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Whole Life Insurance: What To Know

by | Jul 1, 2020

A recent study revealed that while most people believe life insurance will protect their ability to live a long, financially secure life, about half of them have insurance.  When you begin to hunt for life insurance, you may discover a variety of complicated terms that might lead you to throw your hands up in the air and walk away altogether.

Term life, universal life, and whole life insurance are three different terms thrown around. How is a person supposed to know which is the best option for their loved ones? Which one pays out more, and which one can you afford?   Whole life insurance is a type of life insurance that allows you to invest your money and provide financial security for your loved ones. Keep reading to learn what you need to know about whole life insurance and why it may or may not be your best life insurance option. 

What Is Whole Life Insurance? 

A whole life insurance policy is a life insurance policy that provides coverage for the life of the insured. If you have a whole insurance policy when you die, the policy’s death benefit goes to whomever you have listed as the beneficiary.   Whole life is a unique policy in that it also has a savings component. So when you pay your premium, a portion of it goes into a savings account that will accumulate interest over time. You have an investment and an insurance policy in one. Whole life insurance is also known as traditional or permanent life insurance because it lasts the duration of your life. 

How Does Whole Life Insurance Work? 

Many whole life insurance policies have cash benefits and death benefits that give you the option of making your money work for you while you’re alive. 

Whole life insurance policies last for the lifetime of the policyholder. This means that if you purchase your policy when you’re 25, you will have it until you die, even if that is 70 years later. Your beneficiary will receive the death benefit as long as you continuously pay your premium.  When you pay into your whole life policy, your premium goes to both the death benefit and the savings component. The savings component or cash benefit is a unique part of a whole life policy. It is a tax-deferred savings account that accrues interest. 

Cash Benefit

You can access the cash when you are alive by either withdrawing it or borrowing against it. The cash and death benefits last the duration of your life, and your premiums stay level. The insurance company cannot charge you a higher premium as you age even though death is more imminent the older you grow. 

So, with a whole life policy, you can potentially draw from life insurance because you’ve saved. Your returns growth can vary from year to year. Your cash value will grow even if your other investments lose value.   The cash value will earn interest as you leave it alone. It grows tax-free over time, and your policy will determine the steady interest rate.

With that said, a whole life growth rate is slower compared to other investments, but it is stated and reliable. It is slower because the insurance company has costs like administrative fees, underwriting costs, and death payouts.  Because the money is yours and is basically in a savings account, you can take out a low-interest loan against your policy. When you do this, the cash value loan will accrue interest, so you’ll have to pay back more than you took out. If you do not pay it all back before you die, the insurance company will deduct the amount of money you owe from the death benefits. 

You can also withdraw money tax-free from the cash value of the policy. This is not a loan, so you are not putting the money back in or paying it back. If you completely surrender the policy or your policy lapses, you must report the money you withdrew as income and pay taxes on it. 

You might be tempted to withdraw money because your cash value isn’t growing fast enough. Keep in mind, you need to hold the policy for a couple of decades to see some growth. The cash value will most likely not exceed the total premiums you’ve paid if you try to take it out after ten years.  Also, some companies charge a surrender fee. Check your policy before you dip into your cash reserves. 

Death Benefit

The death benefit for a whole life policy is tax-free. Your loved ones will not have to pay taxes on the benefits they receive.  The death benefit is what your family will receive when you die. The amount of this benefit does not change unless you’ve borrowed against your policy and don’t pay it back before you die. So if you purchased a $1 million policy today and then die next month, your family receives $1 million. 

Term Vs Whole Life Insurance

In the world of insurance, there are two basic types of insurance: term and whole life.  Term life insurance differs from whole life in that you pay for the insurance for a specific amount of time. You can purchase twenty-year term insurance, for example. This means the insurance only pays out during the twenty-year period you have it.  Term insurance costs less than whole life and pays death benefits only. Once the term has expired, you have to renew the coverage, and often the insurance company will raise rates because you’re older.

Whole life insurance has a death payout and cash option. You can earn money as you pay your premium, and you have a combination of investment and insurance. The insurance lasts as long as you pay the premium. 

