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What is whole life insurance?
How does whole life insurance cash value work?
Borrowing against the cash value
Top reasons for buying whole life insurance
Can I get whole life insurance?
Top reasons for not buying whole life insurance
What are the types of whole life insurance?
Who is whole life insurance good for?
Whole life insurance & tax
Whole life insurance by state
What is Whole Life Insurance?
Whole life insurance is a type of permanent life insurance which is intended to remain in place indefinitely or for the whole of your life. With this type of insurance policy, you aren’t granted any renewal options. The policy simply remains in effect whilst you continue to pay your premiums.
Whole life insurance is largely distinguished from term life insurance. A term policy is only valid for a specified period of time. After the period expires, you need to either renew (if the option is available) or reapply for new coverage. Whole life policies are often chosen over term policies due to their cash value advantage. For a detailed evaluation of these two main types of policies, see our term vs whole life insurance comparison guide.
There are two value amounts to a whole life insurance policy, the cash value and the death benefit. The death benefit is the amount which is paid to your beneficiaries in the event of your death. The cash value, which is lower than the death benefit, is the amount you are paid out in the event the policy ends other than by death (for example where you stop paying premiums).
How Does a Whole Life Insurance Cash Value Work?
Cash value build-up is a very popular feature of whole life insurance, which is the original cash value policy. It enables policy holders to accumulate equity in their policy over time, making it a type of investment in addition to the insurance component.
The cash value is collected from premiums, since a portion of the insurance premiums go toward the cash value. The value amount is invested by the insurance company to increase its worth. Unlike variable life insurance, you do not have control over the investments. Since the insurance company manages premium investments, many offer guarantees that the cash value will rise, regardless of the performance of the investments. The investment earnings are tax deferred and as they continue to increase, you can start to rely on the earnings to pay the premiums or a portion of them.
Borrowing Against the Cash Value
Another feature of the cash value component is that you can borrow all or part of the equity. Retirees access their whole life cash value in order to supplement retirement income. Wealthier families can use this feature to pay for college tuition fees for their children. Whatever the purpose of withdrawal, you need to be careful with regard to any tax consequences.
You need to be aware that drawings on the cash value do incur interest which may over time diminish the value of your investment and also the death benefit. If you surrender the policy, the loan and interest are deducted from the surrender value. It’s best to speak to an accountant first about your financial options if you’re considering drawing on the cash value of a whole life insurance policy.
Top Reasons for Buying Whole Life Insurance
The main reason for purchasing whole life insurance is to have some type of coverage, to ensure your family and loved ones are looked after financially in the event of your death. As for choosing this specific type of policy, the core motivations include:
- Having a surrender value – With term policies, you may be paying premiums for 5, 10 or even 15 years only to be given nothing in return once the period expires. This is not the case with whole life insurance. If you surrender the policy, you actually have something to show for your dollars;
- Stable premiums – As you age and your health deteriorates, other forms of life insurance can be difficult to obtain. If you’re not in good health, the premiums can be exorbitant and prohibiting. With whole life, the premiums generally stay the same throughout the term and you will even have investment earnings to help out with premium payment in due course.
- Tax deferred earnings – You can build income from investments within a whole life policy without paying tax until the policy is either surrendered or paid out due to death. Watch out, there may be some tax implications if you draw on the cash value.
- Continuous life insurance – As stated before, the older you get, the harder it is to obtain appropriate life insurance coverage for an amount your family will need to continue their lifestyle. Whole life enables you to have indefinite coverage as long as you continue to pay your premiums. The policy does not end due to your age or health problems.
- Additional retirement income – If you require additional moneys on retirement, for that long deserved holiday or simply just to get by, you can dip into the cash value which has accumulated in your policy. Whilst it’s not an alternative to retirement funding, it is an additional source of funds in time of need. Remember that any amount you draw does incur interest and is deducted from the death benefit.
- Dividends – Some insurance companies offer dividend returns with their whole life insurance plans. Payment of dividends is not guaranteed.
Can I Get Whole Life Insurance?
Unlike term insurance, whole life is available to persons regardless of their age or health. If you can afford to pay the premiums, then you will be able to purchase a whole life policy. Before you do, you should consider the financial impact and whether there are alternative options which could be more suitable. Discuss these issues with your accountant since buying a whole life policy should be a highly thought about decision. Once you’ve made the decision to purchase a policy, obtain lots of whole life insurance quotes and compare the plans thoroughly. Once again, an accountant’s advice can be very valuable.
