Written By Ben Lacomis, CSLP®
While whole life insurance is generally expensive, you’re not only paying for the permanent death benefit but also for other guarantees (e.g. premium amount, duration, cash value). Something about guarantees is easy to plan around.
In terms of asset distribution, much like any cash-equivalent, whole life insurance offers the advantage of being safe and predictable. For effective savers who grew their wealth enough to meet personal and future generation goals, whole life insurance can be used in retirement to either:
- Preserve legacy through tax-free death benefit, or
- Preserve legacy through spending (borrowing against) the death benefit rather than market-invested assets that would also pass.
Many retirees express uncertainty about how much of their retirement portfolio they can spend. Market returns are always uncertain, as is the nature of life — we have little-to-no control over our health and how long we live. While rules of thumb like the 4% rule exist (distributing 4% of your portfolio annually in retirement) with variables like age and health, knowing how much to spend such that you don’t run out of money or fail to pass wealth to your subsequent generation is really difficult.
Having a guaranteed and known death benefit amount for surviving spouses or heirs can provide more confidence in spending the assets you saved and invested.
Whole life insurance; predictable if nothing else
With life insurance death benefits being generally tax-free, the living portion of death benefits or cash values might also be accessible tax free. It’s best not to view these cash values as growing like market assets. Contrary to market assets, once cash values go up, they can’t go down regardless of performance. They might grow slower in future years, but they can’t go down.
This predictability and control leads some financial planning industry experts to discuss potential uses of insurance like whole life insurance on retirement distribution. Wade Pfau, Ph.D. and CFA, considers this notion in a paper that’s published in the Retirement Income Journal.
To summarize Pfau’s points, cash values can be leveraged in times of poor market performance thereby allowing more efficient distributions for your market-based assets. This avoids taking as big of withdrawals for income when their performance is poor — avoiding realized losses when systematic risk implications are high.
Also, despite the uncertainty of life expectancy/longevity, spending out of retirement and market-asset portfolios on themselves might feel more comfortable knowing that they have a permanent death benefit to provide for their family. Some of these are behavioral and emotional benefits too, as not everything in financial planning is numbers.
It’s a piece of the puzzle, but not the entire picture
If you read the article, you’ll notice this use of cash value is only part of a comprehensive strategy for retirement income, and not the sole plan nor even the most important part.
In these efficient wealth distribution strategies, you might consider leveraging an income product like an annuity at retirement age to protect against longevity risk (living too long). A whole life insurance can be leveraged to protect against a premature death risk while the biggest income needs are met by a traditional investment and retirement portfolio.
They are parts of a strategy, not the driving force. If pensions were as prevalent in these recent years as prior decades, the relevance of insurance and annuity planning would be reduced. However, today, defined contribution plans or 401(k)s are the primary retirement savings solution and that puts the burden of market risk on individuals rather than larger entities who were providing safety through pension plans.
For this reason, a case can be made for permanent life insurance among those who’ve prioritized investment risk and accumulation — particularly for those who value its guarantees and permanent death benefit.
When whole life insurance might make sense
If you already played, and presumably won, the game of wealth creation and accumulation, whole life insurance might be used in the battles below.
Whole life insurance can be used for asset protection
In most U.S. states, the cash value of a whole life insurance policy is protected from creditors and claimants under a “cash value exemption” or “asset protection” statute. This exemption safeguards the policyholder's cash value from being accessed by creditors seeking repayment for debt or claims.
The level of protection varies across states. Some states provide full protection of the cash value, while others might impose limitations on the amount shielded from creditors' claims. Generally, these protections are designed to support the policyholder and their beneficiaries in maintaining a level of financial security, despite potential external financial challenges.
These regulations can change and differ over time. Consult legal counsel to confirm, or refer directly to your state's insurance laws and exemptions to get the most precise details.
Be aware these projections or even enhanced versions also exist in other forms of financial accounts/products. ERISA laws (Employee Retirement Income Security Act) protect your dollars in employer-sponsored retirement plans.
Whole life insurance can be used for estate planning
With life insurance death benefits generally paid tax-free and bypassing your estate, any estate taxes or needs for liquidity may be met using a whole life insurance policy’s permanent death benefit.
Any potential benefits might be greater, lesser or non-existent at the time of death, based on estate planning laws at that time. Estate tax limits and how different types of assets are treated when distributed also have an impact.
With whole life insurance having cash values, it can be more of a flexible vehicle for estate planning than other permanent life insurance vehicles like Guaranteed Premium Universal Life insurance policies that are designed for only permanent death benefit and no cash values. If solely looking for permanent death benefits, consider all of your options.
When you just need life insurance for now, buy term life insurance
Many people simply don’t need estate protection, additional asset protection or a significant base of cash equivalents in retirement.
The primary need for life insurance is often the need to protect against premature death risk during dependent years and up to when a non-working spouse may enter retirement. If only needing death benefit for a limited duration such as 10 to 30 years, then term life insurance is your best bet.
Term life insurance is the purest form of life insurance in that it’s simply protection against premature death risk with no other benefits. Term policies are normally structured like auto insurance where it's “use it or lose it”. The premiums paid will be lost when the policy expires and you are alive and well.
With the risk of your mortality being low over a certain defined period rather than your lifetime, term insurance has far lower premiums and cost of insurance than permanent products.
If you need protection against premature death, but haven’t built an emergency fund, are paying down other debts, maxing out other tax-advantaged options for long-term investing, and don’t have cash flow to do all this while living the life you want — then term insurance is for you.
What to do if you have whole life insurance
If you have whole life insurance and don’t have the cash flow to meet your other financial needs, you probably need to replace it with term insurance. At the very least, consider significantly reducing the policy or contract immediately. An insurance agent or financial planner can help you to understand your contract’s options.
If you have whole life insurance because you value the guarantees it offers — and also have enough cash flow to cover your immediate, short-, medium- and long-term retirement goals — then you should probably keep it.
Many times the drive to cancel whole life insurance is because it looks bleak up front. The cost of insurance and costs of the policy consume your premiums and you are left with only a permanent death benefit and often low to no cash values. Frankly, it sucks to put a lot of money into something and feel you got little to nothing in return.
After years or a decade of premium payments, you may then find that each premium payment leads to more cash value growth than you are paying into the policy. Whole life insurance is a financial product that truly loads the ‘bad years’ up front and if you are thinking of canceling during early years then you likely should never have purchased the policy in the first place. Either way, if it's not a fit for you, get out.
If you have a whole life insurance policy or are being sold a whole life insurance policy, our team of financial planners at SLP Wealth can help you understand the decisions and implications such that you have more confidence in reaching your financial goals.
