Whole Life Insurance: What You Need to Know

Whole life insurance

Also known as cash value insurance, whole life insurance policies are designed to stay in effect over the course of your entire life. They can help to provide peace of mind by providing for your loved ones in the event of your death.

Whole life insurance is the most common type of life insurance policy. Whole life insurance has a number of benefits, including the ability to build cash value over time. However, as monthly premiums can run substantially higher than the average term life policy, whole life insurance may not be right for everyone. Read on to find out more about the perks and drawbacks of whole life insurance policies and whether or not they offer the right coverage for you.

Whole life insurance defined

Whole life insurance is a form of permanent insurance that covers you for the duration of your life. However, with permanent coverage comes a lifetime of payments, and these payments tend to be much higher on average than those for term life insurance. On the other hand, whole life insurance policies offer a tax-deferred savings component that may be attractive to those looking to bolster their retirement funds. These policies often allow the withdrawal of funds soon after retirement, helping to supplement income.

Whole life insurance policies explained

Whole life policies are comprised of a cash value component and a death benefit, as discussed below. 

• Death benefit: The policy’s death benefit is in place to pay out to beneficiaries in the event of the insured’s death, covering not only final expenses but also the income that would be lost due to the insured’s early death. Also known as the face value amount, the amount paid out to beneficiaries stays the same during the duration of the policy. 
• Cash value: A whole life insurance policy builds cash value over time. This cash value is accumulated on a tax-free basis at a fixed interest rate. This money can be accessed through loans or other means.

Whole life insurance has some constants: rates never increase and the plan remains in place for the duration of your life, provided you continually pay your premiums. As a level premium policy, whole life insurance does not involve steep rate increases, regardless of the insured's age or health conditions that develop after the policy commences. A whole life insurance policy’s savings account affords some payment flexibility, as long as the account has accumulated adequate funds. For instance, if you find yourself in a tricky financial situation, you may be able to use the policy's accumulated value to pay your premiums.

Whole life policies offer a guaranteed rate of return (typically at a very low interest rate). Those interested in higher returns would do better to look for other investment opportunities such as an IRA or 401(k). Whole life policies are designed to mature when the insured reaches the age of 100. This means that payments would end and the cash value and face amount are equal. The face amount is paid out to the beneficiary when the insured reaches 100 years of age, even if they are still alive. Keep reading to learn more and decide whether a whole life insurance policy is right for you.

The pros and cons of whole life insurance

Those interested in a whole life insurance policy should consider the following benefits and drawbacks of whole life insurance:

How to access the cash value of your whole life policy

One of the biggest perks of a whole life policy is the tax-deferred cash value that it accumulates. The insured can access this money before the time of their death, differing greatly from term life insurance policies. Bear in mind that a lot of the operating costs are front-loaded with this type of policy, so the accumulation of cash value is typically quite slow at first. Still, after a few years of regularly paying premiums, policyholders can expect some cash value to appear. However, you should know when and how you can access this money to avoid issues. Below you'll find common ways of accessing your whole life policy's cash value.

Policy loans

Whole life insurance policies allow you to take out a loan or make a withdrawal from their accumulated value. The cash value acts as collateral, allowing you to borrow from the insurance company. If the loan is not paid back (with interest), you can expect the death benefit to be reduced. Loans on a policy are not considered taxable while the policy is still in force. 

Dividends

Some policies may pay yearly dividends based on company performance. These dividends can also be used to pay premiums if the policy allows. 

Dividend options include:

• Cash dividends: Received by check once or twice per year
• Accumulation options: Dividends stay with the insurer and continue to draw interest
• Loan repayment: This goes toward any outstanding loans against the policy
• Paid-up additions: Can be used to increase the face value and cash value of the policy
• Reduced premiums: Can be applied to the premium, lowering the out-of-pocket expense of the policyholder

Surrendering the whole life policy

This option allows you to surrender the policy to the insurer and collect the accumulated cash value. Once the policy has been in place for a number of years, the cash value can be substantial. This is a common practice for those who wish to use the policy for supplemental retirement income. However, keep in mind that surrendering your policy removes the death benefit as coverage is no longer in place.

Whole life insurance and taxes

Death benefits paid out to your beneficiaries are not considered taxable income. However, because whole life insurance policies have a savings component that accrues interest, there are tax implications to consider.

While the cash value of a whole life policy grows tax-free, accessing that money can result in a tax bill. A whole life policy's cash value is made up of your premiums paid and the cash accumulated through interest (investment gains). The total amount of money paid through premiums is known as the policy basis. This amount is not considered taxable. For instance, if you have paid $15,000 of premiums, but your policy's cash value is $17,500, only the amount above $15,000 ($2,500) is considered taxable, as it represents investment gains.

If you withdraw less than the amount in premiums that you have paid, the money will not be subject to taxes.

What is the difference between term and whole life insurance?

Unlike whole life insurance, term life policies have an end date — usually one, five or 10 years after the inception of the policy. Death benefits can only be paid out if the insured’s death occurs during this specified period of time. Because of the shorter duration of time, premiums for term life insurance are often much cheaper than those for a whole life policy. However, upon the completion of each term, a new policy must be put into place. It’s very likely that a customer’s rates will increase substantially due to advancing age.

Another difference between whole and term life insurance is that term life policies do not gain cash value. The premiums paid only ever go toward the death benefit which — depending on the lifespan of the individual — may or may not pay out before the completion of the term.

Most life insurance companies allow term policies to be transferred to whole life policies.

Other alternatives to whole life insurance

Whole life insurance policies are good for many people, but there are other options for those who may want long-term coverage but have slightly different needs.

