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The first consideration when shopping for home or auto insurance is the annual premium. But life insurance is different because it not only provides you and your family with financial peace of mind but also has cash value. Therefore, the cost of maintaining a life insurance policy is often on the higher side.
Life insurance can be divided into two broad categories: term and permanent (also known as whole life). As the names suggest, term life insurance has shorter, customizable lengths, while whole life insurance is for a longer duration.
The amount your life insurance will yield at the end of the term is determined by calculating the policy’s expected yearly growth, also known as internal rate of return. However, if you have a whole life insurance policy, determining the rate of return over a period of 30 years or longer can be confusing and inconsistent.
What is whole life insurance?
While a term life insurance policy can last anywhere from five to 20 years, whole life insurance lasts until the death of the insured. When you purchase a standard whole life insurance policy, the rate of premiums remains the same under all circumstances and the beneficiary gets a lump sum amount after the death of the insured. Since the length of the policy often spans decades and the insurer knows that a payout is inevitable at some point, the premiums are higher than other types of life insurance policies.
Whole life insurance is beneficial only for those who have families or dependents. If you are single or have financially stable family members who do not rely on your money, whole life insurance could be expensive and unnecessary.
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’s rarely the case. If you are looking to calculate your money’s projected growth in a whole life insurance policy, you have come to the right place. We compiled a few tips to help you figure it out without all the complicated insurance jargon.
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, 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
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. What you should be looking at is the company’s dividend payout history. If a company has never generated dividends under 5.5% or 5.25% in the past 100 years, it has a strong financial position.
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. But since this rate can vary greatly, it is impossible to 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 haul.
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—it is worth it for some people. Specifically, 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 have life-long dependents, like children with special needs.
However, whole life insurance policies are typically very expensive. Unless you are getting an amazing internal rate of return (IRR), it is not worth the high premiums. For a majority of people, a term life insurance policy is a better option. The premiums are cheaper and you can get a similar amount of coverage.
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.
Frequently asked questions
What is the best whole life insurance?
There is not just one life insurance company that offers the best whole life policies for everyone. Each company has their pros and cons, so the best one for you depends on your personal needs and life situations. It is recommended that you research the major life insurance companies that offer whole life in your state or work with a professional advisor to make the choice easy for you. The Insurance Information Institute suggests you get a minimum of three quotes when shopping for coverage so you can compare rates and plans.
Who needs whole life insurance?
Not many people actually need whole life insurance. It can be a good option for high earners who have reached the maximum contribution limit for tax-deferred investments, like a 401(k) account. Because whole life insurance stays with you for your entire lifetime, it can also be a good choice for individuals with life-long dependents because their coverage will never terminate.