Whole life insurance is the most basic permanent policy. It pays out a death benefit to your beneficiaries, and it also accumulates cash value that you can tap into during your lifetime. But like all lifelong coverage, it can be expensive.
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What is whole life insurance?
A whole life policy is a type of permanent life insurance coverage that lasts your entire life, as long as you pay your premiums. The premiums should stay the same for the life of the policy, so you’ll know exactly how much you’ll pay each month.
Unlike term life insurance, these policies earn cash value on a portion of your premium.
What’s the difference between whole life and term life insurance?
Similar to whole life insurance, term life coverage provides a lump sum death benefit in the event that the policyholder passes away while the policy is still active. There are some notable differences between whole life and term life insurance. These include:
Whole life insurance
Term life insurance
More expensive, due to the investment portion of the policy.
More affordable during earlier terms. The cost can increase significantly as you age.
Length of coverage
Coverage for your entire life, provided that premiums are paid.
Remains active for the term selected by the policy owner in the agreement. This can usually be renewed for additional terms.
Not so much — you generally can’t change your coverage amount when your needs change.
Very flexible — you can usually apply to increase your coverage
Features and benefits
The cash value component allows you to borrow funds when required and can serve as a relatively secure savings and investment option.
Greater range of features — you may also be able to link term life with other types of life insurance to cover temporary and permanent disabilities.
Financial advisers will often recommend term life insurance for insurance purposes and suggest that you find other ways to invest the remainder of your money to get a greater return. However, this depends on how much money you have available for investment purposes and whether you have already maxed out more traditional savings options like RRSPs and TFSAs.
How does whole life insurance work?
A whole life insurance policy has two parts: a death benefit, and a savings component. The death benefit is guaranteed, which means your beneficiaries will receive a payout when you die. The savings component is called the “cash surrender value” (CSV) and can benefit you while you’re still alive.
How cash value works
Whole life insurance policies invest a portion of your premiums so your policy can build cash value over time, which accumulates on a tax-deferred basis. Once you’ve built up sufficient cash value, you can use that money to pay your premiums, or withdraw it to cover other costs like tuition or a mortgage. You’ll likely be able to withdraw a maximum amount of funds which adds up to the total value of the premiums paid. Because of this additional investment component, your whole life insurance policy eventually becomes an asset, or a source of equity.
Borrowing from your cash value
If you decide to take out a loan against your policy, your insurer will likely charge you interest. And if you don’t pay it back before you die, your insurer could reduce the death benefit by the outstanding amount (so your beneficiaries receive less money).
On the other hand, cash withdrawals will decrease the value of your policy — but they won’t affect the death benefit. With whole life insurance, the cash value doesn’t automatically roll into the total payout. Make sure you review your policy closely, because in many cases if you don’t use your cash value while you’re alive, you’ll lose it.
A helpful hint
If you want to build cash value faster, find out if you can pay an additional premium on top of your regularly scheduled payment.
Why is whole life insurance relatively expensive?
Whole life insurance costs significantly more than term life for a few reasons.
Term life insurance is temporary and doesn’t build cash value. If life insurance is a game of risk, term life is a good gamble for insurers because most people outlive their policies. When that happens, insurers don’t need to cough up any money for a death benefit payout, so they can pocket all of the money payed as premiums.
Whole life insurance offers permanent protection and a guaranteed death benefit. As long as you keep up your premiums, your insurer will pay your beneficiaries when you die. This type of coverage also has a cash value — and often a guaranteed rate of investment return on a portion of your premium.
It’s an investment, and that’s why the coverage amounts are higher.
What about taxes on whole life insurance?
The CRA states that premiums paid for whole life insurance are not tax deductible. Here are a few things to be aware of when it comes to taxes:
Tax-free death benefit. The money paid out to your beneficiaries from the death benefit portion of your coverage won’t be taxed.
Taxed interest. Interest made from cash value investments is taxable once you withdraw that money. The interest is still taxable even if it is payed out after the policy holder has died.
Taxable loans. If you take out a loan from the cash value of your policy, it may be taxable. In these situations, check with your insurance provider and tax consultant to ensure you’re aware of your tax obligations.
What are the pros and cons of whole life insurance?
Whole life insurance policies present a number of benefits and drawbacks to owners.
Peace of mind from having lifelong protection.
Often used as automatic savings.
Access to cash if your circumstances change.
Premium remains the same throughout the life of the policy.
Guaranteed death benefit.
Your cash value portion will continue to grow each year with guaranteed interest earnings.
Possible dividend earnings, which can be used to increase your cash value, reduce premiums, or withdrawn.
The cash value can be used to save money to fund your retirement.
Premiums are much higher compared to term life insurance when you are younger. Although, as you age it may become the same or less expensive than term insurance.
Not very flexible to increase or decrease coverage depending on changing needs.
Coverage doesn’t keep up with inflation, which puts your beneficiaries at risk of underinsurance at the time of claim.
Potentially poor investment choice as the interest you earn on the cash value may be lesser than other available investment alternatives.
Less control over investments because the insurance company decides where to invest your cash
It’s important to note that whole life insurance policies could have expiration dates. Some policies expire when the insured turns 100 years old or older. Read through your policy carefully to find out what happens to your CSV should your policy expire.
