Whole Life Insurance
From the end of World War II through the late 1960s, whole life insurance was the most popular insurance product. Policies secured income for families in the event of the untimely death of the insured and helped subsidize retirement planning. After the passing of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1982, many banks and insurance companies became more interest-sensitive.
Whole life insurance is a type of permanent life insurance that accumulates cash value. In addition to paying a death benefit, whole life insurance also contains a savings component in which cash value may accumulate. Interest accrues at a fixed rate and on a tax-deferred basis.
Whole life insurance also has a separate cash value component, which grows as the insurer pays policyholders dividends, a portion of the insurance company’s revenue that is paid to policyholders. Policyholders may be able to withdraw from or borrow against the cash value portion of their policy to fund expenses while they are living.
Breakdown of whole life insurance
Whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level, regularly-due premium payments. The policy includes a savings portion, called the “cash value,” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis. Growing cash value is an essential component of whole life insurance.
To build cash value, a policyholder can remit payments more than the scheduled premium (known as paid-up additions or PUA). Policy dividends can also be reinvested into the cash value and earn interest. The cash value offers a living benefit to the policyholder. Over time, the dividends and interest earned on the policy’s cash value will often provide a positive return to investors, growing larger than the total amount of premiums paid into the policy.
To access cash reserves, the policyholder requests a withdrawal of funds or a loan. Interest is charged on loans with rates varying per insurer. Also, the owner may withdraw funds tax-free up to the value of total premiums paid. Unpaid loans will reduce the death benefit by the outstanding amount. Withdrawals and unpaid policy loans reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could moreover chip away at the death benefit or even wipe it out altogether.
Whole Life Insurance vs. Term Life Insurance
There are three key differences between Whole life insurance and Term life insurance. Whole life insurance stays in effect as long as the policyholder pays the premium. Secondly, there is a huge difference in the cash value. Another critical difference involves premiums – term life is generally much less expensive than permanent life because it does not involve building a cash value.
- THE POLICY LENGTH – A whole life policy lasts your entire life, while a term policy only provides coverage for a limited number of years. Once the term expires, your beneficiaries are no longer entitled to a death benefit.
- THE CASH VALUE – A term policy has no value once it expires. A whole life policy is a life-long asset that can be accessed to help meet financial goals up to and after retirement.
- THE PREMIUM – For a given death benefit – e.g., $100,000 – premiums will be higher for
Example of Whole Life Insurance
For insurers, the accumulation of cash value reduces their net amount of risk. For example, BP Insurance issues a $25,000 life insurance policy to Mr. Smith, the policy owner and insured. Over time, the cash value accumulates to $10,000. Upon Mr. Smith’s death, BP Insurance will pay the full death benefit of $25,000. However, the company will only realize a loss of $15,000, due to the $10,000 accumulated cash value. The net amount of risk at issue was $25,000, but at the death of the insured, it was $15,000
Using the cash value in Whole Life Insurance
You can tap into cash value with a withdrawal or a loan, or also by surrendering the policy. If you take a loan, it’s tax-free, and you can pay it back, with interest. There are no taxes as long as your withdrawal is less than the portion of your cash value that’s attributable to premiums you’ve paid. If your withdrawal is greater, you’ll owe taxes on the difference because those are investment gains. Outstanding loans and withdrawals will both reduce the amount of death benefit paid out if you pass away. That’s not necessarily a bad thing. After all, one of the reasons to buy a whole life insurance policy is to get cash value.
Death benefits and picking beneficiaries
When you buy a policy, you’ll choose a life insurance beneficiary to receive the death benefit. You don’t have to split the payout equally among beneficiaries. You can designate the percentage for each, such as 75% to Mary and 25% to John. It’s also a good idea to designate one or more contingent beneficiaries. These folks are like your backup plan in case all the primary beneficiaries are deceased when you pass away.
Designating beneficiaries is an important task, as is keeping your designation up to date with your wishes. The life insurance company is contractually obligated to pay the beneficiaries named on the policy, regardless of what your will says. It’s wise to check once a year to verify your beneficiaries still reflect your wishes.
What happens when you die?
A major selling point of whole life insurance is that it will be in force until your death, as long as you’ve paid the required premiums.
But here’s a kicker: For most policies, the policy pays out only the death benefit, no matter how much cash value you’ve accumulated. At your death, the cash value reverts to the insurance company. And remember that outstanding loans and past withdrawals from cash value will reduce the payout to your beneficiaries.
Some policies allow you to purchase a rider that gives your beneficiaries both the death benefit and the accumulated cash value. This provision also means you’ll pay higher annual premiums, as the insurance company is on the hook for a larger payout.
How much Whole Life Insurance costs?
The cost of whole life insurance varies and is based on several factors, such as age, occupation, and health history. Older applicants typically have higher rates than younger applicants. Insureds with a stellar health history typically have better rates than those with a history of health challenges. The face amount of coverage also determines how much a policyholder will pay; the higher the face amount, the higher the premium. Interestingly, certain companies have higher rates than others, independent of the applicant and their risk profile. It’s also worth noting that for the same amount of coverage, whole life insurance is more expensive than term life insurance.
Factors that affect whole life insurance premium:
– Age and gender
– Height and weight
– Past and current health conditions
– The health history of your parents and siblings
– Nicotine and marijuana use, including nicotine patches and gum
– Substance abuse
– Criminal history
– Driving record ( DUI convictions and moving violations, such as speeding tickets)
– Dangerous hobbies and activities (such as piloting planes or rock climbing)