What is Whole Life Insurance? The Pros and Cons

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Whole life insurance, by definition, covers you for your entire life, as long as you pay the premiums. It is sometimes referred to as "guaranteed whole life insurance," because companies promise to keep premiums the same the whole time you have the policy. If you die, and the policy hasn't lapsed, your beneficiaries will receive a payout.

Whole life insurance also has tax benefits and a cash value component that grows. It's good for people who want the benefits of life insurance and the ability to invest the cash value.

How does whole life insurance work?

Whole life insurance is permanent life insurance, which means you'll be covered for life if you pay the premiums.

If you die, your beneficiaries will file a claim with the insurance company. They will review the circumstances of your death and pay out the death benefit (also called the policy's face value), if everything is in order.

Make sure you inform your family members about your life insurance policy. If your spouse or child doesn't know they are the beneficiary, they may not claim the payout.

A whole life insurance policy consists of a few key elements:

Death benefit

This refers to the payout your beneficiaries receive when you die. Death benefits are tax free if you're below federal and state estate exemption levels, which most households are. The federal exemption level is about $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 affects that cost, so it's important to evaluate your family's needs before buying.

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, because they have a low face value and are designed to cover end-of-life costs only. The average cost of a funeral is $10,000. So a policy can be valuable if your family doesn't have an emergency fund or would have a hard time paying for your burial.

Premium

This is the cost of the policy, which can be paid annually, biannually or monthly, depending on the company. Premiums are generally paid over the life of the policy. But some people choose to pay a higher premium for a shorter time, such as 20 years, to ensure the policy doesn't lapse later.

This option can be useful for people who have a high income and 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.

Cash value

As with other permanent life insurance policies, whole life builds a cash value over time. The cash surrender value is what you'd get if you surrender the policy to the company. It is not added to the face value that your beneficiaries would receive.

The cash value grows, tax deferred, over time at a set rate. This is why whole life policies are often referred to as investments. While the guaranteed rate may be lower than with other investments, it can lower the risk of a portfolio (assuming you have many other investments). The cash value can be used to:

  • Pay premiums
  • Buy 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 borrow against the cash value of your policy, the loan amount will be deducted from the policy's payout when you die.

Dividends

Dividend-paying whole life insurance, also known as participating whole life insurance, refers to policies that pay a bonus if the company performs better than expected. Policyholders get a piece of the company's profits once they have paid all death benefits and other business expenses.

Here's a simple example. Let's say the company collected $90 in premiums and made $10 in other income. But they only spent $95 in payouts and costs to run the company. The $5 remaining would be shared with policyholders as a dividend.

Dividends depend on the company's performance, and there's no guarantee they'll be paid each year. That said, some insurers have consistently paid dividends for decades. If you're considering whole life insurance from two companies with the same features and premiums, dividends are an advantage.

Guaranteed acceptance and no-medical-exam whole life insurance

While the medical exam isn't a component of life insurance, it's a fairly standard requirement, along with the underwriting process. Both are used to evaluate your health and determine your premiums.

Some companies require no medical exam, but they may charge much more for taking on the risk. You'd still have to answer questions about your health and medical history, but not in person. An exam is generally short ( 30 minutes) and relatively painless. It can often be scheduled at your work or home.

Similarly, with guaranteed acceptance whole life insurance, you can 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.

The first few years of coverage are usually restricted, so if you die during that time, your beneficiaries won't receive the full payout. Unless you have concerns (like a life-shortening diagnosis) regarding your ability to get coverage, this is a poor choice.

The pros and cons of whole life insurance

Here's an overview of the benefits of whole life insurance in a variety of situations:

Benefit
Overview
Cash value accrualA whole life insurance policy's cash value has guaranteed, tax-deferred growth.
Tax-free policy loansYou can take out a policy loan using the cash value as collateral.
DividendsDividends aren't taxed as income.
Fixed premiumsWhether you pay over a short time or your lifetime, premiums are guaranteed to stay the same.
Lifelong coverageThis is a benefit of all permanent life insurance policies, as long as premiums are paid.
No additional examsIf your health changes in the future, you'll stay covered and won't need another health assessment.
Option to surrenderIf your financial situation changes, you can surrender the policy and receive its cash value from the company.

Similarly, there are multiple downsides to whole life insurance. These can outweigh the benefits, depending on your goals:

Downside
Overview
Complex productWhole life insurance has many features and benefits, but it can be challenging to take full advantage of them without a professional.
High premiumsThe cost of whole life insurance is much higher than term life.It may not be a good choice unless you take advantage of every benefit.
Growth rate and feesThe cash value is guaranteed to grow, but the rate can be lower than for other investments. You should also think about any fees.

Should I buy whole life insurance?

Whether whole life insurance makes sense for you depends on your financial goals. If you mostly want your policy to cover your family's expenses if you die, other products are probably a better fit.

Consider whole life insurance if you're interested in the benefits but also want to use the cash value as an investment. For example, if you're a young parent with a high income, you may be fine with the higher costs and the ability to lock in a lower premium by buying early in life. And you would potentially have decades for the cash value to grow into a sizable asset.

Whole life insurance needs to be 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 large emergency fund, have maxed out your IRA and 401(k) and are looking for new tax-advantaged accounts for retirement or estate planning, you should consider whole life insurance.

If you're not sure if whole life insurance is right for you, here are common scenarios where a different life insurance product would be better:

  • You have significant outstanding loans or upcoming expenses you want to cover, such as a mortgage or your child's tuition. For these situations, a term life insurance policy would probably be better.
  • You want coverage for your entire life so your family can pay for your final expenses, Or you simply want 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 instead, because they cost less for long-term coverage.

Editorial Note: The content of this article is based on the author's opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.