Should You Be Looking Into a Whole or Universal Life Insurance Policy?

One of the more common questions I get as a financial planner who doesn't sell anything is around the topic of life insurance, specifically whether or not to invest in a whole or universal life policy. Note that I use the word "invest," because I view this decision as a bit of an investing trade-off. Here are my thoughts.

Red flag alert

When a doctor friend of mine asked for my thoughts on a whole life insurance policy a while back, a small red flag went up right away - my husband is a physician and I spend a fair amount of time fighting off insurance folks on his behalf. When I was selling products during my brief stint as a financial advisor back in 2009, seeing MD behind someone's name usually signaled "more dollars," so I'm always leery when my doctor friends mention they're being pitched insurance.

When she also noted that she was being pressured to buy a specific whole life policy after meeting with an agent to discuss disability and term life insurance (which is considerably less expensive), the flag went to full staff - someone saw commissions when they got that appointment. She was pretty sure that whole life was bad since that was the thing the agent was pushing the most, but wanted to check with an unbiased person first. Here's how I handled that question.

Should you even be looking into a policy like this?

Most people don't go out searching for whole or universal life insurance policies - they usually go in search of a term policy, which is the cheaper life insurance that basically pays out if you die during the term, but offers no other benefit if you happen to live (this is a good thing to me!).

It also offers very little in terms of commissions to agents - the one life insurance policy I sold in my career was a $500k term policy to a friend and her husband and my commission was $300 - a huge percentage of the first-year premium that they paid for their coverage, but not exactly enough to pay my rent.

Whole and universal life insurance policies are a whole other ballgame, but chances are if you're talking to a financial advisor about life insurance, he or she is going to bring one of these options to the table along with a term policy quote as you requested. I personally think there are very specific circumstances where whole or universal life policies make sense for people, and that everyone else is best served with term insurance, so I'm offering that line of reasoning here.

For purposes of simplicity, I'm lumping universal and whole life policies into the same bucket (universal is basically a subset of whole life), as the reasons to consider either are usually the same. It's important to note that how the policies work and their specific benefits are very different.

The purpose of this article is mostly to offer a screen out for folks - if you find that you fit the profile of someone who may want one of these policies, then choosing whole life versus universal is a very different decision and is actually something you want to trust your financial advisor on.

How to determine whether a whole life policy is right for you

The big downside to whole life policies (which are named such because they last your whole life) is that they tend to have high fees, especially in the first couple years, when the agent makes their big bucks off commissions. In my opinion, whole life insurance is most appropriate for people who are financially stable enough that all their other tax-advantaged ways to save money are being fully utilized.

Ask yourself the following questions:

  1. Are you and your spouse (if applicable) both maxing out available workplace retirement savings plans such as 401k, 403b, SEP-IRA, etc? And by maxing out, I mean putting the annual IRS-allowed limit in, which is probably more than any company match you're offered. If not, then I'd focus on getting to that milestone first - it's cheaper and offers you more access to the money.

  2. If you are enrolled in an HSA-eligible healthcare plan, are you contributing the maximum amount for the year, while also being able to avoid spending the money for routine healthcare? If not, then work to get to the max here so that your HSA can build up as a tax-free investment fund. (I'd actually argue that you strive for this milestone even before trying to max out your 401k - more on that here)

  3. Are you maxing out a Roth IRA (using the “back door” method, if necessary and applicable)? If not, then you might want to start that - "back door" Roth IRAs work best when you don't have any pre-tax IRAs out there, so if you do, make sure you are aware of the account aggregation rules.

  4. Are you debt-free besides a mortgage, car loan, and possibly student loans as long as the rate is 3% or less? If not, then work to pay off higher interest debt first.

  5. Do you have an adequate emergency fund to tap in case of job loss or extended illness? If not, then I'd work to build that up first (more on emergency funds in this post).

  6. Do you feel like you have enough extra money every month to do the stuff you want to do within your lifestyle values like travel, caring for pets, entertainment, etc. while also adequately funding things that might pop up like medical procedures, veterinary costs, etc? If not, then the premium for a policy like this might be too much of a stretch for you right now, unless the need for something like this exceeds your desire to have a more flexible lifestyle - that's a bit of a personal values thing.

If all of those financial needs are either met or you’re on track to meet them, and a whole life policy premium wouldn’t derail them, then they can be a decent way to grow some tax-deferred savings while also offering a pay-out to your loved ones upon your death. The rest of the bells and whistles of these policies really depend on your personal goals and investing risk tolerance, but if you're not taking advantage of all the other ways to save in a tax-advantaged way mentioned above that are cheaper, a whole or universal life policy is probably not right for you yet.

Consider what might happen in the future

One way that a financial advisor may push back on you about the above is by pointing out that you may not qualify for a policy in the future, which is a valid thing to consider. However, your decision should be based entirely on your own family history and personal health status - the fact that it will likely be more expensive in the future is a futile argument; you'll be paying for less years, so of course it's cheaper when you're younger.

You may be surprised to learn that I own a small whole life policy - I check all the boxes above AND at the time of the purchase, I had concerns about my ability to qualify for insurance in the future. I decided to purchase my whole life policy because it has a long-term care rider and I knew there was a strong chance I may not qualify for long-term care down the road due to blood clot issues.

Coincidentally, I got my first blood clot exactly one week after my policy was accepted for underwriting – I now no longer qualify for long-term care insurance, so it turned out to be the right decision. But beyond that, there were things to consider. Here’s how we looked at it:

How I decided to buy a whole life policy

The annual premium for the policy I purchased was equal to an amount that we would typically be saving in a bond fund or other less-risky investment anyway, so we looked at it as a trade-off for that investment. My policy builds a guaranteed cash value and based on the projection of the cash value’s growth, we would break even (aka the cash value would equal and then exceed the total amount of premiums we’d paid in to date) after 13 years. In other words, I'm kind of losing money for the first 13 years, assuming this policy is just an investment.

The real question then was whether we would otherwise take that money and save it some other way. Said another way, "What would you be doing with the money you'd invest in your policy otherwise?" Your answer to that question may help you decide what's best for you.

Since the answer for us was that we'd probably just stash that money in a savings account, we went with making this a small part of our overall investment savings strategy. So far, that investment has paid off since the policy dividends FAR exceed what we'd earn in a savings account.

Once I’m 65, we no longer have to pay premiums and at that point, we could borrow against the policy and use the cash value as we needed. It’s actually a great way to invest tax-deferred, as long as it’s truly looked at as a long-term investment.

Could we take that money and invest it in a bond index fund for lower fees and expenses? Yes, and that's an important thing to consider. The trade-off to the "losing money" in the first 13 years of the policy is the guarantee: there’s no guarantee on the growth of market investments, and should I meet an early death (heaven forbid!), my policy would pay its full face value starting from the day we made the first premium payment. It’s worth it to us, but only because we were in the position to even consider it in the first place.

Questions about your own specific life insurance decision? Feel free to book a no-BS unbiased session with me to review your situation. I am NOT a registered representative, so cannot give investing advice, but I am happy to review the pros and cons of your situation to help you arrive at an informed, personalized decision.

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