Should Doctors Buy Whole Life Insurance?
Last week while enjoying brunch with a new attending physician and his wife, the topic of discussion turned to the differences between term and whole (permanent) life insurance. It occurs to me that there are likely others who wonder about that very same question.
What is whole life insurance?
Whole life insurance is a product that provides a guaranteed death benefit. So whether you die at 35 or 105, as long as you pay the requisite premiums, the beneficiary of the policy will receive the proceeds. Depending on the type of policy you have, you may make payments for the rest of your life, until age 65, or some other determined payment schedule.
Many whole life insurance policies accumulate a cash value that grows on a tax-deferred basis. Typically, the amount that makes up this cash value may be accessed at any time and for any reason. Cash value includes basis (the amount of money you have contributed in premiums) and growth.
Because the policy guarantees a death benefit so long as you pay the premiums, the payments can be substantial. In most cases the policy beneficiary receives a tax free benefit at your death.
What is term life insurance?
Term life insurance is a policy that provides a death benefit only if you die within the applicable term. This term varies in length depending on the policy that you buy, but it’s not uncommon to find term durations of 10, 20, 30 years, or even until you turn 80 years old. The longer the term, the higher the premium payments. Also, term life insurance does not accumulate a cash value.
If you review term and whole life insurance policies with the same death benefits, generally the term insurance policy is dramatically less expensive. Why is this? Insurance has been around for a very long time, and life insurance companies have become really good at understanding mortality rates. In other words, for a given group of people, insurance companies understand the statistics for how many people in that group will die each year. This understanding allows them to price life insurance accordingly so that they can earn a profit while still being able to pay out death benefits for those who die while having coverage.
Because the majority of people who by term insurance won’t actually die during the time that coverage is in force, the insurance company can charge much less.
Similar to whole life insurance, the death benefit for term insurance is tax free in most situations.
Why all the contention?
You may have noticed that the term v. whole life insurance debate can be pretty fierce. Why? Following the money trail can help find answers.
Those who sell whole life insurance can earn BIG commissions if you buy from them. For you residents, many insurance agents would love to sell you term life insurance coverage during your training, and then groom you for a big whole life insurance sale when you become an attending.
When might it make sense to purchase a whole life insurance policy?
As a young physician, you will likely get a whole life insurance pitch at some point, if you haven’t had a dozen already. Be very careful as you consider making a purchase so that you don’t do something you might regret later. Like marriage, whole life insurance is an “until death do ye part” type of commitment. If you get a few years in and things aren’t working out, a separation might not be pretty.
But when does it make sense? Whole life insurance’s primary purpose is to provide a benefit at your death. In the case where you really want a guaranteed death benefit beyond the period of time a term life insurance policy provides, whole life insurance is a tool that can get the job done.
When doesn’t it make sense to purchase a whole life insurance policy?
If a guaranteed death benefit isn’t that important to you, then whole life insurance isn’t likely the best tool for your situation. Again, as a young doctor, you’re going to get the whole life insurance pitch a time or two, and you shouldn’t be surprised if “secondary” features of whole life insurance are often presented as primary reasons to buy a policy.
With that in mind, you should avoid whole life insurance when the cash value feature is being sold as an investment vehicle to create wealth during your retirement years. Whole life insurance cash value returns are often disappointing in the short term (returns may be negative for years) and conservative in the long term.
You should also avoid whole life insurance when the cash value is being sold as a tool to create tax-free wealth. When “financial advisors” make this argument, what they often fail to note is that there are other vehicles that can be used to provide tax-free income, such as a Roth IRA or Roth 401(k). Using whole life insurance cash value for tax-free withdrawals may also not be as straight-forward as it was pitched.
Here’s how it actually works.
As you make premium payments to your whole life insurance policy, cash value begins to accumulate. Cash value begins small and for years will likely trail the total amount in premium that you’ve contributed to the policy. At some point, your total payments should be less than the amount of money available in the policy’s cash value. The amount above your total premiums paid constitutes growth.
So how is tax-free income taken out of the whole life policy? First, the amount that you have contributed in premiums is considered your basis. This amount may be taken out tax-free.
But what about the growth in the cash value? Believe it or not, you can take the growth out tax-free. How? You take it out in the form of a loan. So even though the growth may be taken out tax-free, you still have to pay interest on the loan. That unfortunate detail makes the tax-free distributions on the growth feel a little less “free.”
Some final thoughts.
It can’t be stated enough that your individual circumstances will dictate the direction that you should go in. But generally speaking, most young doctors would be better served by purchasing term insurance and adhering to a sound investment strategy, than buying a whole life insurance policy. The main reason for a whole life insurance purchase is if a guaranteed death benefit is desirable outside of the timeframe a term insurance policy provides, and one is willing to pay the increased premium.
If you’re considering a whole life insurance policy, or regret the purchase of one, it may be worth consulting a fee only financial advisor to review your options.
These are my opinions, unless I’ve specifically cited other material. The information and ideas I’ve presented are for informational purposes only. Before you implement anything, make sure you have a thorough discussion with a qualified professional who understands your situation.