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Christy Bieber July 19, 2024
My parents got me whole life insurance for nearly $700 a month when I was 17 — am I completely screwed?
For some parents, taking out a whole life insurance policy for their children can seem like a sound investment, but it’s a decision that requires careful consideration.
Whole life insurance policies are permanent plans, meaning they last your child’s entire life and don’t expire. They also come with a fixed yearly premium that remains constant. But are they worth it?
It’s common for parents to purchase these policies for their kids, expecting the policy to help with future needs, such as education or covering expenses in the event of an unexpected death. However, are there better options available?
Understanding Whole Life Policies
Whole life policies consist of two main components:
- Death Benefit: This is the lump sum the beneficiary receives.
- Cash Value: This is a built-in savings and investment feature.
While there are benefits like tax breaks, fixed premiums, and potential loan collateral, it’s vital to understand all aspects before committing to a whole life insurance policy.
Ownership Concerns
When parents or grandparents initially take out a whole life insurance policy on a child’s behalf, they usually retain ownership, even once the child reaches adulthood. Although some companies will transfer ownership to the insured child at age 21, many don’t. This means the adult child doesn’t have legal rights to the policy.
Parents may want to transfer the policy to their adult children, making them responsible for premium payments. But this can be a large financial obligation. If you’re the insured child and want to pay premiums, be sure your parents transfer ownership. Keep in mind that policy owners aren’t legally obligated to transfer the policy, even if requested.
Expert Opinions on Whole Life Policies
Financial expert Dave Ramsey is against whole life policies, citing their high costs. He claims they can be significantly more expensive than term life policies that provide similar coverage during the initial years.
Whole Life policies and similar financial products can be 20 times as expensive as a term life policy that provides similar coverage in those first three years.
Ramsey, during an episode of The Ramsey Show, explained that the whole life policy takes 100% of your payments in the first three years to cover sales commissions. It can also take over a decade before the cash value equals the premiums and fees paid. He has called it “probably one of the worst financial products alive today.” For example, a $100,000 term life policy could cost $5 a month, while a whole life equivalent could be upwards of $100 monthly.
Ramsey also said that the average whole life policy earns a 1.2% return, and if you use that money, you often have to pay interest to the insurance company. In short, he believes you are losing money. In contrast, as of May 2024, the average annual rate of return on the S&P 500 is just over 10%. If you can invest for 50 years, you’ll likely be better off with stocks, mutual funds, or real estate.
PolicyGenius reports that the average monthly cost of whole life insurance is $451 for a healthy 30-year-old with a $500,000 policy. While these policies have a built-in savings feature called cash value, which you can borrow against, the monthly rate is still significantly steeper than that of a term life policy.
Making the Right Choice
Whole life policies are often an unnecessary investment, designed to pay out a death benefit. Once a child is an adult, parents typically do not need a death benefit to stay financially afloat if the adult child passes away. Purchasing a lifetime of coverage makes little sense. Unless you have a child with disabilities needing significant financial assistance for their entire life, term life insurance, providing coverage when needed, is a better option.
If you need life insurance, term life policies are a cheaper option. You’ll have more access to your money, control your investments, avoid fees, and potentially become wealthier.
What to do if you have a Whole Life Policy
What you do if you have a whole life policy depends on your situation.
If the policy has been transferred to your name, you may be able to stop paying premiums using the “premium offset” option. You can do this once the cash value covers the monthly cost. Your cash value and dividends cover the premiums, but your cash value will grow more slowly. You can just let the policy grow until you borrow against it and get tax-free income.
If you’ve had the policy for a short time, consider surrendering it. Early years are expensive regarding commissions and fees, so it’s often best to cut your losses. You may face penalties and taxes. However, it’s often better than continued payments on a poor investment.
