What Are the Different Types of Whole Life Insurance?

Grandmother and granddaughter cuddling on couch
•••

MoMo Productions / Getty Images

Whole life insurance is a type of permanent coverage that’s offered in a range of “styles” to suit different needs. Since permanent coverage, including whole life, is more expensive than temporary or “term” coverage, many of the different types of whole life insurance have evolved to help owners manage the cost of premiums. But other types are built to maximize the death benefit or the cash value “savings” element.

For many people, purchasing term life insurance instead of whole life insurance is the best way to get the amount of coverage they need. But if you want a permanent policy and to build a cash value, whole life insurance could be right for you. 

Before you purchase permanent life insurance, consider the range of available options to determine which best suits your needs.

What Is Whole Life Insurance?

Whole life insurance provides both death benefit protection and a form of tax-advantaged cash buildup (a “cash value” account) that can be accessed by the policy owner. It and universal life insurance are the two most commonly sold types of life insurance policies on the market.

A “standard” whole life policy requires premium payments for the life of the policy for a dollar amount of coverage—the death benefit—that’s determined when the policy is issued. Since this structure can be unnecessarily restrictive, other types have been developed that allow more flexibility. Each type has its own benefits and drawbacks.

Participating Whole Life Insurance 

  • Dividends, fixed payments, fixed death benefit.

This type of whole life insurance pays dividends into the cash value of the policy when the issuing life insurance company makes a profit. These dividends come from the company’s excess investment earnings and are usually not guaranteed. But they can increase the overall return you receive from the policy.

Participating policies are most commonly issued by “mutual” life insurance companies, which are owned by the policyholders instead of being publicly traded. The dividends that are paid to policyholders are not classified as taxable income (unlike dividends that are paid from stocks). Instead, this form of income is generally considered to be partial repayment of the premiums that were paid and therefore a tax-free return of principal.

Life insurance dividends may be paid directly to the policyholders in cash, or they may be used to reduce premium payments. They can also be used to purchase additional paid-up cash value insurance or added to the cash value and earn interest.

Non-Participating Whole Life Insurance

  • Lower premium payments that are fixed, fixed death benefit.

Non-participating whole life policies do not pay dividends. The cash value in this type of policy still accrues interest, but the life insurance company doesn’t pass along any of its current profits to holders of these policies. Non-participating policies are known for their fixed costs and more economical premium payments. 

Non-participating policies are most often (but not always) issued by publicly traded life insurance companies. Policyholders who want to participate in the profits made by these companies will have to buy stock in the company instead of a life insurance policy.

Indeterminate Premium Whole Life Insurance

  • Premiums that adjust according to company performance.

This type of whole life insurance resembles non-participating whole life insurance in that no dividends are paid, but the premiums can be adjusted by the insurance company. The amount of premium you owe is based on the current financial health of the company. So when the insurer is doing well, premiums may go down. Conversely, they may increase during lean periods. However, they can never exceed the maximum amount specified in the policy documents, regardless of the company’s current financial condition. 

Indeterminate premium whole life may be a good fit if you’re confident in the company’s financials and expect it to do well in the future. You could pay less in policy premiums over the long run, but if expectations aren’t met, you could pay more relative to a whole life policy with a level premium structure. 

Economatic Whole Life Insurance

  • Incorporates term coverage for a larger death benefit at a lower cost.

This is a more complex type of whole life policy. It combines a portion of participating whole life insurance along with a portion of decreasing term insurance.

Term life insurance is temporary coverage and more affordable than permanent insurance; decreasing term insurance is a type of coverage in which the death benefit decreases throughout the life of the policy.

Since the whole life portion is “participating,” it confers dividends, which are used to purchase additional paid-up coverage (coverage for which no additional premiums are due). In other words, the dividends are used to purchase increments of permanent coverage to replace the term coverage as it decreases and eventually expires.

The risk is, if the value of the dividends doesn’t turn out to be enough to replace the term coverage, the value of the net death benefit will decline as the term coverage decreases. The tradeoff for that risk is that this type of policy can give the insured a larger amount of coverage from the outset at a price that’s lower than that of a whole life policy that does not incorporate a term insurance element. 

Limited Payment Whole Life Insurance

  • High premums for a set number of years, and then continued coverage with no premiums.

This type of whole life insurance requires a limited number of premium payments until an end date specified in the policy—for example, until age 65. The policy remains in force for the rest of your, or the insured’s life, but does not require any additional payments. This type of policy is popular with policyholders who don’t want to be burdened with premium payments that would otherwise still be required after they retire. 

Single-Premium Whole Life Insurance

  • One large up-front premium pays for a tax-free death benefit.

This form of whole life coverage, commonly known as a modified endowment contract (MEC), differs from all other types of whole life insurance in that it is funded with a single premium payment, meaning that you purchase a specific amount of paid-up coverage for life, with no additional premium payments required. 

Financial advisors and life insurance agents may use these policies to leverage and transfer the wealth clients wish to leave to their heirs.

