Why Whole Life Insurance Is a Bad Investment

Why Whole Life Insurance Is a Bad Investment

A while back I wrote about the mistakes I initially made when purchasing life insurance policies for myself and my wife, and one of the things I mentioned was that at the very least I was relieved we had avoided buying whole life insurance. In response, a reader left the following comment:

“General consensus is that you shouldn’t view insurance as an investment. But nobody has ever been able to make a case for WHY.”

It was a great point. There are a lot of personal finance topics out there where you hear many people repeat the same mantra over and over again without any explanation as to why.

Whole life insurance is one of those topics that often gets a bad rap without much detail. So today I’d like to explain exactly why whole life insurance is a bad investment.

Some background on whole life insurance

I have an entire comprehensive guide dedicated to the importance of life insurance, determining your life insurance needs, and how to buy an affordable policy. There’s no doubt that life insurance is a crucial part of securing your family’s financial foundation.

When you buy life insurance, there are essentially two types: term and permanent.

Term life insurance is very simple. You pay a (typically) small premium for financial protection that lasts a specific amount of time, typically 10-30 years. It is pure insurance. The only potential benefit is the payout upon death. And in my opinion, this is the only type of life insurance that most people should consider, since the financial protection provided by the death benefit is the entire purpose of life insurance.

Permanent insurance comes in many different flavors, but the primary one is whole life. That’s what we’ll be covering in this post, though the principles below apply to almost any form of permanent insurance.

Whole life insurance does not have a term. It has a death benefit that lasts until you die, whenever that occurs. It also has a cash value component that grows over time, similar to a savings or investment account.

From a pure insurance standpoint, whole life is generally not a useful product. It is MUCH more expensive than term (often 10-12 times as expensive), and most people don’t need coverage for their entire life. The primary purpose of life insurance is to ensure that your children have the financial resources they need to get themselves to the point where they can provide for themselves, so coverage that lasts your entire life doesn’t make a lot of sense except for a minority of cases that are the subject of another discussion.

But whole life insurance is often also sold as an investment. The benefits of the cash value component are made to sound very attractive, particularly as a retirement planning tool. It is this purpose of whole life insurance that I would like to deconstruct here.

So without further ado, here are 8 reasons why whole life insurance is a bad investment.

Reason #1: Whole life insurance is undiversified

Diversification is the practice of spreading your money out over many different types of types of investments and different types of companies. It’s the single tool you have that allows you to decrease your investment risk without decreasing your expected return. Unless you’re Warren Buffet, this isn’t something you should part with lightly.

Whole life insurance is by definition undiversified. You are investing a large amount of money with a single company and relying entirely on their goodwill to give you good returns. The insurance company will make their own investments and then decide what portion of their returns they would like to pass on to their policyholders. You are completely at their whim. If that one company goes bankrupt, has some bad years, or simply changes their outlook on paying out to customers, your return will suffer.

Putting a large amount of your eggs in this single basket exposes you to a large amount of risk from a single company and sacrifices the basic principle of diversification. This isn’t something that should be done without compensation in the form of large expected returns, and even then the risk would have to be very carefully evaluated.

Reason #2: Whole life returns are not guaranteed

Life insurance salesmen like to talk about the returns on their policies as if they are guaranteed. They are not. Neither are the returns from stocks or bonds, but don’t be misled into thinking that whole life insurance returns are somehow on a different level.

The illustrations these salesmen present showing beautiful long-term growth are simply projections, and rosy ones at that since the company is trying to sell you. There is plenty of risk that the actual performance will be worse than what is shown during the sales process.

With that said, there is actually a small guaranteed return on these policies, but even this is incredibly misleading. For example, a policy may have a “guaranteed return” of 4%, but when you actually run the numbers using their own growth chart, after 40 years the annual return might amount to less than 1%.

