A client sent me a video this week that claimed that because interest rates are so low, people should look to buy whole life insurance policies instead of certificates of deposit. He asked me what I thought, and while most of the video was correct I found it deceptive in that it did not explain they were comparing apples and oranges.
A CD is an investment product while a life insurance product is not. An investment product purpose is to increase the value of the contributions placed in it. Life insurance – be it whole life insurance or term life insurance – has the purpose to provide a larger benefit at the time of death than the contributions placed in it.
The fact is that CDs and whole life insurance policies have similar features, such as paying interest and beneficiaries, but they are not the same. In trying to determine what you need, ask yourself what is the purpose of the money and when will the money be used.
If the money is for you and needed in the next one to 20 years, a CD is best. If the money is for the cost of your burial or benefit of someone else at your death, then life insurance should be a better choice.
The video mentioned that life insurance policies pay interest and dividends.
Dividends are a sharing of the insurance company’s profits determined each year and shared with the policy holder. I must point out that not all insurance companies pay dividends, so when shopping for insurance ask if the company pays dividends. This sharing of profits may make it sound like an investment product but it is not.
You may be wondering if these two products have different purposes, why did the video imply they are the same? That is because of the internal functions and living benefits that a whole life insurance policy provides. In order to provide the death benefit 30 or 40 years into the future, a whole life insurance policy needs to charge more than the pure cost of the death benefit it provides now.
This extra money is credited to the policy and referred to as the cash value. Once credited to the policy each year the insurance company pays interest on the cash value. At the same time each year the company will determine if a dividend should be paid. Dividends can be paid in several ways, and you, the policyholder, can determine how to receive dividends.
Dividends can be paid directly to you, they can be added to the cash value and they can be used to purchase more insurance. The cash value plus the interest and dividend is referred to as the cash surrender value. This value can be accessed in two ways – surrendering the policy and taking the money or requesting a loan from the policy.
When requesting a loan you are actually borrowing money from the insurance company using your policy as collateral. Your policy continues to function as if there were no loan.
Taxation of CDs and whole life insurance policies are similar when it comes to interest paid, tax due each year. The tax on dividends on the other hand is only owed when they exceed the premiums paid and can be deferred indefinitely if dividends are used to buy more insurance.
In the beginning of this article I said purchase CDs if you want the money for yourself and will need it with in the next one to 20 years. If you want to provide a death benefit to someone else and accumulate some extra money for yourself 20 or 40 years from now, then a whole life insurance policy maybe best for you.
Call a life insurance agent and ask for some illustrations that will explain the death and living benefits of the policy. If I spent more time on whole life than CDs, that’s because they are like apples and oranges.
Bob Hollick is a State Farm Insurance agent based in Washington. His column appears every other Thursday in the Observer-Reporter.
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