What Is Whole Life Insurance? (2024) (2024)

Whole life insurance is a type of permanent life insurance that builds tax-deferred cash value. With a whole life policy, a portion of each premium payment is deposited into a separate account that the insurance company controls. This fund becomes the insurance policy’s cash value and functions as a tax-deferred savings or investment account. Over time, as the investments made by the insurance company pay off and more premium payments are made, the cash value will grow.

Like other types of life insurance, whole life insurance is a contract between the policyholder and an insurance company. Typically, the policy owner is the person the policy insures, though exceptions do exist. As long as the policyholder pays the required premiums, the policy’s beneficiary will receive a payout when the insured passes away.

How Do Whole Life Insurance Policies Work?

A policyholder can benefit from this cash value during their lifetime. Once the balance exceeds a certain threshold — which may take 10 years or longer — the policy owner can access it in one of the following four ways:

• Making a withdrawal: The policyholder can withdraw a portion of the cash value outright. However, the amount withdrawn will be deducted from the death benefit.
• Taking out a loan: The policyholder can borrow against the cash value and pay back the loan with interest. If the loan is not fully repaid before the insured’s death, the insurance company will deduct the remaining balance from the death benefit.
• Paying the premiums: The policyholder can use the cash value to pay the whole life policy’s premiums. This could reduce or eliminate the out-of-pocket cost of maintaining the policy.
• Surrendering the policy: The policyholder can choose to surrender the policy in exchange for a cash payout. The cash surrender value will increase as the policy ages.

A whole life policy may have one or more beneficiaries. Most policyholders typically name their spouses or children as their beneficiaries. However, the beneficiary can be any person or organization, including a business partner, a trust or a charity.

Whole life insurance can benefit nearly anyone whose death would financially impact another individual or organization. It can be an especially wise investment if any of the following scenarios apply to the policyholder:

• You have dependents who will always require financial assistance.
• You want to focus on estate planning as you grow older.
• You would like to minimize the tax burden on your heirs.
• You plan to leave a legacy donation for your favorite nonprofit.
• You believe you will have use for the cash value in a decade or so.
• Your death at any age will negatively impact your business.
• You have an elevated risk of developing certain medical conditions.

Whole life and term life are the two policy types most people consider when shopping for life insurance. Both options typically feature level premiums and a guaranteed payout amount, though the amounts of each will vary. These two types of life insurance differ in four key ways:

• Cash value: Term life insurance policies only have a face value, which is the death benefit. Whole life insurance policies have both a face amount and a cash value. Thanks to the cash value, a whole life insurance policy can double as a savings or investment tool that can benefit the insured during their lifetime.
• Policy length: Term life insurance provides coverage during a limited time period, known as the term. Term policies typically run between 10 and 30 years, although some insurers offer 40-year terms, according to the Insurance Information Institute (Triple-I). Regardless, this type of insurance will eventually expire. Whole life insurance, however, covers the insured for her entire lifetime.
• Premiums: Whole life insurance costs significantly more than term life insurance because of the difference in cash value and policy length. Lifelong coverage is safer for the insured but riskier for the insurer. The higher premiums reflect that risk, the associated costs and the addition of a cash value component.
• Death benefit: Most policies of either type feature a level death benefit. However, some insurance companies offer a second option for term policies. With decreasing term life insurance, the premiums remain the same throughout the policy’s life, but the death benefit decreases over time. This option is not available with whole life policies.

For many people, the cost is the deciding factor. Although a permanent policy, such as whole life insurance, offers more benefits, term life insurance is always more affordable.

One possible solution is to purchase a convertible policy. This type of policy begins as term life insurance, which means lower premiums. You can then upgrade to whole life insurance, typically at any time you choose, without undergoing another medical exam.

Life insurance benefits society as a whole by providing financial security for surviving family members after the death of a caregiver or breadwinner. In recognition of this fact, the federal government allows three key tax benefits for whole life insurance policies.

Tax-Free Death Benefit

Unlike many things your spouse, children or other beneficiaries may inherit after your death, whole life insurance payouts are generally tax free. That means your beneficiaries will not have to pay federal income tax on their death benefits, though the government will tax any interest they receive.

The IRS provides an online tool that can help determine whether your life insurance proceeds will be taxable. If you have any questions, we recommend speaking to a financial advisor or estate planning attorney — especially if you will leave behind a large estate.

Tax-Deferred Growth

As a savings or investment tool, whole life insurance has two key advantages. First, the life insurance company will guarantee a minimum rate of cash value growth, regardless of market conditions. The cash value will only decrease if you access the funds.

Second, that growth occurs on a tax-deferred basis. As long as the funds remain in the policy, the IRS will not tax them.

Tax-Advantaged Funds

If you decide to tap into the cash value of your policy, you have two tax-advantaged ways to do so:

• Withdrawals: Withdrawals from a whole life insurance policy follow the First In, First Out (FIFO) method. Basically, as long as your withdrawal does not exceed the amount you have paid into the policy, it will be treated as a return of premium rather than income. Therefore, you will not have to pay income taxes on it.
• Loans: The IRS does not consider life insurance policy loans to be taxable income. Unlike the rules governing a withdrawal, this holds true regardless of whether the loan amount exceeds your total premium payments.

Before taking advantage of these funding options, remember that a loan or withdrawal may result in a decreased death benefit.

Choosing a whole life insurance policy is simpler than choosing a term policy because you do not need to consider the length of the policy. By definition, any whole life policy will provide coverage for the rest of your life. However, you need to take a few other steps when shopping for a permanent life insurance policy.

Determine Your Coverage Needs

To ensure your policy has the most benefit, determine precisely how much coverage you need. To do this, make a list of all your financial obligations. Include outstanding debt and other final expenses, such as funeral costs. You should also consider your family’s current and future expenses, such as college tuition for your children or assisted living for your parents.

Many insurance providers have a free life insurance calculator built into their websites to assist with this process. All you have to do is answer a few questions, and the calculator will estimate the amount of coverage you need.

Gather Multiple Quotes

Before you purchase a policy, we recommend gathering life insurance quotes from at least three different companies, as rates can vary significantly. Although most insurers will consider the same basic factors when calculating your life insurance rates, they may weigh them differently. Shopping around is especially important if factors such as your age, health or family medical history are likely to be considered high risk factors by life insurers.

Consider Added Benefits

Insurance companies may also offer different benefits and options for accessing your policy’s cash value. For instance, some companies pay dividends, while others do not. You may also want to consider certain insurance riders, such as a waiver of premium. With this add-on, the insurance company will waive your premiums during times when an illness or disability prevents you from working.

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Whole life insurance is a type of life insurance policy that provides coverage for your entire life or as long as you pay the premiums. When you die, your beneficiary will receive the designated payout. Although the premiums will be higher than those for a term policy with the same coverage amount, you will never have to apply for a new policy.

A whole life insurance policy also has a cash value, or a savings component that you can use in several ways, including to supplement your retirement income, help pay for your children’s college, or grow your business. You’ll also have peace of mind knowing your loved ones will be financially protected no matter when you die.

If you are unsure whether you need whole life insurance, speak to a licensed life insurance agent or your financial advisor. Whole life policies provide more guarantees and benefits than term policies, but that does not mean they are always the best choice. Before deciding, you may want to consider other life insurance options, such as variable universal life insurance.