By Dr. James M. Dahle, WCI Founder
I have written a lot on Whole Life Insurance (and its cousins Variable Universal Life and Indexed Universal Life) in the past. I'm always a little hesitant to write on these subjects because every time I do I have to endure dozens of agents leaving 1000-word diatribes in the comments section for years afterward. Nevertheless, I think it is an important enough subject to continue to write about.
As a general rule, I recommend against the purchase of these cash value life insurance policies, which mix insurance and investing. Many people purchase them without really knowing what they're getting. As a result, about 80% of purchased whole life policies are surrendered prior to death. If you're considering getting rid of your policy, I've written before about your various options and deciding whether or not to dump your policy. That decision is entirely different from the decision of whether to buy one in the first place or not. If you have had a policy for many years, it often makes sense to keep it. That's because the poor returns associated with whole life insurance are heavily front-loaded. Basically, the returns are negative for a few years, and then you break even near the end of the first decade. Going forward from there you may see 5% or even 6% returns on your money. Overall, 3-5% per year is a reasonable return to expect from the time of purchase until death at your expected life expectancy.
This post isn't going to deal with any of that, but I don't want anyone to get the impression from this post that I think buying a whole life insurance policy is a great idea. It usually isn't. This post is merely about what to do with a policy you already have that it makes sense to keep. Not only do you want to keep it, but you are now either near or in retirement and trying to decide what to actually do with this asset. At this point it doesn't matter so much why you bought it (although any given policy may be structured to be better for one purpose or another), you still have the same options for what to do with it. We'll discuss each in turn, but first, let's consider a couple of other things.
What to Do with the Whole Life Insurance Premiums
At this point, depending on how your policy was structured, it may be “paid up” meaning you do not need to pay premiums any longer. If it is not paid up, the policy represents primarily an asset, but also a liability. Personally, I think it's dumb to buy a policy that isn't paid up at the time of retirement. That's like going into retirement with a mortgage. But that decision is all water under the bridge. Most policies that you have held for a long time probably have enough cash value that you can use that to pay the premiums (using policy loans-reducing the cash value and death benefit) if you like. If nothing else, you can probably use the annual dividend to fully or partially pay the premiums. That way if you have more money than you need, you can keep the value of the insurance growing by paying dividends. If you need a little more cash, you can pay the premiums with the dividends. If you need more cash, you can let the cash value pay the premiums. If you actually want to do something with the cash value besides leave it to your heirs, then we'll be discussing those options momentarily.
Sequence of Returns Risk
The real benefit of holding a low-return/low-volatility asset, especially early in retirement, is it reduces your sequence of returns risk. A more traditional investor might use bonds for this, but life insurance cash value works too. You've already paid for this benefit by decades of low returns, so you might as well take advantage of it now. This occurs in two ways. First, since part of your portfolio is in this low-volatility asset, your portfolio takes a smaller overall hit in a stock or real estate market crash. Second, you can preferentially take your spending money from the insurance cash value for a couple of years while the market is down, allowing you to avoid selling low and thus further extending the period of time your portfolio will last in retirement.
Withdrawal Options for Whole Life Insurance Cash Value in Retirement
There are a number of things you can do with your whole life cash value in retirement. I've divided these options into three categories – the good, the bad, and the ugly and will discuss each in turn.
The Good
#1 Don't Withdraw the Cash Value
One of the best uses for life insurance, even permanent life insurance, is to simply buy it and use it for its death benefit. In fact, if you really don't need or want a death benefit, this probably isn't the asset for you. But one of the best “returns” on your “investment” in whole life insurance is simply to leave the death benefit for your heirs. While it is probably true if you actually live to (or beyond) an age near your life expectancy that you would likely leave your heirs more money (and just as tax-free as the insurance death benefit thanks to the step-up in basis at death) if you had invested your money in stocks or real estate, that decision is water under the bridge. If your goal is to leave a guaranteed slowly increasing death benefit to your heirs no matter when you die, there is no better product than whole life insurance. (If you don't need it to increase, buy guaranteed universal life for half the price.) Granted, that might not be the goal of very many people, but if it is for you, great!
Another great benefit of using the cash value as an inheritance is that it provides financial security. You always could change your mind and go back and spend it if you get into dire straits. Some retirees have a behavioral issue with spending their money. Insomuch as a life insurance policy on the back burner gives them “permission to spend” their other assets, it's a good thing.
