Whole life insurance, by definition, offers coverage for your entire lifetime so long as you continue to pay premiums. It is sometimes referred to as "guaranteed whole life insurance", because insurers promise to keep the premiums constant over the life of the policy. Should you die, and the policy hasn’t lapsed, the beneficiaries will receive a payout.
In addition, whole life insurance offers tax benefits and has a cash value component which grows over time. It's suitable for those who want not only the benefits of life insurance coverage, but also using the cash value as an investment vehicle.
How does whole life insurance work?
Whole life insurance is a type of permanent life insurance, so you will have coverage for your entire lifetime as long as the premiums are paid. If you die, the policy beneficiaries file a claim with the insurer, who will review the circumstances of your death and pay out the death benefit (also called the policy's face value) so long as everything is in order.
Make sure to keep your family members informed about your life insurance policy. If your spouse or child doesn’t know they are the beneficiary, they may not claim the payout should you pass.
A whole life insurance policy consists of a few key elements:
This refers to the payout the beneficiaries receive upon your passing. Death benefits are tax-free as long as you’re below federal and state estate exemption levels, which will be the case for most households. The federal exemption level is approximately $5.5 million, and only 18 states impose estate or inheritance taxes.
Policy face values are available in increments of $50,000 or $100,000 and can go up to several million dollars. Whole life insurance policies are generally more expensive than alternatives, such as term life insurance. The death benefit directly impacts that cost, so it’s important to evaluate your family’s needs before deciding to purchase.
Some products, such as final expense whole life insurance, have death benefits as low as a few thousand dollars. These policies tend to be less expensive as they have a low face value and are designed to cover end-of-life costs. Given the average cost of a funeral is around $10,000, these policies can be incredibly valuable if your family doesn’t have an established emergency fund, or would have difficulty covering burial expenses.
This is the cost of the policy and can be paid annually, bi-annually, or monthly, depending on your insurer. Premiums are generally paid throughout the life of the policy, though some choose to pay a higher premium for a shortened period of time, such as 20 years, to ensure their policy doesn’t lapse later.
This option can often be useful for people that currently have high incomes who want to lock in coverage for their family, no matter what happens to their income in the future. If you can afford it, this is a simple way to reduce your family’s financial risk profile.
As with other permanent life insurance policies, whole life insurance accrues a cash value over time. The cash surrender value is what you get if you surrender the policy to the insurer. It is not added to the face value of the policy, which your beneficiaries get if you pass away.
The cash value grows tax-deferred over time, and is guaranteed to grow at a particular rate in the case of whole life policies. This is why whole life insurance policies are often referred to as an investment vehicle. While the guaranteed rate of return on the cash value may be lower than other financial products, it can lower the overall volatility of a portfolio (though this benefit assumes you have a breadth of existing investments). The cash value can be used to:
- Pay premiums
- Purchase additional coverage
- Make withdrawals (in certain cases)
- Provide a tax-free loan (for emergency expenses, a mortgage or other needs)
Keep in mind that if you’ve borrowed against the cash value of your policy and pass away, the loan amount will be deducted from the policy’s death benefit.
Dividend-paying whole life insurance, also known as participating whole life insurance, refers to policies that pay a dividend in the case that the insurer performs better than expected. Policyholders get to participate in the profits of the company once they’ve paid all death benefits and other business expenses.
Dividends are dependent on your insurer’s performance, and there’s no guarantee they’ll be paid each year—though some insurers have consistently paid dividends for decades. If you’re considering whole life insurance policies from two insurers with the same features and premiums, dividends are certainly an advantage to note.
Guaranteed acceptance and no-medical-exam whole life insurance
While the medical exam isn’t actually a component of a life insurance policy, it’s a fairly standard requirement that goes alongside the underwriting process, both of which are used to evaluate your health and determine your premiums.
Some insurers require no medical exam, but may charge significantly higher premiums the insurer is taking on additional risk. You still have to answer questions about your health and medical history, but you aren’t evaluated in-person. An exam is generally quite short (about 30 minutes) and relatively painless as it can often be scheduled at your work or home.
Similarly, guaranteed acceptance whole life insurance offers the ability to skip detailed health questions and the medical exam, but premiums will be even higher, and the death benefit will be limited — typically less than $100,000.
In addition, there’s generally a restricted period for the first few years of coverage, so if you pass during that time your beneficiaries won’t receive the full payout. Unless you have concerns regarding your ability to get coverage, such as if you’ve been diagnosed with a life-shortening condition like cancer, our analysis indicates this is a poor choice for most people.
The pros and cons of whole life insurance
Here's an overview of the benefits of whole life insurance as used in a variety of financial situations:
|Cash value accrual||A whole life insurance policy’s cash value has guaranteed, tax-deferred growth|
|Tax-free policy loans||You can take out a policy loan using the cash value as collateral|
|Dividends||If your policy provides dividends, these are free of income tax as they’re considered a return of premium|
|Fixed premiums||Whether you pay over a shortened period or over your lifetime, premiums are guaranteed to stay flat|
|Lifelong coverage||A benefit of all permanent life insurance policies, so long as premiums are paid|
|No additional exams||If your health changes in the future, you’ll remain covered and aren’t required to take additional health assessments|
|Option to surrender||If your financial situation changes, you can surrender the policy and receive its cash value back from the insurer|
Similarly, there are multiple downsides to whole life insurance and, depending on your goals of coverage, these can often outweigh the benefits:
|Complex product||Whole life insurance is a complex product with many features and potential benefits, but these can be challenging to take full advantage of without a professional|
|High premiums||The cost of whole life insurance is significantly higher than term, and means it may not be a good choice unless you take advantage of all the potential benefits|
|Growth rate and fees||While the policy’s cash value is guaranteed to grow at a certain rate, this can be lower than other investment vehicles and you need to determine what fees are applied|
Should I buy whole life insurance?
Whether whole life insurance makes sense for you depends on your financial objectives. If your primary objective is to have a death benefit in place to cover your family’s expenses if you passed away, our analysis shows that other products are likely a better fit, given the cost of whole life insurance.
Whole life insurance is worth considering if you’re interested in the benefits of having coverage, but also want to take advantage of using the cash value as an investment vehicle. For example, if you’re a young parent with high income, you may be fine with the higher costs and the ability to lock in a lower annual premium by buying early in life. In addition, you would potentially have decades for the policy’s cash value to consistently grow into a sizable asset.
Whole life insurance is not a good standalone investment, and needs to be considered as part of a diverse portfolio. If you’re just starting to save and invest for retirement, whole life is probably not the best place to begin. However, if you already have a healthy emergency fund, have maxed out your IRA and 401(k), and are looking for new tax-advantaged accounts for retirement or estate planning, whole life insurance should certainly be considered.
If you’re not sure whether whole life insurance is right for you, here are a couple common scenarios in which a different life insurance product would serve you better:
- You have significant outstanding loans or upcoming expenses, such as a mortgage or sending your child to college, and want to make sure these will be covered. For these sorts of situations, you would probably be better served by a term life insurance policy.
- You want coverage for the entirety of your life so your family won’t be in a financially challenging situation covering your final expenses, or simply to make sure they have money to pull from in case anything happens. In these situations, you should explore final expense whole life insurance and guaranteed universal life insurance as alternatives, as they carry lower premiums for long-term coverage.