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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 coverages, it can be expensive.
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 savings component is called the “cash value” 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 may withdraw funds that add up to the value of the total premiums paid. Your 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 charge you interest. And if you don’t pay it back before you die, your insurer will reduce the death benefit by the outstanding amount (so your beneficiaries will receive less money).
On the other hand, withdrawals will decrease the cash 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. If you don’t use it while you’re alive, you’ll lose it.
A helpful hint
If you want to build cash value faster, you can pay an additional premium on top of your regularly scheduled payment.
How much does whole life insurance cost?
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.
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 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, too.
What should I know about taxes and 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.
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What happens if you stop paying your whole life insurance 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.
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 the key agencies, and associated ratings scale that denotes strong financials.
- A.M. Best – A- or higher
- Moody’s – A2 or higher
- Standard & Poor – A or higher
- Fitch – A or higher
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 growth rate, and how they achieved that number. For instance, some mutual companies will reinvest dividends into your cash value. This is great news for policyholders, 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.
Life insurance companies fall into one of two categories: mutual and public.
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.
Public 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, J.D. Power and TrustPilot. Together, 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.
You can also go one step further and search for an insurer’s complaint ratio score with the National Association of Insurance Commissioners (NAIC). The national median is 1. If an insurer has a score that’s higher than 1, they’ve received more then the average number of complaints for a company its size.
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.
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 offers 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, 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. The insurer will give you a range of investment choices to match your risk tolerance. Since it’s a riskier policy, it’s typically offered by prospectus only.
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|
|Cost||More expensive, due to the investment portion of the policy.||More cost-effective.|
|Length of coverage||Coverage for your entire life, provided that premiums are paid.||Remains active for the term selected by policy owner at time of application. This can usually be renewed into the future.|
|Flexibility||Not so much — you can’t change your coverage amount when your needs change.||Very flexible — you can apply to increase your coverage typically without having to provide further medical evidence.|
|Features and benefits||The cash value component allows you to borrow funds when required, used as a collateral against a loan||Greater range of features and benefits — you can also link term life with other types of life insurance to cover temporary and permanent disability.|
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. However, this depends on how much money you have available for investment purposes and whether you have the capital available to take advantage of the most profitable investments.
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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