What is whole life insurance?

This is a life insurance policy that last the whole life of the insured person named on the policy.  Not only will it pay a tax-free death benefit, but it also generates a cash value over time with the interest being tax deferred.  It is one of the four main types of life insurance, and one of the three types of permanent life insurance.

For the most part, whole life policies pay a death benefit in exchange for regular premium payments.  Policies include a savings portion, or a cash value, that builds interest over time.  Interest is normally tax deferred, and growing this cash value through interest is an essential component to whole life policies.

The person who owns the policy is able to take loans out against the policy, using a portion of the cash value.  The loans will need to be repaid, with interest, before a death benefit is paid however.  The interest is usually less than what you would find at a typical bank or financial institution as a personal loan or home equity loan.

Cash Value

Part of every premium payment goes into a separate account that starts to earn tax-deferred interest.  It is similar to a retirement account, but the value will not be as high as only a small portion of the premiums are being added to this account.

We can access this cash value in two ways.  First, we can take a policy loan out against the cash value.  This is something that we will need to pay back, but if you need the option, its there for you.  The second way is to make a partial withdraw called a cash surrender.  When we make a cash surrender, we are withdrawing money, up to a set amount based on our cash value + fees, that is removed directly from the death benefit.

As an example: you have a $50,000 whole life policy with a cash value of $8,000.  For a $1,000 fee, you can surrender half of your cash value and receive that money tax free.  Your cash value would drop to $3,000 ($4k+1k fee) and your death benefit would become $45,000.

Cash values can also be used to pay the premium.  Most policies have riders that allow your cash value to be applied to the premium if you miss a payment.  This is done so that you do not automatically have your policy cancelled if you miss one monthly payment.

In the event you decide to cancel your policy, you will receive the cash value, minus any surrender fees.

Transferred Risk

Insurance is usually a gamble of sorts.  You pay a company money and they take a calculated risk that the laws of average will work in their favor so they wont pay out more money than they bring in.  Whole life insurance is a bit different because death is guaranteed, it will happen at some point.  Because this insurance policy will stick with us until we die, there is a 100% chance that the insurance company will have to pay.

When we look at term life we are able to get some really high death benefits in the millions of dollars if we wanted.  With whole life the same death benefit is astronomically more expensive.  The calculated risk with term insurance is that we are young so we most likely wont die.  The risk is different with whole life though; its not ‘will this person die’ but ‘will this person die before the amount of premiums they have paid is equal to their death benefit.’

Types of Whole Life Insurance

Whole life can be broken down based on how the premiums are paid.

Level Payment

This is what most people think of.  You pay a set amount that does not change over time.

Single Premium

Instead of paying every month, you make one giant payment upfront.  This instantly generates cash value the death benefit is always larger than the single premium payment you made.

Limited Payment

With this type of whole life, you only pay for a set period of time.  Premiums are higher than with a level premium, but you will only need to make them for a certain number of years.

Modified

This is the opposite of a limited pay.  With a modified policy, you make small payments upfront and larger payments towards the back end.  Its ends up being more expensive this way, but it does offer the ability to purchase a policy with a greater death benefit when we are young and may not be able to afford it otherwise.

Participating vs Non-Participating

This refer to how to company that sells you the policy is structured.  With a participating policy, any excess premium payments that the company collected are redistributed to the policy holders as dividends.  With a non-participating policy, that excess money is instead used as a payout for the insurance company as profit.

Uses of Whole Life

I would not recommend getting a whole life policy for more than $15-20,000.  This is enough for a burial, and if you purchase it young enough, it won’t cost too much monthly.  

Because of how the premiums collected from whole life are used, the death benefit and cash value will never be super high on these policies.  You can definitely get a $30,000 or $40,000 whole life policy, but most companies stop selling around this dollar amount and transition different types of permanent life insurance.

The amount of time and money invested into building a whole life policy just isn’t that great compared to other types.

Thats not to say that it doesn’t have its value, because it definitely does.  Looking for burial insurance?  This is the way to go hands down.  Want to set aside money as a legacy for loved ones?  Nope; look into variable or universal life.  Or better yet, talk with your financial advisor about setting up a trust with a provision for distributions over time.  This will still avoid probate and you’ll have better opportunities to grow the cash value.

Cost

Like all insurance, this varies.  The younger you are, the healthier you are, and your sex all play a role in how much you’ll be paying.  Most companies have a set dollar amount that you pay per $1,000 of insurance.  

Assuming you are a healthy male, 30 years old, who doesn’t smoke, you will pay around $30-40/month for a $500,000 20 year term life policy.  Now that policy will expire, and you will need to get something after that, but thats still a big death benefit for not a lot of money spent each month.

Same person, but this time looking at $500,000 in whole life.  $280-300 a month, until they die.  Assuming you live to 75, you will have paid a little over $150,000 in premiums.  That’s not terrible considering the death benefit is $500,000.  But, put that same money into a basic savings account with only a 4.75% return rate, and in the same time period your balance is $518,000.  A normal interest rate of 5.25% on a high interest savings account leaves you at just under $600,000.

So are the cost worth it?  Maybe.  You shouldn’t look at the cost as a just the monthly premiums.  When we start to talk about high dollar amounts, its becomes an investment, and life insurance unfortunately isn’t the best investment tool.

Takeaway

Whole life can be great.  You’re getting lifetime coverage, a guaranteed death benefit, predictable premium payments, and access to tax-free loans.  You’ll pay more than term and the cash value will grow slower than other policy types, but for some, this is ok.

If you’re looking for a policy to cover your final expenses, this is the way to go.  If you want to leave a legacy, not so much.

No matter your decision, it is important to have the conversation sooner rather than later on how what you want your final arrangements to be.  This will help determine how much you need to have set aside, either as savings or as a whole life policy.

When you are ready to make a decision, of if you want to ask more questions, give us a call.

Aaron

1 thought on “What is whole life insurance?”

  1. Pingback: What is universal life insurance? - Cook Insurance Brokerage

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