There are a number of explanations for this difference, including fees and the way in which the interest rate is applied. But the bottom line is that you can’t take that “guaranteed return” at face value. It is incredibly deceptive. Run the numbers for yourself and see if you’re happy with the result. The reality is that you can often get better guaranteed returns from a savings account or CD that’s also FDIC insured.

Reason #3: Positive returns take a long time to appear

In the rosy illustrations, beyond the guaranteed portion mentioned above, a policy that’s held for 40 years or so will show a return of around 4%. That’s not bad, although 10-year Treasury Bonds have historically returned about 5.4%.

The problem is that it takes a long time for the returns to reach that level. There will be many years at the start of the policy where your return will be negative, and many more years where the return will be only slightly positive. If you stick with it for a long time, you eventually get into a reasonable range of returns. But if at any point before that you decide you want to do something different, you will have spent many years and a lot of money getting very poor returns.

Keep in mind that this is very different from the possibility of poor returns from stocks and bonds. While stocks and bonds guarantee nothing and certainly might deliver poor performance over certain periods, whole life is almost guaranteed to have very poor performance for at least a decade and often upwards of two decades.

This is not the possibility of bad returns. It is the promise of it.

Reason #4: Whole life insurance is illiquid

Investopedia defines liquidity as:

“The degree to which an asset or security can be bought or sold in the market without affecting the asset’s price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets.”

Liquidity is important because it gives you options. While you hope to never have to touch your long-term savings, the reality is that life happens and the more options you have the more financially secure you can be. Having access to your money gives you options.

Whole life insurance is illiquid for several reasons:

  1. For the first decade or so, you are almost guaranteed to have negative returns. This means you can’t even expect to get back the amount of money you put in.
  2. Many policies have a surrender charge, which is essentially a fee you have to pay if you decide to cancel the policy and withdraw the cash value. If you surrender, there will also be income tax consequences on any earnings.
  3. Most policies will allow you to borrow against the cash value, but you have to pay interest. This is true even if you are borrowing only the amount of money you have put in, not what it has earned above that.

All of these factors make it difficult to get to your money if you need it. In theory, you should be compensated for this difficulty in the form of higher returns, but as we saw above this is not the case.

I have seen it argued that retirement accounts are also illiquid because of the penalties associated with early withdrawals, and this is certainly true to some extent. But I have several counters to this argument:

  1. 401(k)s and IRAs, with their penalties for early withdrawal, are indeed illiquid. But they have many other advantages over whole life, namely the ability to choose your investments, true tax deferral, higher transparency in fees, and cash flow flexibility, which I’ll talk about below.
  2. With a Roth IRA, you can withdraw your contributions at any time without penalty. You generally shouldn’t do this except in true emergency situations, but it’s an option that’s available to you.
  3. Regular old taxable accounts have no inherent liquidity issues, give you the full range of investment options, and can be used in a tax-efficient manner.
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Reason #5: Less cash flow flexibility

A corollary to the liquidity issue is the concept of flexibility of your contributions. Even with a 401(k) or IRA, where you can’t access your money without penalty, you can always choose to stop contributing for a period of time if you need that money for other purposes. In the meantime, your account stays intact, steadily earning tax-deferred returns on the money you’ve already put in.

With whole life insurance, you can’t just decide to stop paying premiums. Well, you can, but if you do then the policy lapses and you’re forced to withdraw the cash value, which will subject you to taxes and possibly a surrender charge. And if you haven’t had the policy in place for multiple decades, you will also be left with meager, and possibly negative, returns.

Are you ready to commit to paying that huge premium year after year, no matter what happens in your life? Of course we all want to keep our retirement contributions steady, and even see them increase, but life happens and there are many instances in which having options is incredibly helpful.

Those options are much more limited with whole life than with other investments.

Reason #6: The claim of “tax-free” withdrawals is misleading

One of the big selling points of whole life is the “tax-free” retirement income. What they’re describing is your ability to take out loans against your policy, which are not taxed. This can indeed be an attractive feature of the policy, but it comes with several warnings.

