the premium, dividend, and cash value, which can significantly lower your returns.

A 7-year commitment to a whole life insurance policy can be a lot like a 7-year marriage - it's a long time to be tied down. This type of policy is not something you should buy for just a few years or even a few decades.

It's tough to project your income and family situation for the next decade, much less the next half century. This is especially true when it comes to whole life policies that require a long-term commitment.

A "7-pay" or "10-pay" policy can minimize some of this risk by allowing you to only pay premiums for 7-10 years. Unfortunately, these types of policies can be hard to come by.

If you do find yourself stuck with a whole life policy that's no longer serving you, it's not the end of the world. You can try to exchange it for a low-cost variable annuity or simply walk away with your cash value.

You don't need whole life insurance as an investment option when you have so many other good choices available.

Many people have a 401(k) or other retirement plan with their employer, which allows you to choose your investments and control your costs.

Just about everyone has the option of contributing to an IRA, giving you even more flexibility and control over your investments.

Regular taxable accounts are also an option, allowing you to diversify your portfolio and avoid the downsides of whole life insurance.

You can save money now by buying term insurance and still have the option to convert some or all of it to whole life at any point during the life of the policy.

This means you don't have to lock yourself into a whole life policy now, giving you peace of mind and financial flexibility.

Most whole life insurance policies are sold inappropriately, which is a major issue with this type of insurance. This is because agents often prioritize maximizing their own commissions over finding the best solution for the customer.

Agents may use tactics like selling policies to people with high-interest debt, such as student loans, while ignoring more effective ways to manage that debt, like paying off the loan quickly. They may also sell policies to people who haven't even maxed out their available tax-protected retirement accounts.

Salesmen often use half-truths to sell whole life insurance, like claiming it provides "tax-free income", when in reality, the only tax-free aspect is the death benefit. Borrowing against a whole life policy is more like taking out a home equity loan, where the proceeds aren't considered "income."

Insurance agents often claim that wealthy individuals heavily invest in IUL policies, but this is largely a myth. Most successful people build their wealth through business ownership, real estate, and low-cost index funds.

Some ultra-wealthy people do buy permanent life insurance policies to help their heirs pay the large estate tax bill when they eventually pass. Unless your estate is worth over $12.29 million (or $24.58 million for married couples), you can skip permanent insurance policies like Indexed Universal Life.

Most policies sold inappropriately. A staggering 80%+ of whole life policies are surrendered prior to death, as their purchasers realize they are not suitable for their life.

This often happens when a policy is sold to someone with student loans, who would be better off paying off that debt instead of investing in a policy with terrible early returns and 2-5% long-term returns.

People often buy whole life insurance without understanding how it works, only to discover they're underwater after 2 or 3 years of making payments.

Salesmen may use half-truths like "tax-free income" to sell policies, when in reality the only tax-free benefit is the death benefit.

Policies sold to parents for their kids are often tiny, with face values as low as $20K, and still have the same policy fees that lower returns.

These small policies have fees that make up a much larger percentage of the premium, dividend, and cash value, which is a major issue.

Borrowing terms are often terrible because they can lead to a significant increase in premiums. The average interest rate on a whole life insurance loan is around 8%, which can quickly add up and make it difficult to pay off the loan.

Whole life insurance loans can be taken out at any time, but they can also be a major drawback. This is because the loan will reduce the cash value of the policy, which is the amount of money you can borrow against.

Borrowing too much or too often can lead to a policy lapse. If you're unable to pay back the loan, the insurance company will cancel your policy, leaving you without coverage.

The loan interest rate is typically much higher than the interest rate you'd get from a bank or credit card. This means you'll end up paying a lot more in interest over time.

Whole life insurance loans are not always a good idea, especially if you're not careful.