Whole life insurance is a type of ally permanent life insurance that provides lifetime coverage as long as premiums are paid. It differs from term life insurance, which only provides coverage for a set period of time.
With whole life insurance, part of the premiums go toward building cash value, which accumulates on a tax-deferred basis. The policyholder can borrow against or withdraw the cash value. If the policyholder stops paying premiums after a certain point, the cash value is enough to keep the policy active.
Some key features of whole life insurance include:
- Lifetime coverage as long as premiums are paid
- Premiums remain level and don’t increase with age
- Cash value accumulation that can be borrowed against
- Dividends from the insurance company that can increase cash value
- Coverage that cannot be canceled as long as premiums paid
Pros
- Provides permanent protection
- Premiums remain stable
- Policy accumulates cash value
- Cash value can be borrowed against in emergencies
- Dividends can increase cash value growth
Cons
- Much more expensive than term insurance
- Lower death benefit compared to term insurance
- Requires paying premiums your entire life
- Limited flexibility compared to term insurance
- Low fixed interest rates on cash value growth
Overall, whole life insurance provides permanent coverage and cash value accumulation. But it comes at a higher cost than term insurance. It works best for certain goals like estate planning, business planning, and final expenses.
How Does Whole Life Insurance Work?
Whole life insurance provides lifetime coverage as long as you continue paying premiums. It also builds up a cash value that you can access while living. Here’s an overview of how it works:
You pay a fixed premium amount each month or year. This premium is typically higher than term life insurance since some goes towards the cash value.
A portion of your premium gets added to the policy’s cash value, which grows at a guaranteed interest rate. This functions as a savings account inside the policy.
The rest covers the death benefit payout that beneficiaries receive when you pass away. The death benefit is also guaranteed and will not decrease if you continue paying premiums.
You can take out loans or make withdrawals against your cash value. This allows you to access those funds while alive if needed, for example to help cover retirement. Loans are taken against the cash value and need to be repaid with interest to avoid reducing the death benefit. Withdrawals permanently reduce the cash value.
If you stop making premium payments, the policy will lapse. But the cash value can be used to continue coverage for a period of time. The length will depend on the cash value amount and how it gets applied to cover costs.
So in summary, whole life insurance provides lifelong protection along with a cash value savings component you can utilize. The premiums are higher but guarantee coverage and cash value growth. It’s a matter of determining if the benefits are worth the higher costs based on your financial situation and goals.
Pros of Whole Life Insurance
Whole life insurance offers several valuable benefits that make it an attractive option for many people:
Lifelong Death Benefit Protection
The primary advantage of whole life insurance is that it provides permanent protection. As long as you continue paying the premiums, the death benefit coverage never expires – it lasts your entire lifetime. This ensures your loved ones will receive a tax-free death benefit no matter when you pass away. Whole life policies also accumulate cash value that you can access while living, unlike term life insurance which only pays if you die during the term.
Cash Value Accumulation
Whole life insurance policies build up cash value that you can borrow against or withdraw. This cash value earns interest at a guaranteed rate specified in the policy and can be used for any purpose. Over time, the cash value typically grows to equal or exceed the death benefit. So whole life offers a forced savings element along with lifelong insurance coverage.
Fixed Premiums
Whole life insurance premiums are designed to remain level for the life of the policy. They do not increase with age like term life premiums. This allows you to lock in a fixed, predictable payment for life. The premiums are usually higher than term policies initially, but become more affordable as you get older compared to annually renewable term insurance.
Cons of Whole Life Insurance
Whole life insurance policies come with some potential drawbacks to consider:
Higher premiums than term insurance – The premiums for whole life tend to be significantly higher than term life premiums, since you are pre-paying for a lifetime of coverage. The premiums are also fixed, meaning they do not decrease over time like term premiums. This makes whole life a more expensive option.