First, although there are no taxes, there is interest. When you borrow from your policy, interest starts accruing from day 1 and keeps accruing until you pay back the loan. If you’re using it for retirement purposes, are you going to pay back the loan? Of course not. So the interest keeps accruing. And that interest applies to all money withdrawn, including your contributions, which were already taxed.

Second, these loans reduce the death benefit of the policy, which may or may not be important to you.

Furthermore, you can run into complications when you withdraw too much from the policy and there’s no longer a big enough cash value to support the premium payments. When this happens, you either need to put more money into the policy (likely not part of your retirement budget) or the policy will lapse and then you will face tax consequences.

So no, there aren’t “taxes” applied those to loans, but there are plenty of costs. Whole life insurance policies are fraught with complications like this that the salesmen never tell you about.

Reason #7: Lack of transparency

Whole life policies include many fees that are never explained to you. There’s the commission to the salesman. There are administrative costs. There’s the cost of the insurance.

I challenge you to find an example of a whole life illustration that clearly details these costs for you, similar to the way a mutual fund has to tell you the expense ratio, sales commissions, and other fees. They just aren’t transparent, which makes it impossible to understand what you’re truly paying for.

And there are many other terms and conditions that make these policies very complicated. One such example is the issue described above where borrowing too much from your policy can cause it to lapse. Another is the “guaranteed” interest rate that’s actually much lower than what they state.

Even the salesmen selling these policies often don’t understand how they work. One salesman, after I asked a number of questions he didn’t know the answer to, showed me his watch and said that he didn’t know how it worked, he just knew that it worked. Whole life, he said, was the same way.

Is that really the kind of person you want to trust your money with?

Reason #8: There are plenty of other options available

Whole life insurance might be more attractive as an investment if there weren’t so many other good options available.

Many people have a 401(k) or other retirement plan with their employer. Just about everyone has the option of contributing to an IRA. Then there are regular taxable accounts. All of these options allow you to choose your investments, control your costs (though employer plans will be more limited here), diversify, and avoid the downsides of whole life insurance we’ve just gone over.

And if you’re worried about some day wanting the permanent life insurance coverage, know that any good term insurance policy will allow you to convert some or all of it to whole life at any point during the life of the policy. This means that you can save money now by buying term, but still have the option open to get some permanent coverage later. There is no need to lock yourself in now.

Whole life insurance is a bad investment

There are certain instances where whole life can be useful. If you have a genuine need for a permanent death benefit, such as having a disabled child, it can serve a valuable purpose. If you have a large amount of money, have already maxed out all of your tax-deferred savings, and you can afford to front-load your policy with large payments in the first several years, it can provide better returns than was discussed above. So it is a useful product in a limited number of cases.

But the majority of people to whom whole life is sold do not fit these criteria. The majority of us do not need a permanent death benefit and do not have the large amounts of money on hand to make these policies a reasonable investment.

For most people, whole life insurance is a bad investment. You’re simply better off investing your money elsewhere.

Update 3/16/2016: For those of you who are interested in “banking on yourself” or “infinite banking”, financial planner Michael Kitces wrote a smart article explaining the major flaws behind these strategies. You can read it here: How Life Insurance Loans Really Work And Why It’s Problematic To “Bank On Yourself”.

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449 Comments... Read them below or add one of your own
  • Not every day that somebody writes an entire post based on your comment, thanks!
    If anyone ever tries to sell me on a whole life policy again, I’ll take a much closer look at those “guaranteed” returns.

    • Matt @ momanddadmoney June 19, 2013

      No problem! Thanks for asking a good question. Definitely approach any whole life sale skeptically. There are situations where it might make sense, but not for the majority of us.

      • lisa romano February 28, 2016

        Hi Matt how does whole life insurance differ from Northwestern Mutual adjustable comp life insurance Thanks

        • Matt Becker March 1, 2016

          Good question Lisa. I’m not an expert on Northwestern Mutual’s policies so I can’t give you a precise answer. But I believe that their adjustable comp life insurance policies allow you to combine term and whole life insurance in various proportions based on your desired outcome. In other words, it’s a more flexible policy than typical whole life insurance.

