Deciding which type of life insurance to get is not a decision you have to make alone. While only a licensed agent can work with you one-on-one to tell you which type of whole life policy would best fit your needs, this article can equip you with the basic facts you need to know about how whole life works, the different types of policies available, and what buying a policy can do for you.
What Is Whole Life Insurance?
Whole life is a type of permanent life insurance that provides coverage for your entire life. It’s the most popular of all permanent life policies sold. One of the keywords to remember about whole life policies is the word “level.” Level most often applies to the premium rate, which is designed to remain level or fixed during the payment period.
Some whole life plans also have a level face amount for the life of the policy, while others let you buy more insurance to increase the face amount. The face amount is the amount of insurance protection you decide to buy, which is equal to the death benefit amount. A death benefit is guaranteed with these policies.
Like all permanent life insurance, whole life includes a savings account that builds equity (or cash value) on a tax-deferred basis. This means that your cash value is not taxed as it grows; it’s only taxable when you make a cash withdrawal.
How Whole Life Insurance Works
There are several important facts you should be aware of before enrolling in a whole life policy.
- Premium payment period: You typically pay premiums for the life of the policy or until a maturity age. Some policies let you pay premiums for a shorter time or up to a younger age. Premiums can be paid annually, quarterly, or monthly.
- Premium rate: Policies typically have a fixed premium rate. There are many factors, such as your age, that determine initial whole life rates.
- Cash value build-up: Because you usually put more money toward premiums in the early years of the policy, the excess you pay in premiums stays in the insurance company’s accounts to accumulate interest. This feature allows your policy to build cash value as the interest grows. It can take about 8 to 10 years for the policy to build up cash value that’s greater than the amount you’ve paid in premiums. After that, the cash value continues to grow until it reaches the face amount of the policy.
Understanding Whole Life Cash Value
Depending on what type of whole life coverage you have, you may have more than one option for how your policy builds cash value. Understanding how the cash value feature works can help you know how to access funds from your policy and how doing so will affect your coverage. Let’s go over the different ways whole life policies accumulate cash value and what you can do with it.
Types of Whole Life Cash Value
There are two ways whole life insurance policies build cash value:
- Through the standard guaranteed cash value method that’s available with all policy types, or
- Through the dividend cash value method that’s available with certain types of policies.
Guaranteed Cash Value: A whole life policy’s guaranteed cash value is used as a reserve account to offset the cost of the death benefit to the insurance company. For an example, if you have a $100,000 policy with a guaranteed cash value of $40,000, the risk to the insurance company is $60,000. Because whole life policies have a lifetime guaranteed level premium, your risk to the insurance company must decrease to keep your premium level. The cash value in your policy grows income tax free. You may only have to pay taxes when you make a cash withdrawal in certain instances.
Dividend Cash Value: Dividends you receive, which are excess earnings on investments that the insurance company pays you, can be left in your policy to build cash value. Dividend cash value also grows on a tax-deferred basis. It’s usually recommended that you use whole life insurance dividends to buy paid-up additions, which are insurance riders that will increase the policy’s cash value and death benefit at the same time.
What Can I Do With the Cash Value?
You can leave the cash value in your policy to pass on to your heirs or a charity. If you want to use the cash value while you’re alive, you can borrow against it or get cash from it.
Taking out a loan: An advantage of cash value life insurance is that you don’t need to qualify to get a loan. You can borrow up to the amount of cash value you have in the policy. The money you borrow is from the insurance company, not your actual cash value. Your cash value is used as collateral for the loan. On the bright side, the money you borrow is usually tax free, and you don’t have to pay it back. If you choose not to pay back the loan, the loan amount plus interest will be deducted from the policy’s face amount upon your death. This lesser amount is what your beneficiaries will receive.
Keep in mind that the loan will become larger as the interest grows each year, which will reduce the death benefit and the cash value even more if left unpaid for several years. This means your beneficiaries could be at risk of not getting enough or any money from the policy when you die. And it could also cause your whole life policy to lapse if enough money isn’t put toward premium payments. It’s a good idea to at least pay the interest so that your heirs can get enough death benefit to cover expenses. If you make payments on the loan, this will in turn increase the policy’s cash value and death benefit.
Withdrawing the cash: Withdrawing money from your dividends is the only way to get cash without your coverage ending. If your policy pays dividends, your insurance company can send you a check for the dividend amount. Taking cash from dividends will decrease the policy’s cash value and death benefit amount.
What if I Want to Cancel My Policy and Get the Cash?
Besides getting cash through dividend payments, cancelling your policy is the only other way to withdraw cash. The insurance term for this is “surrender”. When you surrender your policy, you are taking the cash that has built-up from the policy’s cash value. If you surrender too soon within the policy’s life, you may have to pay surrender fees, which will decrease the cash value. Because you’re getting cash from the policy, you may have to pay income tax plus extra taxes if you have an active loan on the policy.
When you cancel your policy, there is no longer any death benefit for your beneficiaries to receive upon your death. If you decide to enroll in a similar policy at a later time, it may be harder to enroll and could cost you more because you’re older.
Types of Whole Life Insurance
There are several types of whole life insurance policies available. The most common of all is level premium whole life, often called ordinary life, traditional whole life, or straight life. There are pros and cons for each type, just like when comparing whole life vs term life. Whole life policies fall under two main types: participating or nonparticipating.
