Whole life is a type of permanent life insurance. It has both a death benefit (like term insurance) and an investment component. The investment component lets whole life policies accrue cash (on a tax-deferred basis) as you pay into them over time. Once the cash balance builds up, the policyholder can take out loans against the balance of the policy. You should repay the loan along with interest, or else the your withdrawal will reduce both your death benefit and your cash value. Many people also think of this feature as 'forced savings' because funding the policy also forces you to set money aside over a period of years.
One of the key differentiators of permanent insurance compared to term life policies is the coverage timeline. Permanent insurances, such as whole life, are designed to cover you until the day you die, whereas term policies only cover you for a specified period.
Since whole life policies accrue a cash value, you'll also find that simple whole life policies will state a guaranteed minimum on the cash value portion of your policy. The exception to this is if you purchase a variable rate policy. These policies allow for the insurance companies to adjust your interest rate in reaction to market fluctuations.
The largest benefits of taking out a whole life policy versus other life insurance options are:
|Cash Accrual||Gives you financial flexibility as you get older|
|Tax-Deferred||Pay tax only on dividends that exceed the premiums you've invested|
|Forced Savings||If you lack savings discipline, whole life helps you save money each month|
|Lifelong Coverage||Unlike term insurance you're covered until the day you die|
|No More Exams||Even if you get sick you're still insured and not required for further testing|
Investing Through Whole Life
Is using whole life as an investment vehicle a good strategy? We suggest you ask yourself a couple questions to help make that determination:
How long will you need your life insurance policy for?
Assuming you only need life insurance protection for a set number of years, term life insurance will be a better investment. However, because permanent insurances such as whole life are structured to last til the day you die, a person searching for longer lasting life insurance may be best suited for whole life coverage. One thing to keep in mind: most people don't find themselves needing much life insurance when they retire. However, there are circumstances where you could find yourself wishing you had a large whole life policy during your retirement years. Some of those circumstances are:
- Having a dependent child who may be counting on the insurance money to finance their life after you're gone
- Having a large estate where significant taxes will be owed at the time of your death
- Not having funds set aside for any funeral/burial costs that will burden your family
How much life insurance do you need?
There's definitely such a thing as purchasing TOO much life insurance. The possible exception would a small minority of wealthy individuals who may use the policy as a tax shelter. But for 99% of policyholders, you'll want to buy enough coverage to protect your loved without overdoing it. Once you determine the amount you'll need you should stick to that number. If you find that purchasing whole life won't financially allow you to hit your coverage target you'll need to scale back, buying some combination of permanent insurance combined with a less expensive term policy.
Participating whole life
These policies are typically offered by mutual insurance companies (non-public companies that are owned by the policyholders and not shareholders) and stipulate that the policyholder is able to receive dividends when issued. These dividends are issued in a few different ways: cash payment, reduction in your future premium payments, or held in an account to compound at a rate determined by the insurance company.
Non-participating whole life
Non-participating policies are more common with publicly traded insurance companies. In this case, the shareholders own the company and receive the dividend disbursements that are paid out. To compete with mutual insurance companies, publicly traded insurance companies have also started to issue participating whole life policies as well. It is worth noting however that dividends from either policy type are not guaranteed and will be solely based on the insurance company's performance.
Level premium whole life
Level premium whole life policies are exactly what they sound like. They're policies where the insured pays a consistent premium for the duration of the policy. This usually means that premiums payments are relatively higher in initial years and lower in later years (accounting for inflation).
Single premium whole life
Single premium whole life policies include a one-time, lump sum payment that pays for the cost of the insurance immediately. While not a practical form of insurance for most shoppers on the market, it is popular as an investment vehicle for older people who are looking to put large sums of money into a cash-deferred vehicle. Regarding flexibility, some single premium policies will even give you tax-free access to your death benefit so you can pay for long-term care (LTC) expenses should you need to do so. And since most insurers have stopped offering LTC insurance, or are continually raising premiums on current policyholders, this is a good fallback plan to help fund your LTC needs.