          • David July 22, 2016

            Interesting perspective.

            I think what happens is you look at mediocre or terrible whole life policies or maybe just a mediocre or average design and then compare it to the best of alternatives.

            I did an in-depth analysis awhile back showing the exact opposite of what you presented here. If you adjust for risk tolerance, and look at the best policies on the market, they’re not only competitive, they’re good. And, what I found corresponds with the research currently available about whole life vs BTID. Namely, sometimes, they’re better than a traditional 60/40 split portfolio (though I’d be hesitant to make that comparison as a blanket rule).

          • Matt Becker July 22, 2016

            Have you shared this analysis anywhere David? I would love to dig into a thoughtful and comprehensive view from the other side. Nothing I’ve seen yet has been convincing.

          • David July 23, 2016

            Yep. Here’s one analysis I did:


            Keep in mind this is not comprehensive and only deals with a narrow issue: the question of a basic whole life vs BTID analysis. If you’ve got any other questions, I’d be willing to address these on your blog if you wish.

          • Jmark April 26, 2018

            Hey Matt this is cute, glad you had time to explain many bullets that are very misleading and incorrect on your part. Are you an expert? Are you licensed? If the answers are no then stop blogging and keep your opinions to yourself. You can affect many who actually own it and it has done wonders for me specifically

          • Matt Becker April 27, 2018

            I’m a Certified Financial Plannertm.

      • David January 3, 2017

        Almost too much false information/lack of understanding here to even try to tackle. You do realize participating whole life/phantom loans are one of the MAIN ways that the wealthy keep their wealth, avoid taxation and funnel income into an investment vehicle right? The hiltons have been doing it for years as well as virtually every wealthy family manager out there. The lack of understanding most people have regarding these policies, is why they advise against them. They themselves do not understand.

        • Matt Becker January 4, 2017

          I have no idea how the Hiltons manage their money, so I can’t comment/fact check what you’re saying here. But in a broader sense, the right financial moves for the wealthiest 1% of Americans are often much different than the right moves for the other 99%. If you’re already incredibly wealthy, then sure, a well-designed permanent life insurance policy can make a lot of sense. If you’re trying to build wealth, then no it usually doesn’t.

          • Josh November 21, 2017

            This. LIfe insurance salesman like to talk about rich people who swear by life insurance as investments, even while they are selling to people who are barely making it. There is a difference between “investing” and gaming the system; and only people with a lot of money (and the people who facilitate them) need to know about that game.

          • Sjturner January 28, 2018

            I’m stuck with whole life supposed to be paid off now. Have to pay high premiums now . Should I take a paid up policy. Can’t pay those premiums!!!

          • Matt Becker January 30, 2018

            I’m sorry to hear that. Shoot me an email at matt@momanddadmoney.com with a little more information about your situation and I will be happy to help if I can.

          • Sarah September 12, 2020

            What if you’re not trying to build wealth and don’t care about yourselves at all. What if the main goal is to set your children up for financial freedom for when you DO pass. WhenEVER that may be. We are newly looking into this. We have no clue how to start. Also, does whole life premiums increase as you age, or are they locked in like term?

          • Matt Becker September 16, 2020

            Good question Sarah. If all of your other goals are completely on track and you have extra money that you’d like to use for that purpose, then some kind of permanent life insurance policy could work. That decision should be part of a larger conversation with a good estate planning attorney though, and you’d likely want to ensure that the policy is designed so that you’re only paying for the features you want and there aren’t any unnecessary fees. This is a fairly specialized scenario and I would be very careful about which professionals you trust to guide you in the right direction here.

            As for premiums, they can remain constant for life and even potentially disappear at some point depending on the policy design and how you manage it over the years.

