Jul 25, 2024
For some parents, taking out a whole life insurance policy can sound like a good investment for themselves and their children — but there are a few factors that should be considered first.
In essence, whole life insurance policies are permanent plans that last your child’s entire life and don’t expire. They’re also locked into a fixed yearly premium that never increases.
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It’s not uncommon for parents to purchase these policies for their kids, with the expectation that the policy can assist with the child’s future needs — be it for educational purposes or to cover expenses the parents may encounter in the event of the child’s unexpected death.
Whole life policies consist of two parts: the death benefit — which is the lump sum your beneficiary receives — and cash value, which is a built-in savings and investing feature.
While there are certainly plenty of benefits — such as tax breaks, fixed premiums, and potential loan collateral — it's important to understand all aspects of whole life insurance policies before making this important financial decision.
Who owns the whole life insurance policy?
Let’s say your parents took out a whole life insurance policy on your behalf when you were a kid — so, who owns it now?
When parents (or even grandparents) take out a policy on a child's behalf, they typically own the policy — even once the child reaches adulthood. While some companies will transfer ownership over to the insured child once they reach the age of 21, most don't — which means the insured child, even in adulthood, doesn’t have legal rights to the policy.
In some cases, parents may want to transfer the policy to their adult kids and have them carry the burden of continuing the premium payments, but this can add a significant financial hurdle to their kids’ monthly expenses.
If you're the insured child and want to start paying the premiums, be absolutely certain that your parents/grandparents transfer full ownership of the policy over to you. Note: policy owners aren’t legally obligated to transfer the policy over to the now-adults, even if it’s requested.
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Why some experts are against whole life policies
For starters, whole life policies are quite expensive. Personal finance celebrity Dave Ramsey explains that, in the first three years alone, these policies can be 20 times as expensive as a term life policy that provides similar coverage.
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While all insurance policies set aside a cut for sales commissions, whole life insurance takes 100% of your payments in those first three years. Therefore, it could take you more than a decade before your cash value starts to mirror the amount you’ve already paid in premiums and additional fees.
It’s “probably one of the worst financial products alive today,” Ramsey said to a caller during an episode of his series, The Ramsey Show. He illustrated this by saying that a $100,000 term life policy may cost $5 a month, while a whole life equivalent could run upwards of $100 a month.
Ramsey added that the average whole life policy earns a 1.2% return and, if you’ve managed to build wealth on it and use that money, you’ll have to pay the insurance company interest to use it. In short: you’re losing money.
By contrast, the average annual rate of return on an S&P 500 is just over 10%, as of May 2024. If you have the means to invest for 50 years, you’ll do better with stocks, mutual funds or real estate.
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As a further example, PolicyGenius reports that the average cost of whole life insurance is $451 a month for a healthy 30-year-old with a $500,000 policy.
While these policies come with a savings feature called cash value (which you can borrow from when you’re alive), that monthly rate is significantly steeper than a term life policy rate.
In general, whole life policies tend to be considered an unnecessary investment by financial experts as their primary purpose is to pay out a death benefit to your beneficiaries in the event of your death. But once the child is an adult, most parents wouldn’t need a death benefit to stay afloat financially in the event of the adult child's passing.
For that reason, paying for a lifetime of coverage makes little sense. Unless you have a child with disabilities that will need a substantial amount of financial assistance for the entirety of their life, buying a term life policy that covers you only when it's needed is a better option.
You are far better off buying a much cheaper term life policy if you're in need of life insurance. You'll have more access to your money, you'll be able to control your own investments, you'll avoid fees, and you'll end up richer.
What to do if you're stuck with a whole life policy
If you’re stuck with a whole life policy, the best course of action depends on the specifics of your situation.
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If the policy has been transferred to your name after years of your parents contributing money toward it, there may come a time when you no longer have to pay premiums if you exercise the “premium offset” option, which can be done once the cash value is big enough to cover the monthly costs.
This means the cash value and dividends are used to offset, or pay for, the premiums. However, your cash value will grow more slowly as a result — but you aren't spending any additional money. You can just leave the policy to grow until you're ready to begin borrowing against it and getting tax-free income.
If you've only had the policy for a short period of time and are looking at years of premiums ahead of you, though, your best option may be to surrender it.
As mentioned earlier, the early years are the most expensive in terms of commissions and fees, so you'd be wasting money for quite a while. You'd also have to accept a lower rate of return for decades to come. It may be best to just cut your losses and take whatever surrender value you can get out of the policy.
It's true you'll likely face penalties, so you probably won’t get much money back. You may also end up owing income taxes on any gains if you happen to get back more money than the premiums you paid into yourself. However, this can be a far better option than continuing to set aside good money for a bad investment.
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Christy Bieber has 15 years of experience as a personal finance and legal writer. She has written for many publications including Forbes, Kilplinger, CNN, WSJ, Credit Karma, Insurify and more.
