My parents took out a $500K whole life insurance policy for me when I was 15 — but was that magnanimous or misguided?
The problem is, her parents have asked her to take over payments — the exact opposite of what she'd like to do. Additionally, she'd need their consent to take out any cash value to purchase her home, since they own the policy.
But Sarah's stressed about approaching them, as it's a big ask and money hasn't always been an easy subject in her family.
Sarah has learned that if they pass away, ownership could go to her, as a contingent owner, or to their estate, further complicating the situation. Unless they officially transfer ownership to her, Sarah could be stuck with either paying or surrendering the policy and may have to forget about her dream of a new home.
On top of this, while her folks surely thought it was a good investment at the time, this may not be the case today. Several considerations factor into this, particularly as many experts urge caution with whole life insurance.
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What is whole life insurance and who owns it?
Whole life insurance is permanent coverage designed to last your entire life, with two main parts: the death benefit and cash value.
The death benefit is the guaranteed payout to beneficiaries, while cash value is a savings component that grows, is tax‑deferred and can be borrowed against.
Policyholders can boost their cash value by paying more than the required premium or reinvesting any policy dividends. Then, over time, interest and dividends can help the cash value grow beyond the total premiums paid.
This cash value can be accessed while the insured person is alive, either through tax-free withdrawals or low-interest loans that typically have lower rates than personal or home equity loans but must be repaid to avoid reducing the policy's value (including the death benefit).
But here's the twist: Because the policy was initiated by her parents while she was still a minor, they remain the owners of the policy, not Sarah. So, she can't access the cash value or cancel the policy without their permission.
Parents often like whole life policies for their fixed premiums, tax breaks, lifelong protection and potential dividends. However, advisors warn that the high premiums and slow cash value growth make them poor investments for many families.
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Pros and cons of whole life insurance
Here's a look at the common benefits and drawbacks of whole life insurance.
Pros
Whole life insurance features predictable, stable premiums that don't increase with age or health conditions. This makes them a great tool for long-term budgeting. It also covers the insured for their entire life, as long as premiums are paid.
One of the biggest selling points of whole life insurance is that aforementioned cash value component. A portion of each premium goes into this savings-like account, which grows on a tax-deferred basis and can be borrowed against or withdrawn.
Finally, some whole life policies pay dividends (depending on the insurer), which can be reinvested to buy additional coverage, grow the cash value or reduce premiums.
Cons
On the flipside, these policies can cost five to 15 times more than term policies with similar coverage.
There's also low cash value and slow growth in the first several years, when most of the premiums go toward administrative fees, agent commissions and the cost of insurance coverage. It may take several years before the cash value reaches what's been paid in premiums.
Unlike other life insurance, whole life isn't too flexible in adjusting the death benefit or premium amount, which may not suit those whose financial situation or goals change over time.
And experts warn of the opportunity cost: Returns, typically 4-5%, are usually lower than potential gains from investments like stocks, retirement accounts or real estate, making them a less ideal investment vehicle.
So, while many, like Sarah's parents, feel that whole life may make sense for goals like covering a lifelong dependent or leaving an inheritance, it can be a sub‑optimal savings strategy compared to other investment options out there.
On top of this, whole life policies can be difficult to understand, especially when it comes to dividends, interest rates, policy loans and surrender charges. This makes it harder for policyholders to assess whether the policy is truly benefiting them over time.
In Sarah's case, she will need to study her policy in detail — perhaps with the help of a financial advisor — so she can explore the best path forward for her financial future.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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