How Does Whole Life Insurance Work?
Whole life insurance policies will last your entire lifetime, unlike term life insurance policies that expire after a pre-defined period of time. Whole life insurance rates cannot increase, the death benefit won’t decrease, and cash value will accrue over time.
Like all forms of life insurance, a whole life policy will ultimately pay out a tax-free cash benefit when you die, which your beneficiaries can use as they see fit.
Whole life insurance cash value
One fundamental aspect of a whole life policy is its cash value component. Every time you make a payment, a small portion is allocated to the cash value account. Each payment, along with a small amount of interest, will cause the cash value account to grow on a tax-deferred basis.
The policy owner may take out a tax-free loan from the cash value and use the funds however they desire. It’s important to note that borrowing from the cash value will count as a loan against the policy and will incur interest, increasing the loan balance over time.
Outstanding policy loans are not required to be paid back, but they will reduce the death benefit if not.
For example, if you have a $100,000 death benefit and an outstanding $5,000 loan when you die, the insurer will pay only $95,000. If you ever surrender a whole life policy, the insurer will refund you the “surrender value,” which is essentially the policy’s current cash value (minus any surrender fees if applicable).
A whole life insurance cash value chart is included in every policy, so you can clearly see how much cash value develops in each policy year.
Who Should Consider Whole Life Insurance?
Whole life insurance is a good investment for those who need permanent coverage and want peace of mind that there are iron-clad guarantees that nothing can change. Some common reasons why people buy whole life insurance include:
- To pay for funeral costs.
- Estate planning.
- Tax-deferred growth via the cash value.
- Need permanent coverage to protect a surviving spouse during retirement years.
- Want to leave money as a charitable gift to loved ones or a charity.
What Are The Disadvantages Of Whole Life Insurance?
Whole life insurance, like all financial products, does have some potential drawbacks, such as:
- It’s always more expensive than term life or universal life insurance.
- Lower returns via the cash value growth compared to pure investment products like Index or Mutual funds.
- No payment flexibility. Your payments are locked in, and you can’t adjust them if your budget changes.
- For certain types of whole life policies, it may be possible for your premiums to exceed the death benefit if you live well beyond the average life expectancy.
How Much Does Whole Life Insurance Cost?
Whole life insurance rates are generally determined based on the following factors: age, gender, state or residence, health history, tobacco or nicotine usage (if any), lifestyle, and how much coverage you choose. That said, below is a table with some sample premiums for various coverage amounts.
How Much Whole Life Insurance Do You Need?
The amount of whole life insurance you need depends on why you need the policy. Ask yourself- what do you want the death benefit to be used for?
For example, if you need a policy to cover your funeral costs, then use a funeral cost calculator to estimate your final expenses.
If you need the policy for estate planning, then consult with a tax attorney to calculate how much coverage you’d need to offset any death taxes your estate would incur.
Types Of Whole Life Insurance
Whole life, like other forms of life insurance, has different types. It’s essential to understand how each type works so you can choose the one that best suits your needs.
Simplified
Simplified issue whole life insurance does not require you to complete a medical exam as part of the application process. Instead, the insurer assesses your eligibility based on your answers to health questions, combined with its receipt of your medical information from electronic databases. This all results in a fast application process that typically yields an approval in less than 24 hours.
Graded
Graded whole life insurance has a limited payout of the death benefit during the first two years. These policies appeal to those with severe medical conditions who cannot qualify for traditional life insurance products. On the surface, a limited payout sounds unattractive. Essentially, people who opt for a graded policy do so because they cannot medically qualify for full life insurance coverage from day one and would rather have some protection than none.
Modified
Modified whole life insurance has a full 24-month waiting period before you’re insured for natural causes of death. These are a last resort for applicants with very dire health issues (such as dementia or HIV) that render them unable to qualify for partial or immediate coverage during the first two years. Oftentimes, these policies have no health questions because acceptance is guaranteed.
Final expense
Final expense insurance is a type of whole life policy designed to cover all your final expenses. It’s unique in that it A) offers fast death benefit payouts, B) accepts applicants with high-risk medical conditions, C) offers small coverage options as low as $1,000, and D) has very fast application approvals.
Participating
Participating whole life insurance offers the ability to earn dividends, which can be paid out as cash or used for what’s called “paid up additions (PUA)” to increase the death benefit. It’s important to note that, in nearly every case, a whole life policy that is not labeled “participating” is, by default, considered “non-participating” and will not pay dividends.
In general, participating whole life policies have stricter underwriting requirements than non-participating whole life policies.
Limited-payment
Limited-pay whole life insurance specifies that you pay premiums for only a defined period of time. After all the required premiums have been made, the policy becomes a paid-up whole life policy. At this point, the policy remains in force forever and does not require any additional premium. There are various types of limited pay whole life policies, such as:
- 7-pay
- 10-pay
- 20-pay
- Paid up at age 65
- Paid up at age 80
- Single premium
Keep in mind that any policy that is not defined as “limited-pay” will be considered what’s called “life-pay,” which means you make payments until age 100 or 121 (varies by insurer). Lastly, expect higher premiums if you opt for a limited-pay option, as the insurer can only collect premiums for the specified period. A life pay option will always be the least expensive.
