Whole Life Insurance: Everything You Need to Know Before You Buy

Considering what life insurance is meant to cover, you want to be sure you choose the right type. Here’s what you need to know about whole life insurance.
Last updated Sep 13, 2020 | By Matt Miczulski
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If you’re looking for the best life insurance to suit your needs, you may be wondering which of the two major types of life insurance is the better option: term vs whole life insurance. As the names suggest, term and whole life provide life insurance coverage for different lengths of time. Each has its benefits and drawbacks, so understanding what each policy covers will help make sure you’re choosing the right coverage for your needs.

In this article, I’m going to walk you through all you need to know about whole life insurance. Before I get into the advantages and disadvantages of whole life insurance, let’s take a look at how this life insurance works.

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What is whole life insurance?

Whole life insurance, also known as permanent life insurance, is one of two major types of life insurance — the other being term life. Whole life insurance is further broken down into the following subcategories:

  • Traditional whole life
  • Universal life
  • Variable life
  • Variable universal life

Although all forms of permanent life insurance exist for the policyholder’s entire life, guarantee a death benefit, and build cash value, there are some differences in the premiums you pay and how your money grows.

Traditional whole life

Traditional whole life is the most common type of permanent insurance policy, according to the Insurance Information Institute (III). As a policyholder, you pay a fixed premium and in return, the insurance company pays out a death benefit when you pass away. You also receive dividend payments from the insurer that grow tax-deferred in a savings account, and you can access this money through withdrawals or by borrowing against it.

Universal life

A universal life insurance policy offers more flexibility than a traditional whole life policy. In general, the death benefit and cash value can fluctuate at the policyholder’s discretion. For instance, you may be able to increase the death benefit after passing a medical exam. The cash value portion of a universal life policy earns a variable interest rate determined by the insurer and also grows tax-deferred. After the cash value has grown enough, you have the option of using it to pay your premiums.

Variable life

With a variable life insurance policy, you receive a death benefit with a cash value account that you can invest in stocks, bonds, and money market mutual funds. Although this allows for more flexibility in how your cash value grows, it also presents increased risk if your investments don’t perform well. In other words, your death benefit and cash value amounts can hinge on your investment choices. Some policies, however, guarantee your death benefit won’t fall below a certain level, according to the III.

Variable universal life

A variable universal life policy includes features of both universal and variable life policies. You can adjust your death benefit, use your cash value to pay your premiums, and you can invest the cash value portion in stocks, bonds, and money market mutual funds.

As you can see, each type of permanent life insurance has its benefits and drawbacks. Traditional whole life policies are the most common, according to the III, and offer no risk compared to the other types. However, you may be able to find better investment options elsewhere. Variable permanent policies, on the other hand, offer more investment options for your cash value, but this comes with added risk if your investments do not perform well.

If you’re considering a permanent life insurance policy, familiarize yourself with the different types so that you can choose the best coverage for your needs.

How does whole life insurance work?

A whole life insurance policy provides a fixed amount of coverage over the duration of the policy. Upon the insured’s death, and only upon their death, the policy pays an income-tax-free sum of money (death benefit) to their life insurance beneficiary.

The cash value component of a whole life insurance policy is separate from the death benefit and grows each year on a schedule guaranteed by the insurance company. A portion of your premium goes toward your cash value. Generally, you can defer taxes on these gains until you withdraw the money or surrender the policy.

You can borrow against your cash value, and the loan isn’t treated as taxable income. However, your insurance company might charge its own interest on the loan. If you choose not to repay the loan, the death benefit and cash value of the policy will be reduced.

Cash withdrawals up to your policy basis are not taxable either. Your basis is the amount you’ve paid so far into the cash value portion of your policy. Any withdrawals in excess of the amount you’ve paid into your policy will be taxed as ordinary income. You can also access the cash value by forfeiting the policy. The cash value portion of your policy is available only during your lifetime and is surrendered upon your death. However, some companies provide an option for beneficiaries to receive the cash value in addition to the death benefit, but it often comes with higher premium payments.

“The cash-value that exists at the time of your death will not go to your beneficiary unless a rider was purchased that pays the cash value,” says Heidi Mertlich, a licensed independent insurance agent and owner of nophysicaltermlife.com. “Typically, only the death benefit is paid to the beneficiary.”

Although a whole life insurance policy will cover you for the duration of your life (as long as you continue making premium payments), you should familiarize yourself with any exclusions on the policy. For instance, the first two years of any life insurance policy is typically the contestability period. Within the first two years, the insurer can contest any claims made and can even decline to pay out the death benefit.