        • Richard Parkinson March 31, 2017

          The author of this article has obviously not been exposed to the details, and perhaps unaware of the Canadian versions of whole life. His comments are just wrong on so many levels, it would take a book to refute them. To make such a blanket statement that all whole life policies are bad, is equivalent of saying because one BMW 750 was a lemon, don’t but one because they are probably all lemons. It is the application of these policies that is critical to understand, and yes they can be sold by inexperienced or crooked advisors looking after their own interests, but whole life has many positive applications both for individuals and especially for corporations.

          • David April 26, 2017

            It would be more like saying don’t buy a car with a high rate of defects. Even in cars with high rates of defects some last a long time. Personally, I still wouldn’t buy them.

        • Jmark April 27, 2018

          Matt you are a CFP? I am as well, Consider CLU, I have story after story of how whole life has saved clients businesses, families, and strengthen next generation wealth….. I also have my CFP and knowing you have it as well i don’t know I just feel as though it is devalued now.

        • Pisset Buojold October 9, 2019

          There are certain instances where whole life can be useful.

          1. The title should not be “Why Whole Life Insurance is a Bad Investment”. Could use: “sometimes”, “some”, etc.
          2. Again, as pointed out countless times in those comments: DO NOT CONFUSE LIFE INSURANCE AND INVESTMENT (with a capital “I”), in some sense life insurance can be an “investment” (with a small “i”)
          3. Again, Canadian experience and U.S. experience are so different in many ways when it comes to financial planning
          4. Proponents of Term policies either are honestly misinformed or intentionally misinforming: if life insurance is used for legacy or final expenses (at death), do you really know when exactly you are going to die?
          5. To the author of this article: kindly post an article about Whole Life policy being “useful”, as you acknowledged.
          Good luck, guys!

      • Larry May 12, 2020

        What about using a Whole Life Policy for the purpose of Investing in Turnkey Real estate? I do have a 401k policy, but after seeing what 2008 did to those gains, and again during this COVID 19, I’m just tired of not having any control.

        • Matt Becker May 18, 2020

          I would be extremely, extremely careful before venturing into anything like that. Real estate also tanked in 2008, and even without a recession this would be a risky proposition.

          • Larry May 18, 2020

            Ok, thanks for the reply and the Caution!

    • Rozelle Latorre February 28, 2016

      A very good article. Congruent to the philosophy in which our company was built: Buy Term, Invest the Difference. I am a crusader at heart and I am peeved every time I see these products in the hands of people who can barely afford it and whose life will be completely damaged for merely owning it because they are grossly under-insured when they could have well purchase a proper term amount for the time they need it.

      • James August 28, 2018

        So you’re telling me a whole life policy worth $30,000 with a $20 premium is worst than having a $30,000 term life policy that will increase from $20 to $100? Why is it better to gamble with your death when it comes to making sure your family has the money to bury you for a lifetime instead of for a period of time?

        • Matt Becker August 29, 2018

          Good questions James. I have two main responses.

          First, a term life insurance policy will cost much less than a whole life insurance policy with the same death benefit, often around 12 times less. So your example of a $30,000 whole life policy with a $20 premium compared to a $30,000 term life policy with that same $20 premium is not a valid comparison. The term life premium would be a fraction of the whole life premium.

          Second, if you are taking care of the rest of your financial plan and saving money, your need for life insurance should eventually disappear. You can read more about that here: The New Parent’s Guide to Life Insurance.

          • Aimee Sherrod October 21, 2019

            I have found what James is saying to be true though. Term life through the company I got the policy from would be $25 or $30 for the same coverage that I am paying $50 for whole life. And every year it keeps going up, so locking in those rates was helpful. Also, even though it was a meager amount, when I purchased the policy, I would have had to have lived 83 more years to pay the same amount out. Which means if I die anytime before age 100 or so then I’m going to get something more from the company than what I could have put back on my own. Is that not considered a good deal, even if I’m not considering it an “investment”? Or is that the wrong way to look at it and I should just be saving my $50 every month?