For those interested in having more control over the cash value returns, a universal life insurance policy might be worth considering. Universal life is another type of permanent life insurance that accrues cash value over time. However, the rate at which this occurs may vary. There's no guarantee your money will accumulate interest at a high level.

Policyholders who are mainly interested in setting aside money for retirement could also consider annuities. Annuities are sold in an effort to protect against living too long (i.e. octogenarians and nonagenarians running out of retirement money). Not technically a life insurance policy, annuities are often sold by life insurance agents as a way of guaranteeing income over a number of years late into a person’s life.

How much is whole life insurance?

Because of the permanent nature of a whole life insurance policy, they tend to be much more expensive than term life policies. Overall, the cost of your whole life insurance policy will depend on a number of factors, including the following:

• Age: The higher the age of the insured, the higher the risk to the life insurance company.
• Health: Those in poor health or who have a checkered health history can expect higher premiums.
• Supplemental coverage (riders): Adding coverage can increase your premiums substantially. 
• Coverage amount: Higher value policies require higher premiums.
• Credit history: Like many other types of insurance, those with lower credit scores can expect to pay higher premiums. 
• Career, lifestyle and hobbies: Certain jobs or popular hobbies carry a much higher risk level, driving up what you'll pay for life insurance.

How to find an affordable whole life insurance policy

It’s likely that the life insurance company you choose will require a medical exam as a part of the underwriting process. You will also have to answer a number of health questions regarding past illnesses or other conditions. Because your health information is used to help set premiums, it’s crucial that you be as open and as truthful as possible in order to prevent issues in the future. Overall, the best way to find an affordable policy is to compare options from multiple life insurance companies. Getting a number of life insurance quotes can help you compare rates and coverage options.

Can I cancel a whole life insurance policy?

Yes, whole life insurance policies can be canceled. In fact, whole life insurance policies are canceled at quite high rates due to customers overestimating their ability to pay higher premiums over the policy’s life.

However, canceling a policy within the first few years of its inception can result in a surrender charge. This charge is implemented to deter policyholders from canceling policies within the first few years of inception as costs incurred by insurers are often highest earlier in the policy. Surrender fees are often waived once a policy has been in place for a number of years. This allows policyholders to access funds from their policy without an insurer charge.

In short, if you wish to cancel your current life insurance policy but don’t want to lose your accumulated cash value, it may be worth applying your current policy’s equity towards the purchase of a new one.

What if I can't continue making life insurance payments? 

Because of the lifelong nature of whole life policies, it often occurs that many policyholders find themselves unable to continue making payments. However, whole life policies do have provisions that allow you to keep the value of the policy even if you find yourself in this situation.

• Cash surrender value: You surrender your policy back to your insurer. In return, you receive the policy's current value. With this option, life insurance protection ceases.
• Reduced paid-up life: This provision allows the policyholder to use the policy's cash value to fully pay for the life insurance policy with a lower face value than the original policy. 
• Extended-term life insurance: This provision uses the policy's cash value to fully pay for coverage at the same value as the original policy. Keep in mind that the duration of this coverage will be determined by the cash value previously accrued.

What happens if my whole life insurance policy lapses?

Most policies have a short grace period before the policy lapses. For those who have not been able to keep up with payments, however, most life insurance companies typically allow reinstatement of the policy. Policyholders typically have about three — and in some states, up to five — years to restore the policy. This entails making a formal reinstatement request as well as paying back premiums (with interest) and settling any loans on the cash value in full.

There are a number of reasons why a policyholder might want to consider restoring this policy. For instance, if you're searching for a new policy, it is not likely that you will get better premiums than a policy purchased when you were younger. Furthermore, interest rates on an older policy could make loans more favorable on a former policy. Bear in mind that insurers typically have the right to decline your policy's reinstatement.

How much whole life insurance do you need?

When you start shopping for a life insurance policy, an insurance agent will do a needs analysis to ensure that you purchase the right amount of coverage. Here’s a quick guide to help you determine the right amount of life insurance coverage.

Evaluate what types of holdings or benefits will be available to your beneficiaries

This may include savings, property holdings, stock and bonds, social security and group or employer life insurance plans. Your spouse can receive social security survivor benefits immediately if you still have dependent children, but only after the age of 60 if there are no dependents. Your life insurance agent will be able to help you focus on a policy that takes your family's needs into account.

Determine future obligations

Next, you will want to consider the costs that your beneficiaries will incur. 

1. Final expenses: This can include funeral costs and medical expenses.
2. College funds: If you have children and wish to provide for their college education.
3. Outstanding debts: Credit cards, mortgage payments and other outstanding loans can impact the amount of coverage you need.
4. Mortgage: The amount owed on your home.

Determine income replacement

Bear in mind that it's not simply the costs associated with your death that a life insurance policy is paying, but the overall income you would have produced as well. This can be more than many people might expect, so make sure to speak with an agent about how to set the correct coverage amounts to ensure your family is taken care of.

Whole life insurance riders

Riders are additional coverage options that you can add to your life insurance policy. Common life insurance riders can include the following:

• Chronic illness rider
• Accelerated death benefit
• Waiver of premium
• Long-term care rider
• Family income benefit
• Child term rider
• Guaranteed insurability rider
• Term conversion rider
• Cost of living adjustment

Whole life insurance considerations

Whole life insurance offers security for both you and your family. Unlike a term policy that only offers death benefits, a whole life policy can help provide financial security in the form of cash value that you can access as extra retirement money. However, the sustained premiums over the duration of a whole life policy put them out of reach to many. If you are mainly concerned with providing a death benefit to your dependents in the event of an untimely or accidental death, term life insurance is likely to be a better — and cheaper — option. 

However, if you’ve got the financial flexibility to maintain payments on a permanent policy and the desire for fixed returns over the course of your life, a whole life policy may be a good choice.