Many life insurance shoppers choose whole life insurance for the cash value component of the policy. Life insurance cash value is like a savings account you finance with part of your premium, and over time, that balance accrues interest. But just how much interest can it build? It can be difficult to determine on your own, but Bankrate can help. We’ll go over what whole life insurance policyholders need to know about life insurance rates of return.

What is whole life insurance?

Broadly speaking, there are two kinds of life insurance policies: term and permanent. Term policies last for a pre-designated period of time, usually between 10 and 30 years. Permanent policies, on the other hand, are active for the policyholder’s entire life as long as premiums are paid. Whole life insurance falls into the second category. Because permanent policies last longer than term ones and have a guaranteed payout, they usually cost more.

Whole life insurance policies contain two parts: a death benefit and a cash value component. The death benefit is a predetermined amount your named beneficiaries receive when you die. The cash value component is slightly more complicated. When you pay your premium on a whole life insurance policy, part of your payment goes toward the cash value account. The balance in your cash value account can bear interest over time, and depending on the specifics of your policy, you may even be able to borrow against the value of the account. However, if you take out a loan with a cash value account, you will need to pay it back with interest. If you don’t pay it back while you’re alive, the amount owed is subtracted from the death benefit prior to your beneficiary’s payout.

How to calculate your whole life insurance’s rate of return

It is a common belief that the cash value in your whole life insurance policy will increase substantially year over year. However, that is not always the case. While most whole life insurance policies have a set guaranteed minimum interest rate, the internal rate of return (IRR) can fluctuate based on non-guaranteed values, such as dividends and any paid-up insurance, and if you’re borrowing from the cash value account. Calculating your whole life insurance rate of return can be complex, but the steps below can give you some insight into how to find it.

Hire a professional

Several factors are used to set the IRR, and the average consumer may not be aware of all of them. A life insurance analyst or financial planner is able to analyze your policy’s projected performance over time, compare it to other policies and help you figure out an accurate estimated IRR. They can also look into things that affect the IRR, like mortality rate changes, to give you a realistic idea of how much your money could grow in the near future, and suggest more lucrative investment products.

Examine the insurance company’s dividend payout history

There are two types of whole life insurance: participating and non-participating. If you choose to buy a participating policy, you are able to participate in the insurer’s annual profits. The insurer may pay out dividends to their policyholders based on their financial performance. These dividends, if you choose to keep them invested with the insurer, can increase your IRR. Before buying a participating whole life policy, it’s recommended that you look at the company’s dividend payout history. If a company has never generated dividends under 5.5 percent or 5.25 percent in the past 100 years, that typically indicates strong financial standing.

While whole life insurers frequently will not disclose how your rate of return is calculated, they will offer illustrations of how your policy is projected to perform in the future.

These illustrations should include information on the costs of the policy, how much you have paid, your current death benefit and the cash surrender value you would get for canceling the policy today. It should also include future predictions on how your policy should perform five, 10 and 20 years down the road. But these projections are often lengthy, esoteric and unrealistically optimistic, and it’s best that you work with a financial professional to best understand them.

Check IRR projections over the next decade

To understand the rate of return for your whole life policy, check out how the policy is projected to perform over the next few decades, which includes the average annual and year-by-year rate of return for 20 years or more. However, since this rate can vary greatly, it is difficult to accurately predict how much money you might make in the long run unless you hire a financial professional to determine the future value of your policy. A third-party insurance analyst is the best person to evaluate whether or not a whole life policy makes sense in the long term.

Is whole life insurance worth it?

Given everything we have mentioned until this point, you are probably wondering if whole life insurance is a good investment. The short answer is that whole life insurance is primarily used for financial protection, but should not be considered your primary means of investing for the future. Whole life insurance can be a good option for high-income individuals who have maxed out their tax-deferred investment accounts, like a 401(k) plan or Roth IRA. It can also be beneficial for individuals who want coverage for their entire lifetime.

For people who only need coverage for a set number of years, a term life insurance policy is a better option. The premiums are usually cheaper, and you can get a similar amount of coverage for the shorter period of time.

It is important to remember that just because whole life insurance has an investment component, it does not mean it is a great investment strategy. The IRR on a whole life insurance policy is typically very low compared to other investments because life insurance has additional expenses that other investments do not require. That said, speaking with a licensed financial professional can help you determine whether whole life insurance makes sense for your financial situation and goals.

Frequently asked questions

    • There is no single life insurance company that offers the best whole life policies for everyone. Each company has its pros and cons, so the best one for you depends on your personal needs and life situations. Researching companies that offer whole life in your state or working with a professional advisor can help you choose the right carrier for your needs. Keep in mind that life insurance quotes do not vary as much as home or auto quotes, so you may want to look at coverage options, customer service and policy perks in addition to price.
    • Whole life insurance is suitable for various people with different needs, particularly those doing long-term estate planning or supporting a lifelong dependent. For example, if you have a child with a disability, your family may need a life insurance policy that covers your child for their entire life. Another situation where whole life insurance may make sense is for business owners with insurable interest. Regardless of whether you are a sole proprietor, a partner or a business owner with key employees, you may want to be certain that your family, business and estate are protected. It can also be a good option for high earners who have reached the maximum contribution limit for tax-deferred investments, like a 401(k) account.
    • It is hard to calculate an industry-wide average return on whole life insurance. It will depend on the insurer, your premium, how much coverage you need and how you use your policy during your life. For example, if you borrow against the cash value component of your policy, that will likely decrease the IRR.