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Whole life insurance is the most expensive type of life insurance. It pays out a death benefit to your beneficiaries, and it also accumulates cash value that you can tap into during your lifetime. But the cash value investment component can be confusing to use the right way.
What's in this guide?
- What is whole life insurance?
- How does whole life insurance work?
- How cash value works
- How much does whole life insurance cost?
- Would I pay taxes on whole life insurance?
- What are the pros and cons of whole life insurance?
- Is whole life insurance worth it?
- Compare whole life insurance and get a quote
- Ho do I compare whole life insurance policies?
- Alternatives to whole life insurance
- What’s the difference between whole and term life?
- What happens if you stop paying your premiums?
- Bottom line
What is whole life insurance?
A whole life insurance policy provides coverage that lasts your entire life, as long as you pay your premiums. The premiums 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.
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 payout is equal to the face value of the policy — so if you purchase a $250,000 policy, your insurer will pay $250,000 upon your passing. The savings component is called the “cash value” and you can withdraw from it 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. Your life insurance policy eventually becomes an asset, or a source of equity.
Once you’ve built up enough cash value, you can withdraw funds that add up to the value of the total premiums paid to cover costs like tuition or a mortgage. And if you want to build cash value faster, you can pay an additional premium on top of your regularly scheduled payment.
Keep in mind that with whole life insurance, the cash value doesn’t automatically roll into the total payout. If you don’t use it while you’re alive, you’ll lose it.
You can use that money to:
- Pay your premiums in part or in full
- Take out a loan against your policy
- Surrender the policy for cash
But watch out for these downsides:
- It typically takes years to build enough cash value to pay your premiums.
- You’ll pay interest on a loan against your policy. And withdrawals or loans decrease the death benefit.
- If you surrender the policy, you’ll no longer receive any death benefit.
How much does whole life insurance cost?
Whole life polices typically costs six to ten times more than term life insurance. As a young, healthy individual, you might pay between $250 to $1,000 per month for whole life, and $50 to $150 per month for term life.
Whole life insurance costs significantly more than term life for two key reasons. Firstly, it’s a permanent policy, so as long as you pay your premiums, you’ll have coverage for your entire life. Secondly, it has an investment component and becomes a cash asset over time. The cash value earns a guaranteed rate of return, which sets whole life apart from other, riskier permanent policies that fluctuate with the market.
Would I pay taxes on whole life insurance?
The IRS states that premiums paid for whole life insurance are not tax deductible. However, you are not required to pay taxes on the accumulated cash value. 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 won’t be taxed.
- Tax-free loans. If managed properly, this policy can offer the perk of tax-free loans that come out of your death benefit.
- Taxed loans. If you don’t manage the loan you take out properly it can become taxable. For instance, if your policy loan lapses or is surrendered your loan could be taxed. Or, if your loan and interest combined becomes more than the actual cash value available — you’ll either have to put money in or your policy will be terminated, causing the loan to be taxable.
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 of having a lifelong protection.
- Often used as mandatory savings.
- Access to cash when 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.
- Can be used to save money to fund your retirement.
- Premiums are much higher compared to term life insurance.
- Not as flexible coverage needs to increased or decreased.
- Coverage doesn’t keep up with inflation, which puts your beneficiaries at risk of underinsurance at the time of claim.
- Poor investment choice as the interest you earn on the cash value may be lesser than other available investment alternatives.
It’s important to note that whole life insurance policies can have expiration dates. Some policies expire when the insured turns 100 or 121 years old. If this is the case, the policy would expire, but your cash value would still be payable.
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 want a guaranteed return on the cash value of your policy.
- 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.
Compare whole life insurance and get a quote
Ho do I compare whole life insurance policies?
When you’re comparing carriers, take these factors into account.
Make sure 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. The key agencies that rank financial strength typically give an A rank or better to companies that have a solid financial strength, such as:
- A.M. Best – A- or higher
- Moody’s – A2 or higher
- Standard & Poor – A or higher
- Fitch – A or higher
Life insurance companies fall into one of two categories: mutual and public. Public life insurance companies are publicly owned and traded on the stock exchange.
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 are often invested into the cash value portion of your policy.
Rate of return
Your insurer guarantees 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 base growth rate, and how they calculate that number. For instance, some mutual companies will reinvest dividends into your cash value. But dividends are based on the company’s profits – which aren’t guaranteed. When you’re looking at projections, go off the base growth rate before dividends.
Consider how insurers treats customers, which includes customer experience, transparency and billing. Read reviews on sites like the Better Business Bureau, J.D. Power, TrustPilot and Finder. The BBB also records consumer complaints, and docks points when businesses fail to respond to them in a timely manner.
You can also search for an insurer’s complaint ratio score with the National Association of Insurance Commissioners (NAIC). If an insurer has a score that’s higher than the national median of 1, they’ve received more than the average number of complaints for a company its size.
Best whole life insurance
Alternatives to whole life insurance
If whole life insurance isn’t right for you, these are your other options:
- Term life insurance. The simplest and cheapest policy, term life insurance policies offer coverage for a set period of time, such as 15, 20, or 30 years. If you die during your term, your beneficiaries will receive a lump sum death benefit.
- Universal life. Like whole life insurance, universal life insurance never expires and 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 variable universal life coverage, you’re allowed to invest the cash value of the policy in the market. The insurer will give you a range of investment choices to match your risk tolerance.
What’s the difference between whole and term life?
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. 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.
Notable differences between whole life and term life insurance include:
|Whole life insurance||Term life insurance|
|Length of coverage|
|Features and benefits|
What happens if you stop paying your premiums?
Your insurer will end your policy, which means you’ll no longer have coverage. There is a grace period, though. It varies by state, but you’ll typically have around 30 days to make up a missed payment. During this time, your coverage stays in effect.
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 can dip into that. Just keep in mind that if you don’t pay back the loan, the death benefit will be reduced. And if you withdraw too much cash, your policy could lapse.
- Use your dividends. If you’re with a mutual company, your whole life policy may pay dividends. You’re entitled to use that money to pay your premiums.
- 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.
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 whole life insurance policies.
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