#2 Spend the Cash Value Dividends
Another option for those who don't need the cash value of the policy to meet their needs is to simply take the dividends (assuming the policy is “paid up”) and spend them. Your death benefit won't grow as quickly (if at all) but it won't shrink either. So you have that guaranteed inheritance plus some spending money. Not a bad combination at all.
#3 Partial Surrender
One of the coolest things about whole life insurance is how the money comes out of the policy. Unlike annuities, in which the first money pulled out of the policy is your gains, with life insurance the first money out is your basis – meaning it's tax-free AND interest-free. So if you had a whole life policy that cost $10K a year and paid it up over 30 years, and it gained 4% a year on average, on the eve of your retirement you may have a cash value of $583K. The first $300K of that you pull out will be 100% tax-free because it's just your basis. Granted, after 30 years of inflation, the $300K you pull out won't be worth anything near the $300K you put in, but it's better than a kick in the teeth. Remember that your partial surrender reduces the death benefit substantially.
#4 Borrow from the Whole Life Insurance Gains
Once you have maximized your partial surrender, any further withdrawals from the policy must come out as loans (or else they are taxed at your regular marginal tax rate.) These loans are tax-free, but not interest-free. Depending on your policy, however, the interest may not be too bad. Many policies have a relatively high interest rate if you borrow in the first decade or two, and then a lower interest rate after that. Even better, it is possible to structure a policy so that the dividends on the cash value don't take loans into account – that means you can borrow the money out and still receive the dividend on the borrowed money. You still have to pay interest on the loan, but if you are borrowing at 5% and the dividend is 5%, you're basically borrowing for free. That (combined with using paid-up additions to get to the break-even point faster) is what the Bank On Yourself/Infinite Banking types get so excited about. This type of policy is called “non-direct recognition.” It's not a no-brainer to always get a non-direct recognition policy, but if you plan to do a lot of borrowing from it, it may be a good idea.
The Bad
#5 Exchange Cash Value to a Variable Annuity (VA)
Exchanging your cash value to a very low-cost variable annuity (Vanguard or Jefferson National) is a pretty good idea for those who have been paying into their whole life policy for a while but realized they really don't want a whole life policy. Faced with decades of ongoing premium payments if they stick with the whole life policy, this option allows you both to preserve a loss (and thus get tax-free growth back up to the basis) or to keep gains growing tax-free. However, for someone who's 70 and has had a policy for 30 or 40 years already, I think you're probably better off keeping the whole life policy. This isn't the time to be ramping up your risk and the low returns of the past are already water under the bridge.
#6 Exchange to a Single Premium Immediate Annuity (SPIA)
I like SPIAs. They, especially when combined with Social Security +/- a pension allow you to put a floor under your retirement spending. You're essentially taking a lump sum and purchasing a pension with it, backed by an insurance company (and if the SPIA isn't too large, further backed by the state insurance guaranty corporation.) However, purchasing a SPIA is generally a way to ramp down the risk on your portfolio and acquire a guaranteed income stream. With a paid-up whole life policy, you've essentially already done that (maybe too early in life, but still, it's done.) The cash value almost surely isn't going to go down and while the dividends aren't guaranteed, it's been a long time (the Great Depression) since anything really happened to them for long. Besides, if the dividends dry up, you can start doing partial surrenders and/or policy loans. So while I prefer the approach of buying term and investing the rest and then considering a SPIA around age 70, if you've already got a substantial whole life policy, I don't think you're gaining much by exchanging it to a SPIA and you are losing the death benefit.
#7 Exchange to a Long Term Care (LTC) Policy
Another option with whole life insurance is to do a tax-free exchange into a LTC policy. If you really don't want a death benefit and really want a LTC benefit, I guess that's not a terrible idea. But I think that's an unlikely scenario. I don't like LTC policies for two reasons – first, only a small subset of people really need them. Those with little assets should spend down to Medicaid levels. Those with substantial assets (like huge whole life policies) can self-insure this risk. Second, these policies are relatively unproven. Nobody really knows how to price them well, especially with the rapidly escalating cost of LTC. How lame would it be to take your whole life cash value, exchange it into a LTC policy, and then have the LTC insurance company go bankrupt?
#8 Accelerated Death Benefits
If you are near death, and need cash, many insurance companies will “accelerate” your death benefits and allow you to get some money now in exchange for less money later. This can even be done with term policies. Insurance companies started doing this in order to counter the many life settlement/viatical companies out there who were filling this niche. It is in the insurance company's best interest to give you a better deal than the viatical company (discussed below), so if you're in this sort of situation, this may be worth looking into. Nevertheless, you and your heirs are probably overall better off doing a partial surrender or policy loans than accelerated death benefits.
