Understanding the disadvantages of level premium whole life helps consumers make the most educated decision. Here are the 7 major disadvantages that should be considered.
- Lifetime distributions of cash values are subject to income tax to the extent attributable to gain in the policy.
- The premium may be unaffordable for persons of limited financial resources.
- In the early years, the amount of protection is lower relative to the premium spent than with term insurance. However, later, as term premiums rise while the premiums for ordinary life remain level, the reverse typically will be true.
- Surrender of the policy within the first five to ten years may result in considerable loss because surrender values reflect the insurance company’s recovery of sales commissions and initial policy expenses.
- Policyowners generally may not deduct interest paid on policy loans on their tax returns.
- Cash values accumulating in the contract are subject to inflation. Whole life insurance is by definition a long-term purchase and the guaranteed return on this type of policy provides little inflation protection. However, a partial hedge against inflation is provided by the dividends paid on participating policies which reflect the favorable mortality, investment, and business expense results of the insurer.
- The overall rate of return on the cash values inside traditional whole life contracts has not always been competitive in a before-tax comparison with alternative investments. However, when safety of principal, contractually guaranteed liquidity, and the cost of term insurance if purchased outside the policy are factored into the analysis, whole life often compares favorably to alternative types of policies as well as nonlife insurance investments on an aftertax basis.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM