What Is Whole Life Insurance?
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Whole life insurance is a type of permanent life insurance that issues a cash payout to your beneficiaries at any age you die, so long as you were paying your premiums. Whole life policies also have a cash value component that slowly builds equity with each premium payment. The cash value earns interest and can be borrowed against in the form of a loan depending on your insurer.
Whole life insurance is ideal if you need lifelong coverage and want a portion of your premiums to accumulate cash value over time. However, its higher costs compared to term life policies should be considered, as well.
How Does Whole Life Insurance Work?
Just as with any life insurance policy, your beneficiaries will receive a cash payout (also called a death benefit) from a whole life policy in the event of your death. Beneficiaries are individuals you designate to receive the death benefits and typically include family members, an estate or charity.
As the name suggests, whole life insurance covers you for your whole life — at least for most people. The age cutoff for coverage is typically age 121, but most people die before they reach the limit. Your coverage will be in effect so long as you continue paying your premiums.
Premiums are generally more expensive for whole life policies when compared to term life policies (which cover you for a limited duration). However, whole life premiums are level, which means that they generally do not change throughout the life of the policy — even if you develop a serious medical condition later in life.
How Cash Value Works
Whole life insurance is a type of cash value life policy. Each time you pay your premiums, a portion of the premium is deposited into a separate savings account. Your cash value will generally grow tax-deferred and at a conservative but guaranteed rate (e.g., 2% annual growth).
Some insurers will pay dividends. The dividends can be pocketed, added to the policy's cash value or even used to cover future premiums. Similar to regular stocks, dividends are not guaranteed — you may receive a dividend the first year and none the second year, for instance.
When your policy accrues enough cash value, your insurer may allow you to borrow against it in the form of a loan. The loan can finance a major expense, like your child's tuition, wedding or settling an existing debt. Repayment of the loan plus interest is required or the outstanding balance may be deducted from the cash payout to your beneficiaries when you die.
How Much Does Whole Life Insurance Cost?
Age is a major determinant of how much your whole life insurance policy premiums will cost. Below is an example of how the cost of whole life insurance can increase significantly between ages 50 and 75.
Monthly Premium for $100,000 of Coverage
Source: Lincoln Heritage Life Insurance Company
Sex is another factor of cost, as males generally have a higher mortality rate than females. Therefore, men are more likely to pay higher life insurance premiums. Here is an example of how differences in rates for the same coverage can vary between the sexes:
Monthly Premium for $100,000 of Coverage for Male
Monthly Premium for $100,000 of Coverage for Female
Source: Lincoln Heritage Life Insurance Company
Other factors that can affect the cost of your whole life insurance policy will typically include:
Pre-existing health conditions: People with certain illnesses that can increase their chances of dying will likely pay higher rates.
Recreational activities: Risky activities, like skydiving or rock climbing raise your chances of dying and will generally lead to higher premiums.
Health habits: If you partake in habits that can be negative to your health, such as drinking and smoking, you will pay higher premiums.
Whole Life vs. Term Life Insurance
The differences between a whole life versus term life policy primarily revolve around the duration of coverage and the availability of a cash value component. We highlight some key differences below.
Typically 5-30 years
Builds cash value over time
Does not build cash value
Typically higher rates than term life policy
Typically lower rates than whole life policy
Stays the same throughout life of policy
May increase with each term renewal
Differences in Coverage Period
With whole life insurance, you have coverage until you die (as long as you continue paying your premiums).
Term life policies, in contrast, have fixed periods as short as one year and typically up to 30 years. If you are still alive when the term expires, your beneficiaries are no longer entitled to death benefits unless you renew the policy for another term.
Differences in Cash Value Component
A portion of your premiums for a whole life policy is deposited into a tax-deferred savings account, which builds cash value over time. After accumulating enough equity, your insurer may allow you to borrow the accumulated cash value in the form of a loan. You can also cash it out early by canceling the policy, which would surrender your death benefits.
Term life policies have no cash value component.
Differences in Cost
Whole life insurance policies typically cost more because of their lifelong coverage and cash value component. Term life policies typically have lower premiums with temporary coverage being the tradeoff.
Differences in Premiums
Whatever price you pay when you buy a whole life policy will generally be the same rate you pay throughout the life of the policy.
Premiums on a term life policy will likely increase each time you renew the policy. A higher cost may apply if you convert the term life policy into a whole life policy (not available with all insurers).
Pros and Cons of Whole Life Insurance
Level rates and no medical exams
Less growth potential than variable life insurance
Cash value component
Lifelong coverage: Whether you live to 40 or 100 years old, your beneficiaries are entitled to death benefits so long as you maintain your premium payments before you die.
Level rates and no medical exams: Premiums on whole life insurance generally will not change throughout the life of a policy. Even if you develop a debilitating medical condition later in life, you will not be required to take a medical exam to reassess your premium cost.
Cash value component: A portion of your premiums is deposited into a savings account that accumulates equity over time. Some insurers may allow you to borrow against the cash value in the form of a loan to finance various expenses, like your child's wedding or settling a debt.
Guaranteed interest: The cash value component on a whole life policy generally earns interest at a guaranteed rate. Beyond paying death benefits, a whole life policy can function as an interest-earning savings vehicle — albeit at a lower, but safe rate of return.
Tax-deferred growth: The cash value in a whole life policy grows tax-deferred, which means it will not be taxed until it is cashed out, either by canceling the policy early or in the event of the policyholder's death. Tax-deferred growth generally offers higher returns than if taxes are applied at the time of contribution (when you make your premium payment).
More expensive: Whole life insurance is generally more expensive than term life insurance. Even if you lock in a lower rate at a younger age, the cost will be spread out over time because whole life insurance offers lifelong coverage.
Less growth potential: Other types of life insurance policies, like variable life insurance, gives you greater control over how you invest your accumulated cash value. This can result in a higher return than the guaranteed interest earned on a whole life policy.
Lifelong expense: Whole life insurance will be a fixed expense on your budget for an entire life. Be sure you can accommodate this lifelong expense before purchasing a whole life policy.
Who Should Consider Whole Life Insurance?
A whole life policy is ideal for somebody who needs lifelong coverage and enjoys the appeal of an interest-earning savings vehicle.
If you have a serious health condition that could significantly increase your mortality rate, then the lifelong coverage of a whole life policy could be useful. The cash value component can also be an attractive feature not available in a term loan policy. If your policy has been in effect for long enough, the cash value could be a considerable lump sum on top of the death benefit payout to your beneficiaries when you die.
However, cost is an important consideration. While term life policies have fixed terms of usually up to 30 years, they are typically cheaper to buy than a whole life policy. If your coverage needs are temporary and specific — buying a 30-year term life policy so your family isn't burdened with a 30-year mortgage if you die, for instance — then a term life policy may be a better alternative.
Looking for Lifelong Coverage?
The lifelong coverage and cash value component of a whole life policy are attractive features for future-minded individuals. Beyond a cash payout in the event of your death, your beneficiaries will also receive the built-up cash value that has accumulated over time if you have the right rider in place.
With so many life insurance companies out there, it's important to choose one with the right insurance product, excellent service and affordable rates. SmartFinancial can help by matching you with a life insurance policy that fits your needs. Start receiving free quotes by entering your zip code below and answering a few questions.