#9 Bank on Yourself
I'm not a huge fan of “Banking on Yourself” (overfunding a non-direct recognition whole life policy early in life in order to then borrow from it to buy consumer items or investments) but I don't think it is the worst idea in the world. However, if you're sold on the idea and want to go for it, I think the time to do that is in your working years, not when you're 60 or 70. Plus, Banking On Yourself works best when done with a policy specifically designed for that. Chances are you don't have one of those unless you specifically bought your policy in order to do that. So it won't work as well with you. Plus, if your goal is to consume the money, then go ahead and do that. That's exactly the same as # 4 above. But if your goal is to borrow money from your insurance policy to further invest in real estate, I'm not convinced retirement is the time to do that. In general, you should be ramping down your leverage in retirement, not increasing it.
The Ugly
#10 Surrender the Whole Life Insurance Policy
If you liked your whole life policy enough to pay premiums on it for 30 or 40 years, now is NOT the time to surrender it. Not only do you lose the difference between the cash value and the death benefit, but when you surrender any gains are taxed at your regular marginal tax rate (whereas the death benefit is tax-free.) Probably not a good move at this point. If you're 2 years into the policy and realize you've been had, then sure, surrendering is a reasonable option. (Although there is a better one.) But not now.
#11 Sell the Whole Life Policy to the Insurance Company
Insurance companies realize that many purchasers no longer want their policy and simply want to get out of it. Some policies are structured such that the cash value is relatively low, but the death benefit is relatively high. These policies attract life settlement/viatical companies. They offer the owner of the policy more than the cash value but less than the death benefit. When the person dies, the investors in the company get the death benefit. If they die soon, the return is good. If they live a long time, the return is less good. But once it is sold to the life settlement company, the insurance company is almost surely going to pay the death benefit at some point or other. So rather than do that, they will either offer accelerated death benefits (if you're terminally ill) or purchase the policy themselves. As a general rule at this point, keeping the policy is a better investment than selling it, whether you sell to the viatical company or the insurance company.
#12 Sell the Policy to a Life Settlement/Viatical Company
As noted above, this usually isn't a good idea. These are fairly illiquid assets and there aren't many buyers. Your broker will get a cut, the life settlement company will need to make a profit, and the investors are going to want double digit returns on their investment. Where do you suppose all that comes from? That's right, the death benefit you've been paying so diligently for years to get. While I don't think these are terrible investments (although illiquid and in a market filled with scammers,) I think the policy owner (and especially his heirs) are generally getting a raw deal. If you can't afford your premiums or just need cash I think you'd be better off going to your heirs directly for assistance rather than selling to either the insurance company or a life settlement company. Better to not get into a situation in the first place where you're “life insurance poor.” Even if you love whole life insurance, don't make it a big chunk of your portfolio.
#13 Exchange It for Another Whole Life Policy
The worst idea I could come up with is to exchange your current whole life policy for another whole life policy. Remember the low returns of whole life insurance are heavily front-loaded, primarily due to the massive commission (basically the first year's premium payment) paid to the insurance agent. No sense in going through that twice with the same money. I doubt there is any whole life policy that is sufficiently better than your current one that it makes sense to exchange after 30 or 40 years of making payments. That seems even dumber than just surrendering it for the cash value to me.
One thing whole life policies do is give you lots of options in retirement. Some are better than others. Try to choose one of the “Good” options above if you are in this situation.
What do you think? Do you have a whole life policy? What do you plan to do with it? Why? Comment below!
Taking a loan should typically be done late in retirement instead of early IMO. Dividends continue to fall and it’s very possible to create a situation where you lapse the policy bc of interest. All loans in the US are tax free. While a whole life policy may get bond like returns, it’s a mistake to use it instead of bonds as an initial plan. I personally don’t own bonds bc of the lower returns. I own them to rebalance. You can’t do that with WL. While there are options as mentioned, IF you unfortunately purchased WL and have paid many years into it, best to try to pay yearly, buy PUAs, and take out loan late in life if needed.
I got rid of my whole life, 5 years into it. I was so pissed when I learnt the truth, that I just cancelled it. I had to pay a tax on 24K distribution. Wasnt that bad. I was putting 24 K a year into my policy. The only silver lining I could see was it made me save 24K a year when I did not knew much about savings. Never again. Thanks WCI.
You had a $24K gain after just 5 years? How big were the premiums?
