Life insurance is vital to protect your loved ones financially when you die. While no one likes to think of the worst happening, planning is essential because life is unpredictable.
Whole life insurance is a form of permanent life insurance that protects your beneficiaries for your entire life. It doesn’t expire.
Here’s what you must consider when deciding if whole life insurance is right for you.
Whole Life Insurance – What is It?
Whole life insurance is a policy that lasts for your entire lifetime as long as you pay the premiums. Your loved ones receive a fixed death benefit upon your death, but along the way, the policy might also accrue a cash value.
Many people use a whole life insurance policy as another investment since a part of the premiums you pay cover not only the death benefit but also to grow the policy’s cash value. The cash value is tax-deferred, incurring taxes only when you withdraw more than the premiums you paid (aka the earnings).
How Does Whole Life Insurance Work?
When you purchase whole life insurance, you purchase it for your ‘whole life.’ In other words, it doesn’t expire. This means that you’ll likely have higher premiums than you might have on a term life insurance policy because a term policy expires, a whole life policy does not.
You continue making premium payments on whole life insurance for your lifetime. Some policies have terms for their payments, such as 20 or 25 years. If you choose this option, your premiums will be higher, but your policy will be paid in full at the end of the term, but last for your lifetime.
How Premium Payments Work
Whole life premium payments are based on two factors:
- Death benefit
- Cash value
The death benefit is the amount your loved ones receive when you die. Let’s say you take out a policy for $1,000,000. Your premiums would cover the cost of the $1 million insurance plus administrative costs. Any amount beyond the death benefit gets invested according to the terms of the policy.
The investments grow tax-deferred at a guaranteed rate of return as long as the money sits in your account. Because some of your premium gets invested, though, the premiums can be higher.
Accessing the Cash Value
Many people use the cash value of their whole life insurance policy as a ‘back up’ or emergency fund. It can supplement your retirement income or be something you tap into if you have a financial emergency.
There are a couple of ways to access the cash in your life insurance policy:
- Loan – You can take out a loan just like you would from a bank, except you don’t have to qualify for it. Most life insurance companies allow you to borrow the funds, paying back the loan with interest over a fixed term. You are essentially paying yourself back, but it’s easier and often less expensive than a bank loan. If you don’t pay the loan back before you die, your insurer will reduce your death benefit by the same amount.
- Withdraw funds – You can withdraw funds from your cash value, but you’ll decrease the face value of your life insurance dollar for dollar. This means your loved ones will receive a lower death benefit because you took the funds out early.
- Surrender the policy – If you want or need the entire cash value, you can cash it in and cancel your policy. You’ll receive the current cash value minus any surrender charges the insurance company charges.
Who Benefits from Whole Life Insurance?
Whole life insurance isn’t as common as term life insurance, so you might wonder when you should consider it. Young families just starting out usually choose term life insurance because of its affordability and simplicity.
Established families that can afford the higher whole life insurance premiums and who are looking to broaden their investments or have a ‘forced savings account’ often consider whole life insurance.
Here’s why.
You can Diversify your Portfolio
A whole life insurance policy can provide portfolio diversification. Since it grows at a set rate, some people use it as a conservative investment to offset any risky investments they have in their portfolio.
It’s Another Tax-Deferred Investment
If you’ve maxed out your retirement contributions and want to have more tax benefits on the money you invest, whole life insurance provides that vehicle. Any money invested in your premiums that don’t cover the death benefit are invested in a tax-deferred account.
It can Protect your Beneficiaries for a Lifetime
If you have beneficiaries in your life that require lifelong support, such as a child with special needs or an aging parent you care for, a whole life policy guarantees the coverage will be in place even if you were to suddenly die.
The Proceeds can Help your Loved Ones Cover Estate Taxes
If your estate is worth over $12.06 million, your beneficiaries will pay taxes on any amount above it, and they could be steep. Rather than decreasing the amount of money they receive, you can provide them with a whole life insurance policy that isn’t taxable income.
Are there Disadvantages of Whole Life Insurance?
Like any financial product, there are pros and cons. We’ve touched on the ways whole life insurance is good. Now let’s look at what you might consider a downside.
Premiums are high
Unlike term life insurance, you’re paying insurance premiums for your lifetime. Since the premiums never change, they can feel a lot more expensive at the onset of the policy. Life insurance premiums increase as you age, but since you’re locking in the premiums now, the insurance company takes into consideration your premium costs as you get older, averaging them out for your lifetime.
You can’t control the investments
Unlike with a retirement account, you cannot choose where your money gets invested with a whole life insurance policy. You invest the money each month, but the insurance company decides where to invest the funds.
The rate of return is low
You aren’t going to get rich on the returns from the cash value of your whole life policy. The money may come in handy if you have an emergency or need to supplement your retirement income and let your death benefit lapse, but you won’t see crazy high returns.
You might trigger a tax liability
If you withdraw cash value that exceeds the premiums you paid minus any dividends earned, you’ll pay taxes on those funds.
Whole Life Insurance vs Term Life Insurance
Whole life insurance and term life insurance are often compared since they are the two most common life insurance policies.
Term life insurance, as the name suggests, is only good for a specific term. You buy it to cover you for the unexpected during a specific time. For example, young families often take out a policy that is as long as their mortgage term. This way if one spouse dies before the mortgage is paid off, he/she knows their family can continue living in their home without worrying about how to afford it.
Other reasons to take out a term life insurance policy include to cover the kids while they are living at home (usually up to 18 years old) or to pay for children’s college education should you die before then.
The main difference between term and whole life insurance is this – term life insurance expires and whole life insurance doesn’t.
If you are alive at the end of a term life insurance policy, the policy expires. Some insurance companies allow you to renew the policy but at a higher premium. The premiums are based on your age and overall health, but all premiums increase as you age. If your policy doesn’t allow renewals, you would have to apply for a new policy and start all over again.
Whole life insurance never expires. As long as you can afford the premium payments, the policy remains in effect.
The certainty of whole life insurance is what causes its higher premiums, though. Because coverage is guaranteed for life, insurers must charge more to ensure they make a profit on the deal.
Whole life insurance premiums are often unaffordable for young families and work best for high-net-worth individuals looking for another investment vehicle for tax shelter.
Key Takeaway
Everyone needs life insurance whether you have a big family or you’re single. It’s a way of helping your loved ones afford your final arrangements and to take care of your estate. Whole life insurance is just one option you have to protect your loved ones.
