Whole life insurance is a perpetual life insurance policy that offers lifelong coverage, making it an appealing choice for those who want certainty in their life insurance purchase. This type of insurance combines an investment account called “cash value” with an insurance product. As long as you continue to pay the premiums, your beneficiaries can receive the policy’s death benefit when you pass away.
What is Whole Life Insurance?
Whole life insurance provides coverage for your entire life and includes a cash value component that you can utilize while you’re still alive. It offers three noteworthy guarantees:
- A guaranteed minimum rate of return on cash value.
- A promise that your premium payments will remain unchanged.
- A guaranteed amount of death benefit.
Compared to term life insurance, whole life insurance is more expensive because it guarantees a death benefit payout upon the policyholder’s death. Term life insurance, on the other hand, offers coverage for a specific period, such as 20 or 30 years, and is typically more affordable as it doesn’t include a cash value component.
How does Whole Life Insurance Work?
To begin with, you need to determine the coverage amount that suits your needs. Once you have a policy, it remains in effect for your entire life as long as you continue to pay the premiums. Additionally, a cash value component accumulates over time.
Cash Value Accumulation in Whole Life Insurance
A portion of your premium payments goes into a cash value account, which grows over time and can be accessed through a policy loan, withdrawal, or policy surrender. Similar to a 401(k) or IRA, the cash value grows tax-free. However, if you withdraw cash value that includes investment earnings, the earnings portion will be subject to taxation.
Cash value accumulation is what sets permanent life insurance apart from term life insurance. While the actual growth rate varies depending on the policy, it often takes decades for the accumulated cash value to exceed the total premiums paid. This is because only a small portion of the premium goes towards the cash value, while the rest covers insurance costs and expenses.
Most whole life policies offer a guaranteed rate of return at a low percentage, but they also provide a non-guaranteed rate of return based on dividends. These dividends can be applied to the cash value each year, but the growth over time is unpredictable.
Utilizing Cash Value in Whole Life Insurance
You have the option to utilize the cash value by making a withdrawal or taking out a loan against it. Withdrawals are tax-free as long as they are less than the portion of the cash value attributed to the premiums paid. If the withdrawal exceeds this amount, the excess is considered investment earnings and is subject to taxation.
It’s worth noting that outstanding loans and withdrawals will reduce the death benefit that is paid out upon your death. However, if one of the reasons you purchased a whole life insurance policy is to access the cash value, it may be beneficial to use and benefit from the money rather than leaving it unused.
Before making any decisions, it’s essential to thoroughly understand the potential consequences of accessing the cash value.
Death Benefit and Beneficiary Selection
When you buy a policy, you can choose a beneficiary who will receive the death benefit. You have the flexibility to allocate the payment percentages among beneficiaries. For example, you can designate 75% for Mary and 25% for John.
It’s recommended to designate one or more contingent beneficiaries as a backup plan in case all primary beneficiaries are deceased at the time of your death.
Designating beneficiaries is an important task, and it’s crucial to keep your designations up to date with your wishes. Regardless of what your will says, the life insurance company is legally obligated to pay the beneficiaries named in the policy. To ensure that your beneficiaries align with your desires, it’s advisable to review and update your designations annually.
What Happens When You Die?
One of the significant advantages of whole life insurance is that it remains in effect until your death, provided you have paid the required premiums. However, it’s important to note that for most policies, only the death benefit is paid upon your death, regardless of the cash value accumulation. The cash value reverts to the insurance company after your passing. It’s also worth mentioning that outstanding loans and prior cash value withdrawals will reduce the payout to your beneficiaries.
Some policies allow you to purchase a rider that provides both the death benefit and the accumulated cash value to your beneficiaries, but this option typically leads to higher annual premiums because the insurance company commits to a higher payment.
How Much Does Whole Life Insurance Cost?
While whole life insurance offers appealing cash value features and lifetime coverage, it’s simply not affordable for many individuals. Comparing the costs of whole life insurance and term life insurance is not a direct comparison, as the policies differ significantly. However, here are some sample whole life insurance quotes based on a 30-year-old man in average health and with an average build, seeking coverage of $500,000.
These cost differences make whole life insurance less attractive to many individuals who are in need of insurance coverage.
To determine your life insurance needs, you can use a life insurance calculator.
Factors Affecting Whole Life Insurance Premiums
The amount of coverage you choose plays a role in determining your premium, along with factors such as age, gender, height, weight, health conditions (past and present), family health history, nicotine and marijuana use, substance abuse, credit history, criminal record, driving history, and participation in high-risk activities or hobbies.
Other features and provisions in whole life insurance can also impact costs:
- Payment period: You can opt to pay off the entire policy over a shorter period, such as 10 or 20 years, but this will result in substantially higher premiums.
- Guaranteed return rate: Some companies offer a higher guaranteed return, which leads to higher annual premiums.