Top Reasons for Not Buying Whole Life Insurance
Whilst there are many advantages to purchasing a whole life insurance policy, there are drawbacks and alternative options available. Some of the reasons financial planners and other experts advise against whole life include:
- The expense involved with the investment component is higher than many other forms of investment. Due to the higher costs, consumers make a decision to sacrifice on the face value (death benefit) on the premise that the value will rise over time. Many say this defeats the purpose of insurance, which is to cover in the event of a premature death.
- It is argued that it’s more cost effective to purchase an adequate amount of insurance cover through an alternative type of policy (such as term) and invest the surplus. These investments may not however provide tax deferred advantages. An accountant can best advise you of your options taking your individual circumstances into consideration.
- If you can’t afford adequate coverage through a whole life insurance policy, then you shouldn’t be considering this product. The major concerns are your loved ones and family members. You need to consider how much they need in order to keep the family home, continue their lifestyle and pay debts and other expenses such as the mortgage and college.
- Whole life insurance involves high commissions being paid to salespersons, often as high as 100% of your first year’s premium. This ultimately reduces your investment cash value.
- Other investment products can offer higher returns with investment control, lower commissions and without the risk of being underinsured.
- Keeping life insurance and investment separate, so one doesn’t trump the other.
- Salespersons provide you with estimates of your investment growth. These are estimates only and can change significantly if you need to draw money from the cash value.
- Having something to show after years of paying premiums does sound enticing, however you need to weigh this up against the possibility of dying and leaving your family without adequate financial support.
What are the Types of Whole Life Insurance?
Being a complex yet versatile product, whole life insurance companies have made variations to the standard whole life insurance policy. Here are some of the common forms of whole life policies:
- Universal – The policy includes a cash account with variable premiums. Investment earnings are credited to the cash account each month less the cost of insurance. You do not have control over the investments.
- Variable – The premiums are fixed, guaranteed minimum death benefit and you have investment control.
- Variable universal – Ability to control premiums, face value and investments.
- Non-participating – The premiums, surrender value and death benefit remain the same during the life of the policy. They usually cannot be altered once the policy is issued.
- Participating – The policy holder receives a share of the company profits (dividends).
- Indeterminate premium – Constant surrender and death values, however the premium fluctuates each ear up to the maximum guaranteed amount.
- Economic – Dividends are used to purchase additional term insurance.
- Limited pay – Limits the number of years the policy holder will receive dividends. Some plans enable the policy to be fully paid up by a certain age.
- Single premium – Allows the owner to fully pay for their whole life insurance upfront.
- Interest sensitive – Variable interest accrues on the cash value rather than dividends.
To see a detailed explanation of a particular type of whole life insurance policy, click on the relevant page link above. Please note that not every insurer offers all of these policies. You may need to search around for a company who offers a policy that’s right for you.
Who is Whole Life Insurance Good For?
Whole life policies are usually available to anyone willing to pay the premiums regardless of health or age, making them highly appropriate for those who cannot otherwise obtain term insurance. Premiums for term life insurance are affordable and even cheap for people under the age of 50 and who are in good health. So, whilst you are in the lower risk category, financial planners would advise you to purchase term life insurance during the less expensive period and invest the surplus through other means. The reasoning is to avoid paying high commissions and costs of having combined whole life and investment plans.
Many insurers won’t offer term policies to people over the age of 65 due to the higher risk of mortality. In many cases, these persons are only offered whole life insurance. However, due to the high costs of investment, the death benefit is usually minimal. Also, experts state that it takes about 20 years to yield a reasonable return on such policies. So, whole life insurance is mainly good for people over their 60s who cannot purchase term insurance and who do not require a large death benefit. It’s also useful for wealthy persons for estate planning purposes (by establishing an insurance trust to pay the estate taxes from the whole life insurance proceeds). People in their late 40s or early 50s who are just starting families may also like to consider their whole life insurance options.
Whole Life Insurance & Tax
One of the great advantages of whole life is that the cash value can be invested and earn income on a tax deferred basis. This enables the policy holder to accumulate funds without having to pay annual income tax on that income. On the death of the insured, the beneficiary generally receives the death benefit (including the accrued income) tax free. Despite this, whole life insurance tax is still payable in certain circumstances.