What Is Whole Life Insurance?
And how do you know if its benefits and coverage are right for you?
If you’re like more than half of Americans in these unprecedented times, you’re probably thinking about purchasing life insurance. At the start of 2020, of the Americans who didn’t own life insurance, 36% intended to buy it. In May, that number jumped to 53%.
Whole life has advantages, but it isn’t for everyone—more than one-fourth of people with whole-life policies allow that insurance to lapse in the first five years. Here’s more on what whole life insurance is, to help you decide if whole life insurance is a good option for you, and how it works.
When buying insurance, ensure that your policy doesn’t have a limited payout in the first two years, which might reduce what you intend to leave to your family.
What Is Whole Life Insurance?
Whole life insurance is a type of insurance designed to provide coverage throughout your life, with a benefit paid at your death to your family (or the beneficiary of your choosing), as long as you maintain the terms of your contract. This is unlike like term life, which only pays a death benefit if you die within a limited time period, say five or 10 years.
Payments you make toward your whole life policy should remain consistent throughout your life, which may make budgeting easier. You pay for your death benefit while also building a cash reserve or “savings account” of sorts. Whole life premiums can be far more expensive than a term policy–6 to 10 times more.
You may also hear whole life insurance referred to as “cash value life insurance.”
Whole Life Pros and Cons
Dependable premium payments
Guaranteed benefit at death
Dividends may be available with some insurance companies and plans
Guaranteed cash value may not be as competitive as investing
Restrictions on accessing cash value
More expensive than term insurance
Complex plan options, which can be confusing
How Does Whole Life Insurance Work?
You’ll apply for insurance, which may require a medical exam, your medical history and your parents’ medical history, financial information, and other details. You’ll also indicate the policy features and payment terms you’re interested in. In all, the application and approval process may take about four to six weeks.
The insurance company then sets the premium (price you’ll pay), which should be predictable over the course of the contract. It’s based on your age, health, and amount of insurance at the time of purchase—it won’t change as you age or if your health declines. Part of your monthly premium covers the policy’s death benefit, or the amount that’s guaranteed to be paid at your death. The other part goes into the savings portion known as the cash value of the policy.
People buy whole life insurance for various reasons, but the most common are to supplement retirement income, replace lost income for beneficiaries after death, and to help pay for funeral costs.
Some life insurance policies require “full medical underwriting,” which means you need to take a medical exam, including having lab work done, and waiting—perhaps for a month or more—for the results.
Alternatively, depending on your age and health, you may be able to get a whole life policy by filling in a medical questionnaire. If you pass the questions, some life insurance companies will issue the policy without the need for a medical exam. This is called simplified issue or simplified underwriting.
Simplified issue makes it convenient and quick to apply for insurance. But if you’re healthy, you can get a much better rate by taking the medical exam and getting full medical underwriting.
Cash Value and Whole Life Insurance
Whole life insurance is unique in that part of your premium goes into a tax-deferred savings portion known as the policy’s “cash value.” This amount is usually guaranteed to grow over time at a minimum rate of return—perhaps around 3%-4% overall–without going down. This is a living benefit that you can draw against while you’re alive.
Here’s how it works. Once you’ve paid into your life insurance policy for some time (usually at least two to five years), the cash value accumulation will be enough for you to borrow tax-free, with the right planning—although you’ll pay interest, much like you do with any other type of loan. And if you borrow and don’t repay, the amount may be deducted from the death benefit.
The accumulated cash value could also pay your premiums in later years, and some policies even let you put it toward a higher death benefit. But to access the entire cash value, you may need to surrender the policy. If you surrender the policy, you’ll lose the death benefit you signed up for, and will owe taxes. You might pay a “surrender charge” as a penalty, as well.
Upon your death, your life insurance policy keeps your accumulated cash value and only pays the death benefit. It might be paid as a lump sum, interest only, or in smaller installments. In most cases, if you want to leave a million dollars to your children, an insurance plan’s death benefit isn’t considered taxable income for the person receiving it, whether in a term insurance plan or whole life insurance.
Types of Whole Life Insurance
Most whole life policies have the same goal—to provide insurance for your whole life. However, there are many different types of whole life policies you may encounter. Three more common options:
- Participating/non-participating whole life insurance: Certain insurers offer “participating” plans, which could qualify you for dividends, although they aren’t guaranteed. The dividends the company pays are based on the insurer’s annual profits, which may vary. Nonparticipating plans don’t offer dividends.
- Guaranteed whole life: Coverage is usually limited (typically to $25,000 but sometimes up to $50,000) but it doesn’t require a medical exam. This is potentially helpful if you have health issues or are a senior looking for life insurance Guaranteed whole life is also a type of insurance known as final expense or burial insurance.
- Children’s whole life: These are low-cost policies designed for children. Age ranges vary, with many policies only available to kids 17 and under, though some are available into the applicant’s 20s. The policy never expires, and the cash value can be used to pay for college.
Within the buckets of participating and nonparticipating whole life plans, you may also come across options dealing mostly with payment structure—which may be important considering the costs involved.
- Indeterminate premium whole life: Unlike many other whole life plans, the premiums for this type of policy may change, though they won’t go beyond a guaranteed maximum.
- Limited payment whole life: Premiums (usually higher) are paid over a shorter period of time.
- Single premium whole life: Premium is paid as one upfront payment.
Who Needs Whole Life Insurance?
Whole life might be a good fit for those who want long-term coverage, have stable cash flow to consistently pay premiums, and have an adequate emergency fund and regular retirement contributions underway. You’ll need to strategize on using up the entire cash value or death benefit without leaving money on the table.
Whole life may not be a good fit for those with temporary insurance needs, those with limited budgets, or those who don’t want the whole life insurance cash value approach to savings. For an alternative, investigate term insurance plus investing in risk-appropriate vehicles, including tax-deferred retirement accounts, low-cost index funds, bonds, and other options. Single people with no children often don’t need any kind of life insurance at all.
Cost of Whole Life Insurance
Prices will vary depending on your age, health, policy term, coverage features, and the life insurance company you choose. As with other types of insurance, costs might also change if you add riders, such as a premium waiver if you become disabled, or the ability to add to the death benefit later without taking a medical exam (guaranteed insurability).
If you take a medical exam for life insurance while young and healthy, you may qualify for preferred rates, saving you money and making higher amounts of coverage available.
Sample Whole Life Insurance Costs
|Examples of Whole Life Insurance Monthly Rates for Women|
|Examples of Whole Life Insurance Monthly Rates for Men|
- Whole life is 6 to 10 times more expensive than term life, but offers lifetime coverage
- Whole life insurance provides a death benefit, a “cash value” portion that acts like tax-free savings, and in some cases, dividends
- Whole life policies are available with or without a medical exam
- Taking a medical exam can lower your costs if you are healthy
- Set payment premiums can help you budget
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.