If you have money that you intend to leave your family and don’t need to access it yourself, it can make sense to purchase a life insurance policy with that money for those heirs to inherit instead. The death benefit is tax-free and may be larger than what a conservative investment would amount to at the time of your death.

For example, if you have a $100,000 certificate of deposit (CD) that is earmarked for your grandchildren, you could withdraw the funds from that CD and instead purchase an insurance policy with, say, a $200,000 tax-free death benefit. Because you’d purchase the policy with such a substantial payment, it would be considered a MEC. 

MECs have special tax rules and steep withdrawal penalties if you take money out of the policy in the early years. But MECs usually pay higher interest rates than CDs or other guaranteed investment vehicles.

Modified endowment contracts are subject to different rules than standard-issue life insurance contracts. Policy withdrawals are taxed as income, and those made before the owner is 59 ½ are subject to an additional 10% tax.

Modified Whole Life Insurance

  • Lower premiums in the early years of the policy, level death benefit.

This form of whole life coverage offers lower premiums during the early years of the policy that increase after a certain number of years. If you anticipate making more money in the future (and therefore being able to afford a larger premium), this type of policy can enable you to purchase a higher initial coverage amount than you could otherwise afford. 

The period of lower payments may last anywhere from five to 20 years, and then the premiums are increased. While payments during the initial phase are usually lower than those of a traditional level premium whole life policy, the premiums after the increase are usually higher. Premiums increase only once during the life of the policy. The death benefit is level, which means it stays the same during the whole time you’re covered.

Variable Whole Life Insurance

  • The cash value can be invested in mutual funds, death benefit is not always guaranteed.

This form of whole life insurance invests the cash value in a selection of mutual fund “sub-accounts” that gain or lose value based on the performance of those investments. Variable life insurance policies do not pay a guaranteed interest rate but instead allow the policyholder to participate in the long-term gains of the stock, bond, and real estate markets. It is possible to lose money in these policies when the market, or the particular investments you choose, perform poorly.

Variable whole life policies can lapse if the value of the subaccounts drops far enough. You may be forced at that point to either inject a large cash payment into the policy to keep it active, or let it lapse, which voids the entire policy, including the death benefit.

Children’s Whole Life Insurance

  • Savings and coverage for babies and children.

This form of whole life insurance is offered as a means of providing a savings vehicle and insurance coverage for babies and children. The parents (or other payor) of the policy can lock in low premiums that are guaranteed to never increase and also secure life insurance for the child regardless of any future health issues. Coverage is often capped at a fairly low amount, such as $50,000, but it may be possible to increase it in the future. 

Guaranteed Issue/Acceptance Whole Life Insurance

  • No medical exam required, low coverage limits.

This form of whole life coverage is commonly known as burial or final expense insurance. It is usually issued to policyholders who are at least 50 years old, and it has limited or no underwriting requirements, which makes it more expensive. Since no medical exam is required and few, if any, health-related questions are asked, it may appeal if you have health problems that make getting coverage through a traditional underwriting process difficult or impossible. 

Final expense coverage is designed to provide a small death benefit that can be used to pay for funeral and burial expenses along with other debts or bills you owe. The death benefit usually ranges from $10,000 to $50,000.

Most guaranteed issue whole life policies have a clause that limits the benefits that can be paid during the first two years of the life of the policy.

Interest-Sensitive Whole Life Insurance

  • The potential to profit from current interest rates.

This type of whole life coverage credits a variable rate of interest to the cash value that fluctuates with prevailing interest rates. There are three main types of interest-sensitive whole life policies. 

  • Universal life policies: These policies pay a variable rate of interest and also have flexible premiums and death benefits. If you want to be able to skip a payment without having your policy lapse, universal life may be a good choice. 
  • Excess interest whole life: The premiums and death benefit are set, and any excess interest is paid into the cash value of the policy. This type of coverage can make sense if you need a fixed premium and death benefit and want the cash value to grow reflective of current interest rates.
  • Current assumption whole life: The rate of interest is set by the insurer, and the policy premiums can be adjusted by the insurer depending upon its financial circumstances. If premiums are raised, some policies may let you decrease the death benefit to keep paying the original premium.

Although technically, universal life is a type of interest-sensitive whole life policy, it’s not considered a "whole life policy" in everyday use. That’s because it features flexible premiums and a flexible death benefit, which differ from whole life’s traditional fixed premium/death benefit structure.

The Bottom Line

Each type of whole life insurance has its place and value, though not all types work for all situations. For example, young parents may be attracted to the benefits of children’s whole life insurance, while older policyholders may need the protection afforded by guaranteed issue policies. And consumers with higher risk tolerances may be attracted to a variable life policy, while more conservative investors will prefer traditional whole or universal life coverage, because, unlike a variable life policy, the cash value can’t lose value based on investment performance.

Before you choose a specific policy, know why you’re purchasing one, how much you can afford, how much coverage you need, and how much flexibility you’d like the policy to have. This information will help you explore the range of offerings to determine which is best for you.