PERSONAL FINANCE
Whole Life Insurance Explained
written by Mike Ballew|February 24, 2019
As the name implies, whole life insurance provides coverage for your whole life. It's also known as permanent life and straight life. Here’s how it works: you pay premiums for the rest of your life, and when you pass away your loved ones receive money. How’s that for a simple explanation?
The Details
A premium in the insurance world is a periodic payment made by you, the policyholder. Whole life insurance premiums are typically paid annually but for slightly more you can pay them on a monthly basis. The good news is, your whole life insurance premium will never go up; it typically remains the same throughout the life of the policy.
A whole life insurance policy has a face value and a cash value. The face value is the amount the policy beneficiaries (your loved ones) will receive upon your passing. The cash value is the amount you receive if the policy is terminated. Whole life differs from the more common term life in that with whole life you can access the accumulated cash value.
Cashing In
If the purpose of life insurance is to provide for your loved ones when you pass away, why would anyone terminate their policy and take the cash? How could anyone be so selfish?
It’s not a matter of being selfish. The ability to withdraw the cash value or borrow against it is one of the main reasons people choose whole life over term life. Most of us reach an age where we feel like we might not be around much longer. People cash out whole life insurance policies to enjoy life with their families while they’re still around. Or, the money can be used to pay bills if other sources of income have dried up.
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Types of Whole Life Insurance
Non-participating whole life, also known as traditional, level-premium, and fixed-premium, does not share investment gains with the policyholder. The policyholder pays a fixed premium and beneficiaries receive the face value in the amount specified in the policy. Non-participating is the most common and straightforward type of whole life insurance.
Participating whole life shares investment earnings with the policyholder in the form of dividends. What you do with them is up to you. You can keep them or use them to pay premiums. Either way, the dividends are taxable income.
Indeterminate-premium whole life, also known as variable-premium and indexed life, exchanges guaranteed returns for the possibility of higher returns based on market conditions. Rather than paying a fixed premium, premiums are tied to investment earnings. In good years your premium may decrease and in bad years your premium may increase. The maximum premium for indeterminate-premium whole life insurance is typically specified in the policy.
Closing Time
Many people include whole life insurance in their retirement planning. Between Social Security, pensions, annuities, employer-sponsored retirement plans, individual retirement accounts, stocks, bonds, savings, and whole life insurance, spreading your assets around is a good way to minimize risk.
Photo credit: PixabayThe Eggstack Blog will never post an article influenced by an outside company or advertiser. Our mission is to help you overcome uncertainty about retirement planning and inspire confidence in your financial future.
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■MIKE BALLEW
Eggstack founder, Financial Planning Association member, engineer, and software developer.
FAQs
Whole life insurance is a permanent insurance policy that pays the beneficiaries a specific amount upon the death of the insured. Because the insurance policy also builds up a tax-deferred cash value over the life of the policy, the policyholder can borrow against it.
How does a whole life policy work for dummies? ›
A permanent estate: Whole life insurance provides a guaranteed death benefit for the entire life of the insured. As soon as the first premium is paid, the entire death benefit is set aside for your family.
What is the disadvantage of whole life insurance? ›
A more complex product than term life insurance. Higher premiums than term life insurance. Could be costly if coverage lapses early.
Why is whole life insurance a money trap? ›
The cash value is slow to grow
Eventually, a higher percentage of your premium will go toward your cash value. But this takes a while, so it can take 10 to 15 years (or even longer) for you to build up enough cash value to borrow against.
Can you cash out your whole life insurance policy? ›
You can cash out a life insurance policy. How much money you get for it will depend on the amount of cash value held in it. If you have, say $10,000 of accumulated cash value, you would be entitled to withdraw up to all of that amount (less any surrender fees).
How much a month is a $500,000 whole life insurance policy? ›
How much does whole life insurance cost? A $500,000 whole life insurance policy costs an average of $451 per month for a 30-year-old non-smoker in good health.
Why is whole life not a good investment? ›
Some critics of whole life insurance compare it to other investments with 8 to 10% annual expected returns, which is not realistic. In addition, those returns are not guaranteed, meaning you can lose the money you invest.
At what age is whole life insurance worth it? ›
Generally, the younger and healthier you are when buying life insurance, the more money you'll save. As we age, we're at increased risk of developing health conditions, which can result in higher mortality rates and higher life insurance rates. You'll typically pay less for life insurance at age 25 than at age 40.
Why are people against whole life insurance? ›
The downsides of permanent
In addition, the premiums are much higher than with a term policy so you might not want to look to whole life to cover all your life insurance needs. If you fail to pay the premiums or if the investments in the cash account plummet in value, the policy can lapse, leaving you without coverage.
Why do the rich buy whole life insurance? ›
Life insurance is a popular way for the wealthy to maximize their after-tax estate and have more money to pass on to heirs. Life insurance can also be used as an investment tool with tax benefits when you're still alive.
One of the most notable risks of Whole Life Insurance is its cost. The premiums associated with whole-life policies tend to be significantly higher compared to those of Term Life Insurance. The reason behind this lies in the policy's structure, which combines a death benefit with savings or cash value accumulation.
Do you ever pay off whole life insurance? ›
You can pay whole life insurance policies forever or over 10 to 20 years — it's your choice. But your monthly premiums will increase dramatically should you choose the latter option. The payment schedule you choose greatly depends on your affordability.
What happens to the cash value of a whole life policy at death? ›
When you die, the insurance company will pay the death benefit. No matter how much cash value you may have had in the policy the moment before you died, your beneficiaries can collect no more than the stated death benefit. Any loans you have not repaid (plus interest) will be subtracted from the death benefit.
How long do you have to pay premiums on whole life insurance? ›
Your whole life premium stays the same for life.
The fixed premium of a term insurance policy typically ends after 10, 20, or 30 years. And with some other types of permanent coverage, the premium cost can go up later.
Is it good to have a whole life insurance policy? ›
For people with long-term financial goals that include providing a death benefit for their beneficiaries, whole life insurance is worth considering. While premiums may be higher than term life insurance, the lifelong coverage provides the necessary coverage along with the potential for cash value growth.
Does whole life insurance eventually pay for itself? ›
A portion of your premium goes toward the insurance itself when you pay for it, and the rest joins the cash value to accrue more funds. Generally, people seeking whole life insurance pay for it forever (i.e., until they die).
Eggstack founder, Financial Planning Association member, engineer, and software developer.