- Dividend crediting: Many whole life policies provide dividend payments that policyholders can choose to receive as a premium credit, reducing their annual outlay.
Options for Discontinuing Whole Life Insurance
Unlike term life insurance, simply stopping premium payments isn’t an option with whole life insurance. If you stop paying the premiums, the cash value will be used to cover them until it is depleted and the policy expires. However, there are alternatives to suspending payments:
Take Cash Surrender Value
You can request to receive the surrender value in cash, which is the cash value minus any surrender charges. This action terminates the insurance policy, so it’s suitable only if you no longer need insurance or have obtained new coverage.
When you take the surrender value, you will be required to pay income taxes on any investment gains included in the cash value.
Explore Reduced Paid-Up Life Insurance
If you prefer a paid policy with a lower death benefit, the life insurance company can calculate the death benefit amount based on the premiums you already paid and provide you with a policy reflecting the reduced benefit. This approach avoids any tax implications and ensures that you still have life insurance coverage.
Convert to Long-Term Life Insurance
The life insurance company can use the premiums you’ve already paid to convert the whole life policy into a term life policy with the same death benefit amount. The length of the term depends on factors such as your payments, age, and the company’s current rates for a policy of that size and duration. This option is suitable for individuals who want to retain some life insurance for a short period without the need for whole life insurance.
Consider a 1035 Exchange
You have the option to change your policy to a different life insurance policy or an annuity. This can be beneficial to avoid taxes on the surrender value or if you discover another whole life policy with substantially better features that align with your preferences.
When Does Whole Life Insurance Make Sense?
Given the cost of whole life insurance and the fact that many individuals don’t require coverage for the entirety of their lives, it may not be the most suitable product for everyone. However, there are specific situations where purchasing some form of permanent life insurance can be beneficial. Universal life insurance may be a more affordable option if lifelong coverage is your primary goal.
- Fund a Trust: Permanent life insurance can serve as a means to fund a trust that will provide support to your children after your passing.
- Estate Tax Payments: If your estate exceeds the current estate tax exemption, which is $12.06 million in 2022, whole life insurance can assist your heirs in paying the estate taxes. It may also be beneficial for individuals residing in states with lower tax limits.
- Buy-Sell Agreement Financing: If you are a business owner with a partner, whole life insurance can be used to finance the purchase of each other’s shares in the event of one partner’s death.
The Top Sellers in Whole Life Insurance
Below is a list of the largest sellers of whole life insurance in alphabetical order based on annualized premiums for 2020, according to Limra:
- Mutual of Omaha
- Gerber Life Insurance Co.
- Guardian Life Insurance Co. of America
- MassMutual Life Insurance Co.
- Mutual of Omaha Cos.
- New York Life
- Northwestern Mutual
- OneAmerica Financial
- Penn Mutual
- State Farm Life
Whole Life vs. Term Life vs. Universal Insurance
Permanent life insurance, term life insurance, and universal life insurance differ in terms of coverage duration, cash value accumulation, and flexibility in premiums and death benefit.
What is the Difference Between Term Life Insurance, Whole Life, and Universal Life?
Term life insurance is suitable for individuals who require financial protection for a specific period, such as the years left on their mortgage. It offers level premiums for a predetermined term, such as 10, 15, 20, or 30 years. Some companies even offer 35-year and 40-year term life insurance. Term life insurance does not accumulate cash value.
Whole life insurance is ideal for individuals seeking lifelong coverage, stable premiums, and a cash value component. The death benefit is guaranteed regardless of when the policyholder passes away, as long as the required premiums are paid. Some individuals may still question whether they should opt for universal life insurance or whole life insurance.
Universal life insurance is another form of permanent life insurance that may be a suitable choice if you value the ability to accumulate cash value and prefer flexibility in adjusting premium payments and death benefits according to your changing needs.
Is Whole Life Insurance Worth It?
To determine if whole life insurance is right for you, consider the following questions and choices:
- Do you need life insurance coverage for more than 30 years?
- Do you require cash value accumulation?
- Do you desire flexibility in payment amounts or timing?
- Do you need a payout upon your death, or is it sufficient for the benefit to be paid after both you and your spouse pass away?
Whole life insurance is a product that serves specific purposes, but it may not be suitable for everyone. Many of the benefits provided by whole life insurance can often be achieved by utilizing investment and retirement accounts in conjunction with a term life insurance policy.
Before purchasing any insurance policy, make sure you fully understand the available options and the various provisions within the policies.
Whole Life Insurance Alternatives
Whole life insurance is just one type of permanent life insurance. Other types of permanent life insurance operate differently than traditional whole life insurance. Some alternative options include:
- Universal life insurance
- Variable life insurance
- Survivorship life insurance
- Burial insurance
Life Insurance Market Share
Whole life insurance accounts for a third of the individual life insurance market based on premiums paid, according to LIMRA, an industry research group.