What happens if you stop paying your whole life insurance premiums?
If you miss several payments, your insurer will end your policy and you’ll no longer have coverage. Some policies can be setup to automatically pay the premium from the cash value if you miss some payments. Still, repeated missed payments could lead to the policy getting canceled. Or when you do start making payments again, you may have to repay the cash value taken to cover your premium.
If you’re struggling to pay your premiums, you may have options:
Reduce the face amount. Depending on your provider, you may be able to lower your policy’s death benefit, which translates to a cheaper premium. You could also drop riders you don’t want or need anymore.
Use your cash value. If you’ve built up enough cash value, you could potentially take a loan from that. Just keep in mind that if you don’t pay back the loan, the death benefit may be reduced. And if you withdraw too much cash, your policy could lapse.
Use your dividends. If you have a “participating policy”, your whole life policy may pay dividends from investment earnings. You could use that money to pay your premiums. In contrast, “non-participating” policyholders do not receive dividends.
Surrender your cash value and buy a term life policy. Term life insurance policies tend to be significantly cheaper than whole life. They offer protection for a set period of time, but they don’t have a cash value component.
Drop your policy. If you no longer need coverage, you can let your policy lapse.
What should I look for in a whole life insurance policy?
When you’re comparing carriers, take these factors into account.
The goal of whole life insurance is not only to provide your family with a financial safety net when you’re gone, but also to earn money. Find out if your insurer has the resources to pay out claims, while also helping you build wealth.
Ratings agencies assess the financial strength of an insurer by looking at the company’s current financial situation, as well as their future outlook.
Here are some of the leading agencies and associated ratings scales that denote strong financials.
DBRS – A or higher
Moody’s – A2 or higher
Standard & Poor (S&P) – A or higher
Rate of return
Your insurer may guarantee a minimum rate of return on the cash value of your whole life policy. The higher the rate, the more cash value you’ll earn.
Ask your insurer about the growth rate, and how they achieved that number. For instance, some companies will reinvest dividends into your cash value. This is great news for policyholders, but if the dividends are based on the company’s profits, they aren’t guaranteed. When you’re looking at projections, go off the base growth rate.
Life insurance companies fall into one of two categories: mutual and stock (or public). Which type of company you choose will depend on your financial preferences.
Mutual life insurance companies are owned entirely by their policyholders. If the company performs well, you’ll benefit from that in the form of dividends. With whole life insurance, those dividends could be invested into the cash value portion of your policy.
Stock life insurance companies are publicly owned and traded on the stock exchange. The value of the company fluctuates with the market, and any investor who purchases stock in the company is a shareholder.
Financials aside, you want to choose a whole life insurer that treats its customers well. There are various sites that determine this, including the Better Business Bureau (BBB) and J.D. Power. These sites rate insurers’ interaction, transparency and operations. The BBB also records consumer complaints, and docks points when businesses fail to respond to them in a timely manner.
Is whole life insurance worth it?
If these situations apply to you, whole life insurance may be a suitable choice:
You have a lifelong financial dependent, like a child with special needs. A whole life insurance policy can fund a special needs trust to pay for your child’s care when you’re gone.
You prefer predictable payments — or level premiums.
You want to build tax-deferred savings within your life insurance policy
You want to be able to withdraw cash from your policy as needed.
You’re looking to leave your heirs money to pay estate taxes.
You have several assets, and need another to equalize inheritances. For example, you have three children, one business and one property. A permanent life insurance policy could bridge the gap and provide an inheritance for the third child.
Alternatives to whole life insurance
If whole life insurance isn’t right for you, these are some other options:
Term life insurance. The simplest and cheapest policy, term life insurance offers coverage for a set period of time. This term usually lasts 10, 20, or 30 years, or to a predetermined age, like 65. If you die during the term, your beneficiaries will receive a lump sum death benefit.
Universal life. Like whole life insurance, this policy never expires and it becomes a cash asset over time. But the payments are flexible, rather than set at a dollar amount. It’s ideal for those who foresee income fluctuations or can’t commit to paying the same premium each month.
Variable universal life. With this coverage, you’re allowed to invest the cash value of the policy in the market. You would be able to choose a range of investment choices to match your risk tolerance.
Term to 100. This insurance product is unique to Canada. It provides coverage for your entire life, although you’ll stop paying premiums after you turn 100 years old. Unlike other permanent policies, this option does not usually include any invested cash value. Therefore, term to 100 is generally cheaper than other permanent policies.
Life insurance is a serious matter, so it’s important that you give it the proper attention. When you know about all of the different policies on the market, you can narrow down which one will work best for your situation. To get the most competitive rates possible with the most flexible policy, reach out to a few choice providers and compare policies.
Richard Laycock is Finder’s insights editor after spending the last five years writing and editing articles about insurance. His musings can be found across the web including on MoneyMag, Yahoo Finance and Travel Weekly. When he’s not doing deep dives on data, he is testing the quality of cocktails in his newfound home of New York. Richard studied Media at Macquarie University and The Missouri School of Journalism and has a Tier 1 Certification in General Advice for Life Insurance.
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