Whole Life Vs Term Life
Term life and whole life share many attributes, as both are types of life insurance. However, when comparing term vs. whole life insurance, many notable differences should be considered when choosing the option that best suits your needs.
| Policy Features | Whole Life Insurance | Term Life Insurance |
|---|---|---|
| Fixed premiums | Yes | Yes & No |
| Lifetime coverage | Yes | No |
| Builds cash value | Yes | No |
| Lowest cost | No | Yes |
| Policy loans | Yes | No |
| Tax-free guaranteed death benefit payout | Yes | Yes |
| Potential dividends | Yes | No |
Whole Life Vs Universal Life
Universal life and whole life are both types of permanent life insurance, but they differ in a few ways.
| Policy Features | Whole Life Insurance | Universal Life Insurance |
|---|---|---|
| Has fixed premiums | Yes | Yes & No |
| Can have flexible premiums | No | Yes |
| Lifetime coverage | Yes | Yes |
| Builds cash value | Yes | Yes |
| Cash value growth can be tied to the stock market | No | Yes |
| Potential dividends | Yes | Yes |
| Policy loans | Yes | No |
| Most affordable type of life insurance | No | No |
| Tax-free death benefit payout | Yes | Yes |
Frequently Asked Questions
A whole life policy payout does not typically include both the death benefit and the cash value. The only time both pay out is if you have a participating whole life policy. Then either some or all of the cash value will pay out in addition to the death benefit.
You can cash out a whole life policy at any time. If you do, the insurance company will issue a cash refund equal to your current cash value (if any), minus any surrender fees.
Whole life insurance is better at covering long-term needs, such as final expenses or estate planning. Term life is better at covering temporary needs, such as replacing your income or paying off a debt, such as a mortgage. It’s not accurate to say one type is always better than the other. Which is best entirely depends on your needs.
Term life insurance is very inexpensive because the insurer knows, statistically speaking, that it’s improbable that you’ll die during the policy’s lifetime. Whole life insurance, on the other hand, lasts forever, which means the insurer will one day have to pay out a death claim. Because there will be a claim, the cost is 2-10 times more than a term life policy.
Most life insurance companies that offer whole life insurance allow you to add on riders for additional coverage. Which riders are available varies by insurer. Some standard riders include: accidental death, waiver of premium, common carrier accidental death, and coverage for children or grandchildren.
The automatic premium loan provision in a whole life policy is a non-forfeiture option that must be chosen at the time of application. Essentially, this provision will draw on the cash value to make premium payments for as long as it has sufficient cash value to do so. It acts as an automatic fail-safe to prevent the policy from lapsing if you miss a premium payment.
- Nationally licensed life insurance agent with over 16 years of experience.
- Personal annual production that puts him in the top .001% out of all life insurance agents in the nation.
Anthony Martin is a nationally licensed insurance expert with over 16 years of experience and has personally served over 10,000 clients with their life insurance needs. He frequently authors entrepreneurial and life insurance content for Forbes, Inc.com, Newsweek, Kiplinger, and Entreprenuer.com. Anthony has been consulted as an expert life insurance source for dozens of high-profile websites such as Forbes, Bankrate, Reuters, Fox Business, CNBC, Investopedia, Insurance.com, Yahoo Finance, and many more.
- Nationally licensed life insurance agent with over 20 years of experience
- Best selling Amazon author.
Jeff Root is a nationally licensed life insurance expert with over 20 years of experience. He has personally helped over 3000 clients with their life insurance needs. Jeff is a best-selling Amazon author and the managing partner of a highly successful insurance brokerage that manages over 2,500 licensed insurance agents across the USA. He has been a featured life insurance source for prestigious websites such as Forbes, Bloomberg, MarketWatch, Nerdwallet, and many more.
- Nationally licensed life insurance agent with over 15 years of experience
- Best selling Amazon author of five insurance sales books.
David Duford is a nationally licensed insurance expert with over 15 years of experience. He has personally helped more than 15,000 clients buy life insurance. David has been featured as an expert source for highly authoritative publications such as A.M. Best and Insurancenewsnet. He also runs one of the largest Youtube channels to help aspiring insurance agents serve their clients better.
- Nationally licensed life insurance agent with over 20 years of experience
- Best selling Amazon author.
Jeff Root is a nationally licensed life insurance expert with over 20 years of experience. He has personally helped over 3000 clients with their life insurance needs. Jeff is a best-selling Amazon author and the managing partner of a highly successful insurance brokerage that manages over 2,500 licensed insurance agents across the USA. He has been a featured life insurance source for prestigious websites such as Forbes, Bloomberg, MarketWatch, Nerdwallet, and many more.
- Nationally licensed life insurance agent with over 15 years of experience
- Best selling Amazon author of five insurance sales books.
David Duford is a nationally licensed insurance expert with over 15 years of experience. He has personally helped more than 15,000 clients buy life insurance. David has been featured as an expert source for highly authoritative publications such as A.M. Best and Insurancenewsnet. He also runs one of the largest Youtube channels to help aspiring insurance agents serve their clients better.
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cash value component. https://www.investopedia.com/terms/c/cash-value-life-insurance.asp
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earn dividends. https://blog.massmutual.com/insurance/whole-life-insurance-dividends
