Whole Life Insurance Performance
What to Expect
Many policyholders buy whole life insurance for its permanent coverage and cash value that grows over time. But how much does the cash value of a whole life insurance policy actually grow? What interest rates can whole life policyholders expect to earn? And how does the performance compare with other investment options?
Slow Growth and Fixed Rates
The cash value of a whole life insurance policy is meant to serve as a stable source of “forced savings.” Part of each premium goes to cover the cost of the insurance policy, including mortality costs and administrative fees, and part goes to add to the cash value of the policy.
While whole life insurance is not FDIC-insured like a bank savings account, it is generally seen as a safe place to put money. While stocks and bonds can go up or down, the cash value of a whole life insurance policy is guaranteed as long as the insurance company is around to honor the obligation to the policyholder.
Whole life cash value interest rates vary from one insurance company to another, so check the details for each insurance company before buying. But in general, whole life cash value earns interest according to the long-term fixed rate investments managed by the insurance company, which are tied to the money markets and prevailing interest rates.
Some whole life insurance policies, known as “participating” whole life policies, also earn dividends based on the performance of the insurance company – this is how the insurance company shares its profits with policyholders. A strong, highly profitable insurance company will pay bigger dividends, so it is important to research the financial performance of the insurance company before signing up for a policy.
Interest and Dividends
It is hard to give exact numbers for this, because so much depends on the individual insurance company, but in general, the cash value of whole life insurance policies currently earn around 4-5% interest, and interest rates are reset annually.
Insurance company dividends can add approximately 2% to the cash value performance, depending on the year and the profitability of the insurance company.
How Does Cash Value Grow Over Time
Whole life insurance cash value grows slowly for the first few years of the policy, and then grows faster as the years go by. This is due to the way the policy’s payments are structured. Similar to a mortgage that has payments heavily skewed toward interest during the early years and then pays more principal toward the end, whole life policies devote a greater share of the early years’ premiums to fees and mortality costs, and then add more money to the cash value as the years go by.
For example, consider John, a 35-year-old man who buys a $100,000 whole life policy. He wants to know how the cash value will grow over time. Assuming John uses his growing cash value to pay future premiums, by year 5 of the policy, the cash value would be almost $4,000. By the 10th year of owning the policy, the cash value would be almost $12,000, and by year 30 (when John is 65 years old) the cash value would be over $46,000. At that point, John can either surrender the policy to receive the cash value, or he can keep the policy so that his beneficiaries can eventually receive the death benefit.
The numbers in this example are not a valid representation of every policy. There are a number of factors involved in calculating the cash value of a policy: whether the policyholder uses the cash value to pay premiums, whether the insurance company’s internal costs go up, and whether the insurance company pays additional dividends.
Whole life is a long-term commitment, and the biggest growth in cash value usually occurs once the policy has been owned for several years.
Whole Life vs. Other Investments – Risks and Rewards
Whole life insurance offers slow growth and fixed interest rates. The cash value may not grow as fast as a blue-chip stock, but it’s guaranteed to be there. For policyholders who want higher cash value growth, variable life or indexed universal life insurance might be better options.
These other types of insurance offer better growth potential. With indexed universal life, the interest rate is tied to the growth of a broad stock market index like the S&P 500 – but is protected from market downturns.
The cash value of a variable life insurance policy is invested in stocks and bonds just like a mutual fund – and while this is great for giving policyholders more control of their investments and better potential for long-term growth, there is also the investment risk that the market could drop and the cash value could decrease.
How does the performance of whole life insurance compare with other places to put your money? CDs are currently yielding around 2.6% for a 5-year CD. Most whole life policies’ cash value will grow faster than that – although it requires a longer-term commitment. Another benefit of whole life cash value is that it grows tax-deferred, while most people buy CDs with after-tax dollars.
The S&P 500, one of the broad indices measuring the overall performance of the stock market, is up 2.9% in the past year – although it’s down 14% during the past five years. Whole life insurance cash value is guaranteed not to decline; sometimes slow growth is better than the risk of huge drops in value.
The primary benefit of whole life insurance is that it provides financial protection for the policyholder’s beneficiaries, while also providing a store of cash value. Compared to the risks, volatility and low returns of investments like stocks, cash and CDs, whole life cash value is an attractive option for many people and a good way to save some money while protecting their families.
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