[Edit: Never mind. You said $24K premiums. That is a ridiculously awesome whole life policy. You put $120K into it and it had earned $24K within 5 years? I calculate a 9% return on that, which is way higher than any whole life policy I’ve ever seen. Most haven’t even broken even in 5 years. Double check your numbers (and the policy, maybe a VUL in a bull market?) if you would please. Certainly if they’re correct you have nothing to be upset about.]
It was a variable universal life insurance policy, started in 2009 and cancelled in 2014. If I had invested the same amount in SPY I would had a CAGR of 50%. My policy was designed with 24K annual premiums so the extra money would outgrow the cost very fast. But not as fast as the Market. Plus my costs were low being only 34 at that time. Another thing I was never told was my insurance costs will keep going up as I age. If you need any more information let me know
That makes a little more sense. Sounds like it turned out fine for you anyway, just some lost opportunity cost. You came out way ahead of where you would have been had it been a whole life policy.
Didn’t you also have a large surrender fee after only 5 years in a VUL?
There was a little difference in face value and cash value, like 2-5 thousand. But that was a small amount considering I have put in more than 120K and the whole thing was worth close to 150K
SPIAs can also be an excellent “unplanned” Medicaid-planning option. Maybe not for readers of this site, but consider it for your parents and grandparents who may be over the asset limit when a spouse goes into a nursing home. The community spouse can put excess assets into a SPIA and shield them from the government. Of course, all alternatives need to be considered and coordinated in a plan that considers other assets, health of community spouse, etc. (NOTE: I am a fee-only planner and do not sell annuities).
I like SPIAs a lot for many situations, even for high earners in retirement. The point of the paragraph about them in THIS post is that I probably would not exchange a whole life policy I had held for decades for one.
Exactly. Just running a thread between the SPIA and LTCI commentary; sorry for going OT.
One thing that I think is likely true…is that as you age, the part of your annual premium that covers the “term Insurance”… is money you never otherwise benefit from. If for example, in a WL policy with level premiums… the term costs increase annually, and quite a bit in the later years. Therefore the payback on your last years premiums gets worse and worse again, at whatever rate your term fees increase. The insurance company will not divulge you you what your term rates will be, or even what they currently are, and will not demonstrate to you that you are or are not getting the so called “guaranteed” rate on your “excess premiums”.
(Confidential part: contact me if you would wish to use my life insurance evaluation … very recent… for your blog. May or may not be useful. It may especially be useful if I can find the initial policy projected numbers and how they compare with the results after 2.5 decades, and how the policy evaluation was reported. )
That would be interesting if you have the original illustration as well as a current in-force illustration.
WCI,
Excellent article. I know discussions of life insurance brings all sorts of crazy into the comments, but keep writing about this stuff. This is a great service to your readers as insurance is such a difficult concept for most people to really understand. Knowledge is the best defense against being sold something inappropriate. This site is where I send people who want to learn about this stuff.
You’re welcome. Nearly every article I’ve ever written about whole life insurance is in response to reader questions.
As in your case, I was sold my modified premium variable life insurance policy (face Value = $150,000) when I was in Med School 45 year ago. I have faithfully made regular monthly premium payments of $195.76.
The Policy now has a net death benefit of $173,686 due to $23,688 of additional insurance benefit. The cash or surrender value is $75,478.22. The tax basis is $63,622.
I have approximately $4.6 million in retirement accounts and liquid assets and no debt on my home or other real estate holdings. I plan on retiring next year. As far as I can tell, I have little need for life insurance at this time, other than perhaps as an estate planning tool.
I am thinking about doing an exchange of the cash value to a Vanguard variable annuity I have which will pay 5% forever beginning at age 70 (next year).
What is your opinion? Have I crossed the Rubicon? Would I be better to continue on at this point? Am I presently over the MEC limit?
Thanks you for your assistance.
PAB, MD
Request an inforce illustration.
Keep in mind the annuity return includes return of principle.
I very much doubt you’re over the MEC limit (you’ll see why below), but you should be able to check with the company or your agent.
After 45 years, I’d usually be pretty surprised if it would be a good move to drop this policy or exchange it elsewhere. So my first thought is to keep it. But then I start looking at your numbers, and they don’t add up well. Probably because this is a VUL, not a whole life policy.
For instance, you say you’ve been paying $195.75 per month for 45 years. That’s 45*12*195.76=$105,710.40. I calculate that should be your basis, no? Did you fail to make payments for a while or have lower payments or something? Why do you think your tax basis is only $63,622?
