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JLeslie's avatar

Should I convert some of my term life insurance to whole life?

Asked by JLeslie (47984 points ) November 16th, 2012

If I understand it all correctly the whole life will earn 5% and I can cancel the policy and get my money back, and the interest is not taxed until I pull it out? Is that correct? Or, do I have to wait 30 years to be able to early withdraw the money? Basically, it is like a taxed deferred savings plan? Or, is the whole amount taxed if you withdraw the money or collect the money upon death? Then the money paid in is taxed twice.

What are the postives and negatives in your opinion? One obvious negative is the plan costs a lot compared to term.

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9 Answers

wundayatta's avatar

There’s insurance and then there’s savings. And with whole life, you get two instruments in one. There are reasons to do whole life, but I’m not sure what they are.

The reason for life insurance is to protect your loved ones from a loss of income if you die. If you have no income, there’s no reason to insure you.

If you add the savings element, then you are creating an inheritance with tax advantages. Again, if you have no children, then there really is no reason to do this. You might as well save your money and invest it after taxes, and have full flexibility and freedom to do with it what you want in your life.

I am leery of tax advantaged savings, except that if you have kids, it does protect money from colleges, and makes you eligible for more financial aid. I don’t think this is fair, but it is the law, so I will take advantage of it.

But I don’t even know why you have term life, unless you are working and I missed that somewhere. I don’t think it’s worth doing whole life. It’s much more expensive, and I don’t see how it would benefit you. But maybe someone else knows.

There are a lot of books out there about personal finance. One is written by a woman—I forget who, but it’s famous. We used that book about twenty years ago to start our financial planning. I don’t know if much has changed in the thinking about financial planning since then, but it is a topic that can eat up an awful lot of time without that much benefit, so I don’t do it much any more.

JLeslie's avatar

@wundayatta The question is actually about converting my life insurance and my husband’s. I am overinsured, especially now that I don’t work, but we have maintained my policy because it is very inexpensive since I bought it when I was very young, and there is every reason to believe I will work again. Plus, we never know what will happen in the future, so God forbid my husband ever had an illness or some other unforseen event and could not earn as much money, and then I died, at least he would have my life insurance. Because if something did happen to him, I would likely go back to work for sure, and as I said since we have established inexpensive life insurance already it seemed reasonable to maintain it. That was our thinking anyway.

The insurance on my husband I do need as a safety net. If he died it would be a big blow to me economically, although we do have savings also aside from the life insurance.

The whole life looks attractive because the interest rate is good by todays terms. I was thinking it might be a better option than even my IRA?

wundayatta's avatar

Look, this is just a general prejudice. Whole life is generally not worth it. For your specific circumstance, I would talk to a financial advisor that you trust.

I think you should keep the money you would spend in whole life premiums, maintain the term life, and invest the rest with your investments. That should be a diversified portfolio, including some CDs or bonds, but also you should own stocks or stock funds, as well. Those will have higher returns, over time.

But diversity is the key. While the economy hasn’t been doing well, stocks have does well in the last couple of years. Maybe that has stopped and maybe it hasn’t. The point with stocks is to buy and hold, preferably for forty years. We just sold a bit because our daughter is about to go to college, and because we need the cash, since my wife is not working. But that’s our post-tax investments. We aren’t and won’t touch the pre-tax investments, since we don’t want to pay the penalties, and they continue to grow our net worth, which is good to see, since our expenses are greater than my income. But we should be fine. We’ve been working for many years, and had our kids late.

Both of us have life and disability insurance. It’s always a little weird carrying disability when you aren’t working, but, assuming you go back to work, it seems like it could be worth it, and thus you maintain the low rates.

But if you have low life insurance rates, would those low rates carry over into whole life? Because perhaps you could gain significant savings cheaply that way. You have to analyze your situation, and not ask for general advice. The devil is in the details.

JLeslie's avatar

@wundayatta I hope I didn’t come across argumentative, I appreciate your opinion. The last time my husband and I thought about this, several years ago, we basically came to much the same conclusion you have suggested. I am not very diversified honestly, especially not at this point. I tend to be very conservative with my money. Looking back over the last 20 years my most conservative investing has done best. Some of that has to do with my age and when I entered the investing arena, meaning the timing of when the market took large dips. Anyway, the whole life insurance is now looking appealing when before I rejected the idea. I agree, the devil is in the details.

wundayatta's avatar

Last I looked, according to quicken, given all the ups and downs, we’ve averaged about a 10% annual increase in our stock portfolio over twenty years. It’s been a while, so that could be up or down now. It’s too complicated for me to want to check all the time like I used to. I would have to compare bonds and money funds to stocks to see what the difference is, but I’m pretty sure, stocks do better.

Of course, if you are rich, you get an average of 20% a year. That’s what some college endowments have been doing. And people who own companies do even better. 50%, or 100% increase per year. How they do that, I don’t know. I don’t want to know. I don’t want to think about it.

But you invest according to your comfort level. It seems like you could probably afford to put a small portion of your money into mutual funds. The risk would not be more than you could take.

JLeslie's avatar

I have some mutual funds.

After seeing the Bernie Maddoff scandal I don’t really believe in making 25%+ years on end. I know he was not even “giving” returns that high, but I just think too good to be true probably is, and generally the tortoise wins the race. Just me.

Tropical_Willie's avatar

My wife and I have whole life policies, we have had them for so long that—if we cancelled them today and tried to get ten year term policies it would cost the same monthly charges.

YARNLADY's avatar

My financially savvy husband has always chosen term life, in 10 year policies. We recently purchased an annuity for me, since he finally found one he liked. It just depends on your situation.

Shippy's avatar

I’ll give this a bash, since your ‘whole of life’ may be slightly different. But whole of life policies here were dumped. Although I thought they were a great idea. A part of your premium goes to saving, and a part to the life cover. It’s called universal costing. So on cancellation, you would get the saved portion. I am not sure if it would be seen as income, thus incurring income tax at that point.

You would not enjoy a tax deduction on your gross income, unless the saving portion had specifically gone into an IRA. Nor would it be recognized as an IRA if the vehicle remained as a saving in the life cover. I do realize though that some life covers do make the saving portion a IRA for this purpose so check with the broker that sold it to you. A lot of people used this portion to fund the policy in later years when it became too expensive. Or used the money to fund Medical Insurance premiums for example. Or just took the cash.

The bet plan is to see a Financial Planner. That way you can maximize any benefits. Since you are not working your life cover amounts need to be adjusted too. As here in SA we would call you over insured since you are no longer working. Some companies would not even pay out the benefit as your financial ‘value” has changed. And you did not notify the company concerned.

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