Why Buy Whole Life Insurance? 

People buy whole life insurance because it is a forced investment, and thus it can help some people save and invest their money. If someone has maxed out all of their other investment options, a whole policy makes sense.  If you’re young and have the cash to regularly pay the premium, a whole life policy can be a good investment. Calculate what you’d earn interest if you lived to the average age of death, which is 79 right now. 

Is Term or Whole Life Insurance Better? 

The type of insurance you get depends on several factors like what your current income level is and how much life insurance you need.  If you have a higher income, then whole-life insurance makes sense. When you have maxed out all of your other tax-deferred investments, you have one more investment place. If you have a dependent that needs long-term care when you die, a whole life policy also makes sense. 

Term life is a better option if you cannot afford a whole life policy. It comes at a cheaper rate making it more affordable for the many years that you pay. Also, if you are not a higher income bracket, you can invest in something with a better rate of return than whole life insurance.

Is Whole Life Insurance Worth It?

Whole life is worth the investment if you can wait on it for the long haul. Your family will have a guaranteed benefit, no matter how old you are. You will not have to change or renew insurance no matter your age.  With term life insurance, you have to renew once the term has expired, and you usually have to pay more.  With whole life, you can watch your money grow, and you have a cash benefit when you retire. Plus, your family is covered when you die. 

There’s no denying that whole life insurance is expensive. Some people overestimate their ability to pay, and they end up with a higher bill than they can afford. Thus they surrender their policy early, often losing money.  A study showed that within the first three years of owning a policy, 30 percent of whole life clients surrender their policy. Approximately 40 percent do so within ten years. 

So whole life insurance policies are generally worth the cost if you can afford the premiums, but you need to budget them in

How Much is Whole Life Insurance? 

Whole life costs will vary, but on average, they will cost more than term life insurance policies. They will pay out eventually, though, if you wait several decades.  So whole life policies are good when you have time to watch them mature. 

Does Whole Life Insurance Have Cash Value? 

Whole life has a cash value along with death benefits. You’re investing your money when you pay your premium. The money goes into a tax-deferred savings account, so the policy includes the death benefit and the cash value.   The cash value is a big selling point for whole life policies. The value builds up over time and is tax-deferred, much like a 401k or other retirement plan. Whole life policies allow you to take advantage of your cash now.   The cash value will be slow at first but builds up quickly as time passes. 

Who Should Buy Whole Life Insurance? 

People who can afford the premiums should buy whole life insurance. If you’re well-established financially with a secure income and high level of income, consider a whole life policy. If you’ve maxed out your other investments, then this is one more place where you can watch your money grow.  Plus, your family will receive a hefty benefit when you die. 

What Are Cons To Whole Life Insurance? 

Whole life receives a bad rap because of its cost. It costs much more than a term life insurance policy. If you have to surrender the policy, the cash value is low when you surrender too early.  A small amount of your premium goes into the cash account while the rest the insurance company uses for upfront costs.  When you draw from the savings account or give yourself a loan, the insurance company may charge you an administrative fee or penalty. This penalty will eat into your earnings. 

Does Whole Life Insurance Expire? 

Whole life insurance does not expire. It lasts as long as you’re alive and as long as you pay your premium. Once you stop paying the premium, you void your contract, and the life insurance does not have to payout. 

Is Whole Life Insurance Taxable? 

Technically, no, it isn’t. You do not have to pay taxes on growth. Whole life insurance is comparable to other retirement plans in that the accumulation is tax-deferred.   If you take money out of the cash value, you have to pay taxes on the difference between the cash value you receive and the total you paid in premiums when the policy was in force. 

The policyholder can take out a loan against the cash value, and the proceeds from this kind of loan are not taxable even if the loan exceeds the total premiums paid into the policy. You do reduce the cash value of the policy when you take money out.   If you die before you pay back your loan, the insurance company will take out what you owe from the death benefit. 

Insurance and Savings

A whole life insurance plan is a savings plan, investment plan, and insurance plan.  For more information about insurance, check out our insurance section. 

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