Lower death benefit for the premium – For the same premium amount, you can get a higher death benefit with term life insurance. So with whole life, you get a smaller death payout for the money you put in. The trade-off is you get the cash value account.
Less flexibility than other types of permanent insurance – With whole life, the premiums and death benefit are locked in. But other permanent policies like universal life provide more flexibility to adjust the premiums and coverage. So whole life offers less ability to modify the policy as your needs change.
Types of Whole Life Insurance
Whole life insurance policies come in a few main varieties:
Traditional Whole Life
Traditional whole life is the most basic type of permanent life insurance. It offers lifelong coverage and a cash value component that grows at a set interest rate. Premiums are fixed and remain level for life. The death benefit is also fixed. Traditional whole life tends to have lower premiums compared to other types of cash value life insurance.
Participating Whole Life
Participating whole life, also known as “par whole life,” has the same basics as traditional whole life. The key difference is dividends. The insurance company pools premiums from participating policies and invests them. If there are surplus profits, a portion is paid back to policyholders in the form of dividends. These dividends can be taken as cash, used to purchase additional paid-up insurance, or used to reduce premiums.
Single Premium Whole Life
With single premium whole life, the policyowner makes one large upfront payment to fund the policy. This lump sum premium covers the cost of the insurance for the insured’s entire life. These policies build up cash value rapidly because the full premium is available for investment immediately. Single premium whole life minimizes the need to pay ongoing premiums. However, the large initial payment makes it unaffordable for many.
Whole Life Insurance Costs
The cost of whole life insurance is determined by several key factors:
Age – Premiums are higher for those who start a policy later in life. Premiums are lowest for policies started in young adulthood and increase each year as you age.
Health – Insurers will assess your health and medical history, with rates being higher for those in poor health. Premiums are lower for those in excellent health.
Coverage Amount – The death benefit amount directly impacts premiums. Higher coverage equals higher premiums. The average policy is around $100,000 – $300,000.
Add-ons – Additional riders like accelerated death benefits or waiver of premium for disability will increase costs.
Premiums are paid for life and are guaranteed not to increase once the policy starts. Average annual premiums can range from:
$200 – $500 for policies under $100k.
$500 – $1000 for policies between $100k – $250k.
$1000 – $4000 for policies between $250k – $1 million.
So for a healthy 30 year old, annual premiums may be $300 for $100k of coverage. A 60 year old may pay $2000 annually for the same $100k policy. While whole life carries higher premiums than term, the premiums remain fixed once the policy starts.
Whole Life Insurance Cash Value
Whole life insurance policies build up a cash value over time that you can access while you’re still alive. This cash value grows in a tax-deferred manner, meaning you don’t pay taxes on the gains each year like you would in a regular investment account.
The cash value starts small but accumulates exponentially as the years go by. For example, a $100,000 whole life policy taken out at age 30 may have a cash value of $2,000 by age 40. By age 60, the cash value could grow to $25,000. And by age 90 it could exceed $100,000.
The actual cash value growth depends on several factors:
- The type of whole life policy – some have higher premiums that build cash faster
- Your age when the policy is purchased – the younger you are, the more time for growth
- The length of time you hold the policy – cash value takes decades to build substantially
- Interest rates earned on the cash value account – insurance companies invest this and pay a portion back
The most important thing to note is that whole life cash value grows tax-deferred. You don’t pay taxes annually on the gains like you would in a brokerage account or 401k when selling investments at a profit. The cash value accumulates tax-free until you make withdrawals or loans against the policy. This tax benefit allows the cash value to compound significantly over the long-term.
Loans and Withdrawals
One of the benefits of whole life insurance is the ability to access the cash value that builds up over time through policy loans and withdrawals. Here’s an overview of how this works and the pros and cons of each option:
Policy Loans
You can borrow against the cash value of your whole life policy at any time. The death benefit remains in place even if you have an outstanding loan balance when you pass away.
Interest rates are relatively low, usually a fixed rate around 5-8%.