- Participating: This means that the policy pays you dividends. Dividend payments are based on factors, such as excess earnings from investments that the insurance company receives. Dividend payouts are not guaranteed. Having this feature usually makes the premium higher.
- What can you do with dividends? You can get the dividends as cash, leave them in your insurance account to grow interest, use them to pay down your premium, or use them to buy more paid-up life insurance coverage.
- Nonparticipating: These policies do not pay dividends. However, not having this feature typically makes the premium lower.
Types of Participating and Non-Participating Policies
Some types of whole life plans are only participating or nonparticipating, while others can be both. Not all insurance companies sell every type of plan. The table below provides details on the most common types.
Ordinary Level Premium Whole Life
Indeterminate Premium Whole Life
Limited Payment Whole Life
Single Premium Whole Life
Graded Benefit Whole Life
If you’re in poor health, but not sick enough that you can’t get life insurance, a graded benefit policy may be the only type of whole life insurance you can qualify for. Graded benefit plans are also called senior life plans, and they are generally available to seniors age 50 to 75. These plans are available without a medical exam and provide either a return of premium or a graded death benefit.
“Graded” means that the death benefit is not level at the time you get the policy. The insurance company pays only a percentage of the death benefit if you die in the first two or three years. Typically, the death benefit becomes level by year five of the policy’s life. Although the death benefit isn’t level in the beginning, the premium rate you get is level. But you will likely pay more in premiums than you would for a standard policy because you pose a higher risk to the insurance company.
Final Expense Whole Life
Another type of permanent life coverage that’s often sold as a whole life insurance policy is final expense. This is also known as burial insurance and is a special type of policy. The purpose of this insurance is to help cover funeral costs. It can also help pay for debts you may leave behind. Some of the attractive features of final expense insurance is that you don’t need to take a medical exam to get insured and coverage is pretty cheap. For instance, it could cost just $3 per week to get $6,000 worth of coverage for a 36-year-old male. The cost is much less than other types of whole life policies because the amount of death benefit you can buy is lower. Death benefits usually range from $5,000 to $25,000, but could be a little more depending on the insurance company. Like all whole life coverage, final expense policies may also build cash value.
Why Buy Whole Life?
Besides the fact that you get insurance for your entire life as long as the policy is active, there are several reasons why buying whole life insurance can be a good fit for you. With whole life coverage you get:
- Different options to fit your needs: While all plans provide the benefit of building cash value, some may be better for estate planning or funding financial needs like long-term care.
- Guaranteed cash value: The policy is designed to earn at least the minimum interest rate that the insurance company sets. Because the cash value that’s kept in the insurance company’s accounts is backed by their assets, your policy is guaranteed to make money.
- Less risk: Unlike some of the other types of permanent life policies where the growth of the cash value depends on how well investments perform in the market, whole life cash value is based on calculations set by the insurance company. While it’s possible that you could get more cash value faster with other types of permanent coverage that allow you to invest a portion of your cash value in things like stocks, there is more risk involved.
- Tax-free dividends: As long as the dividends you get are not more than what you’ve paid in premiums, dividends are not taxable in most cases.
Who Should Buy Whole Life?
Anyone looking for lifelong insurance protection can get a whole life insurance policy. Permanent life insurance in general usually costs more than term insurance because of the cash value feature that’s included. So those who can afford to pay higher premiums should get this type of coverage.
Whole life may also be suitable for:
People who want to supplement their retirement savings: Cash value provides the opportunity to have income you could use during your retirement years. When using life insurance for retirement planning, you should decide how soon you will need to have access to the money in the policy—since it could take several years to build up cash value. If you would need cash value by the time you retire at 65, for example, then you should enroll in a plan by age 55. Of course, the earlier in life you enroll, the more opportunity there is to have a larger amount of cash value when you retire.
Owners of large estates: If you have an estate that’s worth more than $5.45 million as an individual, the IRS requires that you pay federal estate taxes. Your survivors can use money from the policy to pay these taxes. According to an article from LifeHealthPro, your death benefit may not be subject to estate taxes if the policy is owned by a third party, such as an irrevocable trust or adult child.
How Do I Know Which Type of Plan to Buy?
Deciding which type of whole life policy you should buy depends on your needs. Some things you should consider include:
- Your financial goals: For instance, are you more interested in transferring wealth to your loved ones or building a large cash value you can use in your later years?
- How much death benefit you need: Are you looking for a policy that can provide your survivors with a lot of money for many years to come, one that can pay off major debts or large estate taxes, or a policy just to cover your burial expenses and other small debts you may leave behind? Understanding how to use a whole life insurance calculator can help you figure out how much coverage you need.
- Your health: Would your health only qualify you for a graded benefit policy, or do you think your health is good enough to get a standard policy?
- How long you want to make premium payments: Are you comfortable with a policy that requires lifetime payments that may cost less overall, or would you rather pay more if it means not paying premiums for the rest of your life?
Buying life insurance is a big decision, and you don’t have to worry about figuring things out on your own. A HealthMarkets agent can guide you in choosing a whole life insurance plan that can help provide financial security for you and your loved ones. We have thousands of agents across the U.S. to make it easier to provide you with a personalized customer experience.
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