You may be looking at this example and adding up cash value plus death benefit, but remember: With ordinary whole life insurance policies like this one, your beneficiaries do not receive the cash value when you die; they receive only the death benefit.

There are other options. New York Life and other insurers also offer universal life insurance policies that pay out the death benefit plus cash value or the death benefit plus return of premium upon your death.

Buy term and invest the rest?

You may have heard the advice to "buy term and invest the rest" rather than pay the extra premiums for the "forced savings" of a cash value policy. There are good reasons for choosing either term or permanent life insurance, depending on your financial goals. And if you're investigating term vs. perm, it's helpful to be able to compare as directly as possible the costs and benefits of a term policy to a cash value policy of the same face value.

Below is a look at buying the above New York Life whole life insurance policy compared to buying term life insurance in the same face amount and investing the premium difference in a "side fund" such as a bank or mutual fund. This comparison comes courtesy of James Hunt, an actuary for the Consumer Federation of America (CFA) and former insurance commissioner of Vermont. His analysis estimates the "real" interest rate earned on savings within a cash value policy.

In this comparison, Hunt shows that if you buy a comparable term life insurance policy you need to earn 4.6 percent in your investment vehicle in order for your side fund to equal this whole life's cash value after 20 years. If your term life insurance side fund is invested in a bank CD or bond fund, you may not be able to net 4.6 percent after taxes.

Also important to note is the fluctutating rate of return on cash value in this particular whole life insurance policy. Your first year's premium disappears into fees and expenses without a penny into your cash value account. Only at year 4 does the cash value rate of return go positive. That means if you drop this policy within the first few years, you've made a terrible investment.

And according to LIMRA International, 12.7 percent of whole life insurance policyholders will lapse their policies in the first year, 8.1 percent will lapse in the second year and another 5.5 percent will lapse in the third year.

The chart at the right summarizes the estimated average rate of return if you kept this particular life insurance policy 5, 10, 15 or 20 years. Even if you held this policy for 10 years, your estimated cash value average rate of return works out to only 2 percent because you're still making up ground for those expensive first few years. You should be prepared to hold a whole life insurance policy for the long haul in order to make a potentially good investment.

Remember, this is one example of just one better-than-average whole life insurance policy and you may receive illustrations that look better or worse. Hunt's rate of return analysis is offered through the CFA at EvaluateLifeInsurance.org.

According to the Society of Actuaries (SOA), premiums for whole life insurance can be 5 to 10 times higher than the same amount of term life insurance, depending on the kind of level term being compared. For example, if you're comparing the premiums of 30-year level term it will be a smaller multiple, while premiums on a 10-year term policy could be a larger multiple.

Other considerations

Your cash value grows tax-deferred. Cash value is only taxable when it's worth more than what you have paid into the policy. For example, if you've paid $20,000 in premiums, have $25,000 in cash value and withdraw $23,000, $3,000 is taxable. If you withdraw less than what you have paid into the policy, you are not going to be hit with taxes.

Having your cash value exceed your premium payments isn't rare, but it takes a long time. It can take 12 to 15 years on an average whole life insurance policy or 15 to 20 years on universal life insurance, depending on how much premium you've paid in, according to the SOA. The slow accumulation of wealth makes cash value a less desirable choice for the short term.

A loan you take against your cash value could be taxed if you surrender or lapse the policy before you finish paying back the loan. The taxable portion is the difference between the loan amount and the total amount of premiums you have paid into the policy.

Ultimately, your buying decision depends on your financial goals. If you need life insurance for a finite number of years (for example, until your children graduate from college), term life insurance offers pure insurance protection. But if you're looking to create an estate, or ensure that your beneficiaries will receive a benefit no matter when you die, whole life insurance fills that need.

Return to Page 1