How Does Whole Life Insurance Work?

Whole Life Insurance: Frequently Asked Questions

A popular question among life insurance shoppers is “What is whole life insurance and how does it work?” We’re here to answer some of your commonly asked questions and will provide you with all details regarding the whole life insurance policy.

What is Whole Life Insurance?

Whole life insurance is a type of permanent life insurance in which the policyholders get guaranteed coverage for their entire life. These policies include a cash value component, which accumulates value over time and can be used for many things, without impacting the death benefit amount. Although whole life insurance policies typically have higher premiums, the death benefit is guaranteed, the premiums remain level over time, and the cash value will grow at a guaranteed tax-deferred rate. The insured individuals on these policies are also eligible to receive dividends, though they are dependent on the success of the insurance company and are not guaranteed.

How Does Whole Life Insurance Work?

A cash value account is built within your whole life insurance policy which functions as a savings account to help you invest more money. Each premium you pay is split between contributions to the face value of the policy (i.e., the death benefit; what your beneficiaries receive when you die) and adding to the cash-value account, which accrues interest. You can even remit payments beyond the due premiums to accumulate even more on the cash value. Over time, this cash value builds up, and after a certain period of growth time (usually a few years into the policy), it can be used for several things:

1) The insured individual can dip into this cash value at any time to receive a “loan” to help cover costs such as medical bills or a child’s college tuition.

2) The insured can use some of the cash value to fund the insurance policy itself.

3) If at any point you cancel or surrender your insurance policy, you will get at least a portion of the cash value accrued on the policy returned to you. However, if there are any unpaid loans or premiums, some of this cash may be used by the insurance company to cover those costs. Plus, by surrendering the policy, you will lose insurance coverage.

While this is a great investment tool provided by whole life insurance policies, the return rate may be less than other investment opportunities. The tradeoff is that the growth rate of the cash value is guaranteed for the duration of the policy.

Should I Buy Whole Life Insurance?

Whole life insurance is not right for everyone. However, certain life situations might make this the best option for you. If you are someone who needs predictability more than they need flexibility when it comes to life insurance, the guaranteed rates and coverage are an attractive selling point for you. Whole life is also ideal if you need guaranteed lifetime coverage with the added access to your money via the accrued cash value component. Whole life insurance is especially helpful for individuals who need help with estate planning. If there are large valuable assets you intend to leave behind, the cash value from a whole life insurance policy can be used to help cover any estate taxes that may apply. If you can comfortably afford the higher premiums, the guaranteed rates and coverage of a whole life insurance policy will provide the peace of mind and consistency you need as you’re planning.

Profile of a Potential Whole Life Insurance Candidate:

1. Needs lifetime coverage with access to a cash value account
2. Values guaranteed predictability of rates and coverage over flexibility
3. Is in estate planning, and requires a cash value asset to help cover the cost of estate taxes
4. Can afford higher premiums

How Can I Use My Dividends?

If you’re insured under a whole life insurance policy, chances are you may receive dividends from your insurance company at some point. This depends on how successful the insurance company is in a given year and therefore is not guaranteed. However, if you are fortunate enough to receive a dividend, there are many ways it can be put to use:

1. You can re-invest the money into the cash value of your insurance policy, accumulating even more interest.
2. You can also use the dividend to purchase additional death benefits to increase the guaranteed payout to your beneficiaries at the end of your life.
3. You can even use the dividend to pay off a premium. The great news about the addition of a dividend is that it comes to you tax-free, as long as it is not higher than the number of premiums you have already paid.

Are There Any Other Types of Permanent Life Insurance?

If whole life insurance sounds too rigid, there are a few other types of permanent life insurance policies to choose from:

Universal Life Insurance: This permanent life insurance policy has more flexible premiums, also includes the cash value account, and is relatively less expensive compared to whole life insurance. The terms and coverage are not as guaranteed, however.

Indexed Universal Life Insurance: This insurance policy has the added option of linking your cash value interest gains to a stock market index. As this index goes up, so does the growth of your cash value, up to a certain cap. This type of policy is a bit more complicated than whole life insurance.

Variable Life Insurance: With this, you can decide how a part of your cash value gets invested, utilizing sub-accounts, stocks and bonds. If you’re able and willing to track your investments diligently, this is a great way to maximize the cash value of a permanent life insurance policy.

The Pros and Cons of Whole Life Insurance

Pros:

• Whole life insurance policies have many benefits, the first being that you get guaranteed coverage for your entire life as long as you are paying your premiums.
• These policies accumulate cash value over time, which can be used for many things, from medical bills to funding the policy itself.
• You get guaranteed level premiums, guaranteed death benefit at the time of your passing, and guaranteed tax-deferred cash value growth rates.
• Whole life insurance policies are eligible for potential dividends.

Cons

• Because the terms and coverage are all guaranteed, whole life insurance premiums are higher.
• The return on the cash value of the policy might also be less than what you could potentially earn with other investment options.
• The policies tend to be a little more complicated than the simpler term life insurance policies.

If you’re not sure about getting a whole life insurance policy, speak with a licensed life insurance agent who can assess your needs and help you find the best option. Also, comparing the costs and benefits will help determine if it’s worth investing in the long term.