The whole truth

I am frequently asked what I think about whole life insurance. The widespread and highly successful distribution of this product has certainly increased the conversation surrounding it, but a few criteria are key to determining what makes the most sense for you.

To simplify the subject, "term life insurance" is essentially "pure" insurance in that you are paying a very low premium for a high death benefit, and once the "term" ends, so does your coverage. In the case of term insurance, the insured does not want the policy to pay, because it will mean that the insured is deceased. A variety of terms exist, but most commonly people will buy a 10-year or 20-year term. This is generally very affordable insurance, and it allows families to provide for necessities in the event of the breadwinner's premature death.

"Whole life insurance," though, is radically different. Premiums will generally be far, far greater, for even a small percentage of the death benefit. It is not uncommon for someone to see his premium be eight times higher for the same amount of death benefit that a comparable term policy would provide. However, in the case of whole life coverage (or universal life), there is no question that someday the policy will pay. The death benefit coverage is not lost after a 10-year or 20-year term.

Along the way, the massively higher premiums accrue "cash value," allowing the owner of the policy one day to tap some of his premium contributions for investment or savings needs. These policies have always been touted for their potential tax benefits, and the forced discipline they provide in combining a savings vehicle and an insurance vehicle.

But few products in financial services pay the people who offer them better commissions than whole life insurance. As fee-based planners know, there is usually a reason for this. What is the drawback to whole life insurance?

The old expression, "buy term, and invest the difference," is as true today as it was over 30 years ago. For young families, or anyone with a reasonably definable period of need for life insurance coverage, term is the cheapest scenario, and the lower premium will provide additional funds that could easily be saved or invested on one's own (versus the premium cost of whole life insurance). And unlike saving through a whole life vehicle, when you save and invest on your own, you have access to your own funds when you want them, and you also bypass the expensive "mortality expense charges" that are written into the savings vehicles of whole life insurance.

It's true that many people lack the discipline to both pay life insurance premiums and feed a healthy savings habit. The solution, though, lies in developing that discipline, not caving in to a product that may not best suit your needs.

But it would be simplistic and wrong to argue that the entire permanent insurance business is flawed. Many individual situations will call for life insurance that is good for a longer period than a fixed term. Business partners who need to create liquidity for their estates in the event that one of them dies are a great example of people who may need permanent or whole life insurance. A common case would be for people who are potentially exposed to the estate tax. Term insurance is generally needed for income replacement, but when the need for the insurance is longer lasting than that, the insurance needs to be as well. Such is the case with estate planning, business succession, and other situations as well.

The best thing to do is to be careful, prudent, and aware of exactly what your objectives and means are. From there, the specific insurance vehicle to use will be much easier to decipher.