Life Insurance
The definitive guide to whole life insurance
Aug 17, 2023
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Understanding the different types of life insurance policies can be overwhelming at first, but this guide has you covered. By the time you’re done reading, you'll know how whole life insurance works, the different types available, and if this kind of policy is a good fit for you.

What is whole life insurance?

Whole life insurance is a type of permanent life insurance policy that provides coverage for the entire lifetime of the insured as long as premium payments are made. It includes both a death benefit and cash value. It’s different from term life insurance that only covers a specified number of years and does not generate cash value.  It is also different from universal life insurance that has premiums and expenses that can change over time.

In addition to providing a death benefit to your named beneficiaries, the cash value component can grow over time on a tax-deferred basis.

How whole life insurance works

With whole life insurance, a part of your premium goes toward insurance costs while the rest is invested into the policy's cash value. The cash value grows slowly at a guaranteed rate of return, accumulating on a tax-deferred basis. This means you won't pay taxes on the gains unless you withdraw the money.

You can borrow against the cash value or surrender the policy for the cash at any time. However, if you take a loan, it will accrue interest, and any unpaid amount will reduce your death benefit. If you surrender the policy, you'll receive the accumulated cash value, but your coverage will end.

Types of whole life insurance

There are several types of whole life insurance, including:

  • Traditional Whole Life: The most common form, it offers a guaranteed death benefit and cash value that increases at a guaranteed rate, as long as premiums are paid.
  • Variable Whole Life: Here, you can invest the cash value in subaccounts (similar to mutual funds) with potential for higher returns. However, the death benefit and cash value may fluctuate based on investment performance.
  • Graded Benefit Whole Life: This policy is typically purchased by older customers or higher risk customers. It provides limited death benefits, generally a refund of premium plus interest, in the first two or three years. The full death benefit is paid if death is caused by accident or if death occurs after the first two or three years.
  • Final Expense Insurance: Also known as burial or funeral insurance, it offers a small death benefit, typically used to cover funeral costs.
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Is whole life insurance better than term life insurance?

The "better" option depends on your needs. Whole life insurance offers lifelong coverage and a cash value component, making it more expensive than term insurance. If you have long-term financial commitments and want to leave a legacy, whole life might be a better choice.

Term life insurance, on the other hand, can be simpler and cheaper. It provides a death benefit for a certain term and could be a good fit if you want to help offer financial protection during your working years, or until your kids are self-sufficient.

Who should get whole life insurance?

​​Whole life insurance can be a powerful financial tool that can provide lifelong coverage, a vehicle for wealth accumulation, and an efficient means of transferring wealth to the next generation. It's particularly useful for those with long-term financial commitments, high-income individuals looking for tax efficiencies, and business owners. Though everyone’s situation is unique, these are some common reasons why people tend to lean toward whole life insurance policies. 

For lifelong coverage

One of the main features of whole life insurance is that it provides coverage for your entire life, unlike term life insurance that only lasts for a specified term. This makes whole life insurance a good fit for those who want to ensure their loved ones will receive a death benefit no matter when they pass away, rather than within a fixed term. This lifelong protection is especially valuable for those with long-term dependents, such as a child with special needs.

To leave a guaranteed inheritance

Whole life insurance can also serve as a vehicle for passing on a guaranteed inheritance to your heirs. The death benefit from a whole life insurance policy is generally income tax-free and can be set up to avoid probate. Therefore, it can provide a straightforward, hassle-free financial legacy for your loved ones.

For wealth accumulation or tax purposes

The cash value component of a whole life insurance policy has a two-fold purpose. First, it serves as a forced savings mechanism, with part of each premium payment going into the cash value that grows over time. This can be used in retirement or any other financial needs that may arise. Second, the cash value grows on a tax-deferred basis, meaning you don't pay taxes on any earnings unless you withdraw the money. This can be a valuable tool for those interested in a tax-efficient way to accumulate wealth.

If you can afford higher premiums

Whole life insurance premiums can be considerably higher than term life insurance premiums. This is due to the lifelong coverage and the cash value component. For those who can comfortably afford these higher premiums, whole life insurance can be a good option. However, it's crucial to consider your budget realistically, as failing to keep up with premiums can result in the policy lapsing.

For business succession or for estate planning

Whole life insurance can be an important tool for business owners and individuals interested in estate planning. For business owners, these policies can fund buy-sell agreements, which can ensure the smooth transition of the company upon the death of an owner. In terms of estate planning, whole life insurance can provide liquidity to cover estate taxes and other expenses, protecting the value of the estate for your heirs.

Whole life insurance can be a complex topic, but understanding the basic principles and its advantages can help you make an informed decision. Always consult with a financial advisor or insurance professional to choose the best option based on your personal circumstances.

Frequently asked questions

Can I cash out my whole life insurance?

Yes, you can cash out by surrendering the policy entirely, but this terminates your coverage. You can also take a loan against your cash value, but remember that this will accrue interest and reduce your death benefit if not repaid.

Are whole life insurance premiums fixed?

Yes, one of the benefits of whole life insurance is that premiums typically stay the same throughout the policy's life.

Does whole life insurance make sense for children?

Many financial experts argue it's better to save or invest the money elsewhere due to the cost of whole life premiums. However, getting a policy for a child can guarantee their insurability in the future, regardless of their health.

ChatGPT was used for idea generation, but the author made significant modifications and takes ultimate responsibility for the content.