The next number issue I see is the fact that after 45 years, you’ve still got a loss on this sucker. You’ve paid $105K and have a surrender value of $75K. That’s got to be one of the worst permanent life insurance policies I’ve ever seen. I assume this is just a terrible VUL-high insurance costs, plenty of fees and terrible investments.
Obviously, given you’ve got $5 Million, you’re going to be fine whatever you do. But given how shabbily this policy has treated you, I might get rid of it on principle alone.
I don’t think there is enough death benefit there to help much with any estate planning issues. Plus you haven’t really structured it for that (i.e. put it in an ILIT.) It’s been structured to make some schmuck who suckered you into it (and his insurance company)45 years ago rich.
Obviously, 5% forever is a lot better than what you’ve earned on this thing so far. But if your basis is the $105K I calculate, I’d probably exchange it to a VA, then surrender it and take the tax loss. If your basis is really somehow $63K, you’ve got a gain, but not a huge one. You can certainly afford the taxes on it and just get out of it.
If you want a guarantee out of it, exchange it to a SPIA. That ought to pay more than 5% guaranteed until the day you die, but that obviously includes return of principal.
I have whole life insurance where I paid a measly 35 dollars a month, and I started this when I was 25. My payments will end in another ten years. After ten years of holding on to it, it has grown to 27k, 15k which is guaranteed and the rest as paid up additions via dividends. The longer I live, the more this policy will grow even after I finish paying into it in ten years, I bought this purposely to pay for expenses like my funeral. The death benefit will be paid out as long as I hold the policy. It doesn’t seem like a bad investment based on the returns… Am I missing something? Maybe it’s different in Canada?
So you’ve paid $35 a month for ten years and you now have a cash value of $27K? I think you’re mistaken. That’s probably your death benefit. Otherwise, that’s a pretty awesome return. Like 30% a year or something.
Yet another person who doesn’t understand exactly what they’ve bought. Does anybody wonder why I’m not a huge fan of this product? And no, it’s no different in Canada.
Tell us what your cash value is and I bet you won’t think it’s a great investment either. Do you really not have enough net worth to pay for your burial?
Yes you are right, cash value is not very good. And yes, 27k is my death benefit. I bought it when I was 25. I figured 35 dollars wasn’t much when I did it and at that time, my net worth was less than zero since I had no assets, finished paying off debt and leased a car. So if I died the next day, at least my death benefit would cover my funeral costs. That was ten years ago.
I agree, I was one of those people who were sold on this insurance as a good thing ten years ago. I’m lucky I got out ok…for now. Thanks for prompting my curiosity in looking into my insurance again and taking the time to write several articles on this complicated topic. I really appreciate it.
You’re very welcome. Now I’m curious what the cash value is.
Obviously $35 a month isn’t going to determine your financial fate either way, but a 10-30 year term policy probably would have given you ten times the death benefit for the same price.
Hi, Yes cancelling my policy would render it worth $3,825.69. Not very good at all.
That sounds more like it. 10 years at $35 a month means you’ve paid a total of $35*12*10= $4200. You now have a cash value, after a DECADE of holding this investment faithfully, of $3826, a loss of $374, or about 10%. I calculate your annualized rate of return as -2.1% per year.
Actually pretty typical for a small whole life policy designed primarily to maximize the commission to the agent. Your return going forward would be better, but would be unlikely to ever really be good.
What are you going to do with it?
Not sure, I’m still thinking about it. If I cancel, I lose a small percentage. If I don’t cancel and bank on living till I’m 90, then someone gets around 80K (assuming the markets are ok at that time) but i have to contribute another $4900 to get that. Tough question. The only thing I can bank on is death and the death benefit so I’m leaning towards keeping it because I have no other use for that money (I usually buy houses as an investment). I guess sometimes you win and sometimes you lose and this time I lost. I hope my real life example helps your readers avoid whole life insurance! BTW: Your article on disability insurance just persuaded me to not purchase it as well. Thanks for writing it.
I had a ten year policy. In fact, sold several of them – in retrospect an obvious mistake. Once the first was paid up, I cashed out because I figured that the returns on the cash value ($60,000), withdrawn and invested, would with reasonable luck, actually get me to the life insurance value within less than 10 years ($140,000). I’m leaning toward doing the same with second policy. I know that you said in your columns cashing out was not the way to go, but the earnings were so slow I figured that, again with luck (and assuming I stayed alive!), I’d do better off within 10 years. Any thoughts on 10 pay whole life policies in particular? Thanks
I like 7 pay better than 10 pay and 10 pay better than forever pay.