          • Matt Becker October 24, 2019

            I don’t know the specifics of your situation Aimee, but a term life insurance policy is often 8-12 times less expensive than a whole life insurance policy for the same amount and that premium is fixed for the duration of the term. The premium will eventually start going up, but that’s only if you want to keep it in place past the length of the original term (e.g. after your 30 year term has expired).

            To add to that, it’s often the case that you no longer need life insurance past a certain point. If you no longer have people who are financially dependent upon you (which typically means that your children are grown and able to support themselves), then what is the life insurance for exactly? Life insurance does not have to pay out for it to have been worthwhile. It simply has to have provided financial protection during the period you needed it. Paying for it past that point is generally not helpful.

        • Ziyad Zakaria March 9, 2019

          Regarding your concern. I work in the funeral industry and a lot of people don’t know that you can do a pre-arrangement with a funeral home and make small payments and have everything paid off in 3,5,10 years. The beauty of this is that it locks the price in place and garantee the service to your family. About 20-30 years ago our funeral home started to sell these contracts for 195.00 total. Now when the person passes away. The 195.00 cover transfer, embalming, service and a casket. This service is close to 10k
          I always tell people to look into prearranging, because no one will ever have to figure out what you wanted. It’s already done for them, and often times it’s all paid for

          • MIkeM May 5, 2020

            What happens in the case where the Funeral Home goes out of business between the purchase and the need – Seems to me like you would be out what you paid. Not sure I am willing to take that chance.

      • Joanne January 21, 2020

        I don’t like to see clients who can barely afford their life insurance coverage in policies that provide them with too little for their needs either, but the “Buy Term, Invest the Difference” philosophy (force-fed en masse by crooked Suzie Orman) is a reckless term as most people will not fulfill the latter part of that philosophy. It’s in life’s nature to allow things that are not required of us to fall to the bottom of the priority list.
        The fact is, every. single. client. has different needs and different budgets. A good agent will always keep their best interest in mind and try to find the product that best suits their coverage need while making sure they can afford it.
        And let’s face it… someone paying $130/mo. for a 20-Pay Whole Life Policy with a 20-yr $250,000 term rider attached to it, while concurrently paying $250/month for cable TV and $600/mo. on comfort/convenience/entertainment items, well… if they can’t afford that $130 life policy, then there is a disconnect in their personal financial behavior that we cannot solve for them. “Investing The Difference” goes hand-in-hand with that behavior. Life gets in the way, and things that are REQUIRED to be paid tend to take precedence over things that we SHOULD be paying (ourselves). We can’t make them do it, and term life insurance might only be half of a solution without it. Who are we helping in that case?

        • Matt Becker January 21, 2020

          I find it interesting that you seem to ridicule your clients’ financial discipline while at the same time assuming that they’ll be able to maintain a fixed monthly payment on their whole life insurance policy throughout all the ups and downs that life will inevitably bring. Because if they don’t maintain that fixed payment, they will lose not only their coverage but all of the “savings” in the policy as well. And in any case, if they do have the room in their budget for that life insurance premium, wouldn’t it be a whole lot easier to spend a few minutes helping them set up an automatic contribution to their 401(k) or IRA for the same amount rather than making them apply for a whole life insurance policy?

          • Joanne January 21, 2020

            I find it interesting that you see ridicule instead of realism. You know that the pattern I speak of is historically and statistically accurate, so why would you turn my comment into me “ridiculing” my clients?

            And I certainly can set up a client for extra payments to their 401k/IRA, however, that’s assuming they are not already maxing out that option. Additionally, if a whole life policy cancels, the client does not lose the accumulated cash value, so I’m not sure where you’re getting that. Not to mention, that I did use a 20-Pay policy as an example which has no payments after 20 years.
            Obviously, I heartily disagree with the generalized premise of your article on the whole life policy. While you do make some valid points, and I agree it is not for everyone, to say it is not for most is quite a stretch.