Loans are not taxable, so you don’t have to claim the money as income.
If you don’t repay the loan, it will be deducted from the death benefit when you pass away. This reduces the payout your beneficiaries receive.
Failure to repay loans can cause the policy to lapse if the loan balance exceeds the cash value. This terminates the policy.
Withdrawals
You can make withdrawals directly from the cash value, but this reduces the death benefit dollar-for-dollar.
Withdrawals may be taxable above your cost basis. This depends on the nature of the policy.
Frequent or large withdrawals can cause the policy to lapse by reducing the cash value too far.
Withdrawals are often more flexible than loans if you need irregular access to funds.
Withdrawals permanently reduce the death benefit payout to beneficiaries.
Overall, policy loans allow you to access cash value without reducing the death benefit or incurring taxes. However, you need the discipline to repay the loans. Withdrawals provide more flexible access, but reduce the death benefit and may create a tax liability. Consider your needs and ability to repay loans when deciding between these options.
Is Whole Life Right for You?
Whole life insurance can make sense in certain situations, but there are also some drawbacks to consider. Here are some of the cases where whole life may be a good option:
Final Expenses
The guaranteed death benefit from a whole life insurance policy can be useful for covering final expenses like funeral and burial costs. This can provide peace of mind that your loved ones will not be burdened with these expenses when you pass away. The funds will be readily available to them.
Estate Planning
The death benefit from a whole life insurance policy can be an important part of an estate plan. The funds can help provide for heirs or charities, or pay estate taxes. The policy builds up cash value that can also supplement retirement savings.
Retirement Savings
Though not a replacement for dedicated retirement accounts like 401(k)s and IRAs, the cash value buildup in a whole life policy can provide tax-advantaged growth. This can be used to supplement other retirement income sources.
However, whole life insurance also has some potential drawbacks to weigh:
- It can be more expensive than term life insurance, especially at younger ages.
- Returns are typically lower than if investing the premiums yourself.
- There may be high surrender charges if cancelling the policy in the early years.
- It requires a long-term commitment to pay premiums for life.
Alternatives like term life insurance, investing the difference in premiums, or using permanent coverage just for final expenses, may be worth considering instead of a whole life policy in some cases. Speaking with a financial advisor can help determine if whole life fits your specific needs and goals.
How to Buy Whole Life Insurance
Buying a whole life insurance policy requires working with an experienced insurance agent who can help you determine the right type and amount of coverage. Here are some tips for purchasing whole life insurance:
Work with an Independent Agent
Work with an independent insurance agent rather than a captive agent. Independent agents have the ability to provide quotes from multiple highly-rated insurance companies. This allows them to compare policies and find you the best mix of premiums, cash value growth, and death benefits.
Independent agents act as your advocate and can help you navigate the complex process of purchasing life insurance. Make sure to find an agent that specializes in whole life policies.
The Application Process
The application process will require providing detailed medical and financial information to the insurance company. You’ll likely need to get a medical exam and provide access to your medical records. Financial documentation is also required to determine the policy premiums.
Be prepared to disclose information on your health, family medical history, prescription drug use, driving record, hobbies, travel locations, and occupation. The insurance company will thoroughly evaluate all this information to determine the risk level and appropriate premiums to charge.
Tips for Getting the Best Rates
- Maintain a healthy lifestyle and ideal weight
- Don’t smoke or quit if you currently do
- Control health conditions such as high blood pressure
- Have good driving habits with minimal tickets or accidents
- Consider getting a policy at a younger age when premiums are lower
- Ask about discounts for paying premiums annually rather than monthly
- Take advantage of premium discounts if your employer offers group coverage
- Aim for a larger death benefit amount to get a lower unit cost
Working with a knowledgeable independent agent and having a clean medical/financial history are key to getting the best whole life insurance rates. The agent can advise you on steps to take in advance to potentially lower your premiums.