Policy exclusions can vary from company to company, so be sure to understand any exclusions that might be included in your policy.

The pros and cons of whole life insurance

There’s no better way to determine whether whole life insurance is the best option for you than considering its benefits and drawbacks.

“There are a number of pros to buying whole life,” Mertlich says. “For example, your life insurance beneficiary will receive a death benefit regardless of when you pass away. Additionally, whole life insurance builds cash value. The cash value can be accessed for policy loans or withdrawals.”

However, there are some downsides to taking out a whole life insurance policy too. A lot of it has to do with cost.

“Whole life is usually the most expensive type of policy when compared to … term policies,” says Adam Hyers, insurance broker and founder of independent insurance agency, Hyers and Associates Inc. “Premiums might be needed for several years — or even a lifetime. Less expensive policies can be found that may accomplish similar goals.”

Here are some of the advantages of opting for a whole life insurance policy, as well as some of the reasons a whole life policy may not make sense for you.

Pros of whole life insurance

  • Coverage for the duration of your life
  • Guaranteed death benefit payout
  • Guaranteed cash value accumulation
  • Predictable premiums
  • Cash value is an asset
  • May pay dividends
  • Tax advantages

Cons of whole life insurance

  • Typically more expensive than term coverage
  • More complex than term life
  • May find better investments elsewhere

This is a quick list of some of the pros and cons of permanent life insurance. Although there may be more pros than cons, you need to determine whether the advantages outweigh the cost and complexity of whole life. If you’re not sure if whole life is right for you, there’s an alternative.

Alternatives to whole life insurance coverage

Permanent life insurance is broken down into several categories: traditional whole life, universal life, variable life, and variable universal life. Although they differ in the flexibility of their premiums and how the cash value grows, all are meant to cover you for the duration of your life. If permanent coverage just doesn’t sound like the insurance coverage you need, term life insurance might be the better option.

Term life insurance is a type of life insurance that lasts for the duration of the chosen term, usually one to 30 years. Term insurance is the simplest form of life insurance and is a much more affordable option than whole life. Although there is no investment component, a death benefit is guaranteed should you die within that term and as long as you pay your premiums as scheduled.

A term life insurance policy may be the better option if you need life insurance coverage only during certain periods of your life. For instance, you may want life insurance coverage while you have children who depend on your income and during the years up until retirement. If you don’t need life insurance for the duration of your life, term life might be a better alternative.

FAQs about whole life insurance

Is whole life insurance worth it?

One of the benefits of a whole life insurance policy is that it’s an investment in your future and in the well-being of your family. In addition to a death benefit that is paid out to your beneficiaries in the event of your death, your policy has a cash value feature that’s tax-deferred and grows over time.

However, if you don’t have family members who depend on the income you earn, you can likely find a better investment vehicle elsewhere.

How much is a whole life policy?

The cost of a whole life insurance policy depends on the coverage amount you choose, as well as factors such as your age, height and weight, past and current health conditions, health history of your parents and siblings, and nicotine use, among others.

Which is better: whole or term life insurance?

Both term life and whole life insurance policies have their pros and cons and the better option depends on your personal situation. If you want the cheapest form of life insurance and only need life insurance coverage for a certain period of your life, term life coverage may be the better option. Term life is also the simplest form of life insurance according to the III.

Whole life insurance might be a better option if you want lifetime coverage, as well as the ability to build equity through the policy’s cash value component.

When does whole life insurance make sense?

Whole life insurance might make sense if you want a life insurance policy that lasts the duration of your life and has a cash value component that accrues value over time. You may wish to cover the cost of funeral expenses or leave an inheritance no matter when you die.

The final word on whole life insurance

Whole life insurance is both an investment in your future and a way to protect the well-being of your loved ones. It lasts the duration of your life as long as you continue paying your premiums and pays a guaranteed death benefit upon your death. Along the way, the cash value component of the policy accrues value. How much it increases in value depends on the type of permanent life insurance policy you purchase, as variable life and universal variable life allow you to invest your cash value in stocks, bonds, and money market mutual funds. However, keep in mind that this can be riskier if your investments don’t perform well.

If a lifelong insurance policy seems overkill to you, term life insurance may be the better option. You can choose the term for as long as you want to be covered at a more affordable price. To get the most details on any policies you’re considering or for answers to any specific life insurance questions, speak with a life insurance company. In any case, review the terms and conditions of the policy before you purchase so you know the exact details of the policy.

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