Whole life insurance is a hotly debated topic within the financial industry. A lot of writers and advisors are adamant that you're better off buying term insurance and investing the money you'll save on your coverage. On the other hand, whole life insurance gives you a stable cost for lifelong insurance coverage, and also grows cash values you can treat as an asset in times of need. Those cash values might sometimes save your bacon, but there are some potential costs to consider.
The first thing you can lose when you surrender a whole life insurance policy is the premiums you've paid in. Some policies have little or no cash value for several years after you've purchased it. Your statements sometimes show cash building in the policy, but you don't get it back when you cancel. In those cases, your only benefit is that you stop paying new premiums. If you were having trouble meeting your payments, that's a good thing, but you lose what you've paid out to date.
Even if your policy has some cash values you can retrieve, the picture isn't necessarily rosy. Your insurance company uses most of your premium to cover its costs, in the early years. If you want to cash out your policy, you'll probably have to pay some hefty "surrender fees" so the company gets back the rest of its costs. They're spelled out in your policy, or you can contact the company directly and ask for an illustration of what you'll get when all is said and done. Sometimes, the result is a big (and unpleasant) surprise.
Sometimes, your policy is in effect long enough that surrender fees won't be an issue. For example, grandparents often buy an inexpensive whole-life policy on an infant, knowing that when they're grown it will have some value. If you have one of those, your issue might be taxation rather than surrender fees. The cash values in your policy represent the total amount of premiums paid to that date, plus any investment growth. The premiums aren't taxable, but the growth is. In a worst-case scenario, it could bump you into a higher bracket and wind up costing you money instead of helping.
Those are all immediate, tangible costs. The future growth of your policy isn't, but it's also worth considering. If your policy is just beginning to generate value when you cash it out, you're pulling the plug just when you'd start to see some benefit from it. If it's a childhood policy that's already been in force for 15 or 20 years, its costs are already paid and it'll do nothing but make you money for the rest of your life. Many whole-life policies pay 4 to 6 percent annual returns, once they get to that stage. You can do a lot worse, and it'll grow tax-free as long as you leave it in your policy.
The other thing you lose when you cash out the policy is your death benefit. Ideally, you're not going to die any time soon, but -- to be blunt -- the mortuary is filled with people who had plans for next weekend. If you're cancelling a whole life policy to take the cash, or to get relief from the high premiums, be sure you've protected yourself and your loved ones by putting a cheaper policy in place to cover your needs. Don't cancel the old policy until the new one is issued, just in case.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.