The following article is meant to serve as a guide to whole life insurance for those who know very little about the subject. It is our goal to make this a broad overview of whole life insurance for dummies, providing a deeper look at all things pertaining to the best whole life insurance policies.
As you read through the article, please be aware of the many links provided that will take you to articles on the highlighted subject for a more in depth coverage of that specific whole life insurance topic.
Whole Life Insurance for Dummies
To understand whole life insurance it is helpful to start off by contrasting whole life vs term life insurance, the other major type of life insurance.
Whole life is classified as permanent life insurance, meaning that it is intended to last for the life of the insured individual. The owner of the policy contracts with the insurer. Once the policy is in force, the only way the insurer can cancel the policy is due to lapse of payment, i.e. the owner not paying.
Term life, alternatively, is designed to cover an individual for a limited time, for instance 10 or 20 years. The insured is protected with the term life plan for the contracted period of time. If the insured dies during the term, the insurer pays out a death benefit to the beneficiary of the term policy.
Term vs Whole: Different Uses
Term life offers no cash value accumulation. With a term life policy you are basically buying a contract with a death benefit. The only way you “win” is if you die during the period when the term insurance is in force.
Due to its time limitations, a term life insurance policy is often used as a method of dealing with time-specific risks such as making sure that money is available for a child’s education or to pay off a mortgage.
In contrast, whole life insurance offers a more comprehensive insurance coverage solution, including a guaranteed death benefit along with financial benefits such as the opportunity to build cash value over time tax deferred, with access to these funds during your lifetime.
While the premiums for a term life policy are less expensive than for comparable whole life insurance rates, because most whole life policies keep premiums level throughout a policy’s lifespan.
In contrast, term life premiums will rise substantially in cost as you get older. That is why it is typically less expensive to fund a whole life policy over the course of an individual’s lifetime than it would be to keep purchasing term policies at increasingly higher premiums every 10, 20 or 30 years.
In effect, whole life insurance enables you to guarantee that the premiums you pay for a specified amount of coverage will never rise over your lifetime.
Whole life companies do this by charging premiums that are higher than needed to pay insurance costs in the policy’s early years, enabling the buildup of cash value in the account which can be used to pay premiums in the policy’s later years when the cost of insurance is higher.
Because the cash value continues to grow over time such accounts are typically designed to be fully paid up so that the cash value is the same as the death benefit by the time you reach 121 years of age.
At the point in which your policy fully matures, should you live that long, the policy face amount and cash value would be equal, and you would receive the cash in the account.
Benefits of Whole Life Insurance
The comprehensive design options and tax treatment of whole life policies provide you a variety of benefits that no other single financial product can match.
The benefits of whole life insurance are unique among insurance products in offering the ability to lock in your premium amount and death benefit for life, while guaranteeing that your premiums won’t rise and your costs won’t increase as long as premiums are paid.
In addition, the insurance company guarantees the growth of your cash value account over time. The guaranteed cash value growth takes place in a tax favored environment, so you are not taxed on the gains in the policy, allowing the cash value to grow exponentially in a true compound interest environment.
And with a properly designed cash value building policy, your death benefit will also grow over time. As the cash value grows, the policy’s death benefit will also grow. That way, as you age, your policy will actually become more valuable.
Such lifetime policies also offer living benefits which enable you to tap this cash value when you need it in the form of policy loans, withdrawals or early death benefit payouts.
Whole Life Insurance: Participating vs Non-Participating
Different types of whole life insurance are available, including both participating vs non-participating:
Participating Whole Life:
Participating whole life, AKA dividend paying whole life insurance, pays policy dividends from the insurance company’s excess earnings on investments along with funds obtained from advantageous mortality costs and any other cost savings realized.
The life insurance dividends can be received in the form of cash, utilized for the purposes of lowering premium payments, or left in the policy to earn interest.
Dividends can also be used to buy paid-up additional insurance that boosts the face amount of the policy’s coverage.
Paid-up insurance requires no further premium payments – it is fully “paid-up” from the time of purchase.
And the best part is you still earn dividends on paid-up insurance, which can then be used to buy additional paid-up insurance.
Thus, paid-up insurance increases your death benefit as well as the cash value of your policy.
While there are no guarantees dividends will be paid in any one year with participating whole life insurance, there are a number of insurers who have consistently paid dividends to their policyowners year after for well over a hundred years.
Non-Participating Whole Life:
Non-Participating whole life insurance does not pay dividends, as the policy owner has no participation interest in the insurance company’s results.
Non-dividend paying whole life insurance provides level premiums and a face amount of death benefit coverage that is fixed for the life of the policy.
Typically, this whole life insurance type features lower premium payments on a relative basis vs participating policies, along with the typical fixed costs that provide predictability for policy owners.
Types of Whole Life Insurance Policies
Once you have decided whether to purchase a non-participating or participating policy, there are several types of whole life policy options to choose from, including:
Level Premium Whole Life:
Level premium whole life insurance has level premium payments over the insured’s entire lifespan. You would make level premium payments, either monthly, quarterly, semi-annually or annually, in return for lifetime insurance coverage.
In the early years of level premium policies, the premiums are more than sufficient to pay the policy’s insurance costs, allowing for cash buildup in the policy that covers the shortfall in later years when the policy payments normally would not be sufficient to the cost of insurance.
Limited Payment Whole Life:
Limited Pay Whole Life enables you to pay premiums over a specified time period, rather than over your entire lifetime.
The limited pay policy still offers coverage for your whole life, however, because of the truncated payment period the premiums for this type of policy are greater than they would be with a typical whole life policy.
Such overfunded life insurance policies might require payments over a certain period of time or call for payments to be made up until a specified age.
For example, some limited pay options include 7-Pay, 10-Pay, 20-Pay or To Age 65.
Single Premium Whole Life:
When a whole life insurance policy is paid for upfront with a single large payment it is, logically enough, called single premium whole life.
Single premium whole life insurance policies require no additional premium payments and immediately possess cash value which can be used for policy loans or partial withdrawals when applicable.
However, single premium policies are considered a Modified Endowment Contract (MEC) and are subject to different rules under the Internal Revenue Code.
Because such policies involve large initial payments at the inception of the policy, they are often used for estate planning purposes.
Survivorship Whole Life:
Survivorship whole life insurance, AKA second-to-die life insurance, is another option that can be purchased as a single premium or multiple payment whole life policy.
With second to die life insurance, two persons purchase a single policy on the life of both insureds, which pays out the death benefit to the life insurance beneficiaries upon the death of the second insured.
Survivorship whole life insurance is great for estate planning and business succession purposes.
Whole Life Insurance Underwriting
Typically, when you apply for whole life insurance you will need to take a life insurance medical exam. This type of fully underwritten contract requires that a nurse come to your home or work and take a urine sample, blood draw, height and weight measurements, blood pressure and possibly an EKG, depending on your age and how much death benefit coverage you are qualifying for.
Just a few years ago, qualifying for no exam whole life insurance was usually reserved for guaranteed issue policies. However, thanks to accelerated underwriting programs adopted by many of the top life insurance companies, you can now qualify for whole life insurance without an exam, i.e. no blood draw, which is great news for those with little time in their schedule or who hate needles.
Whole Life Insurance Cash Value vs Face Value
Whole life insurance combines death benefit coverage with a cash value account. The death benefit amount, the funds provided to a policy’s beneficiary or beneficiaries upon the insured’s death, is known as the face value of the policy.
The face value is different from the cash value, which is created by placing the portion of your premium payments in excess of the amount needed to pay for the insurance costs of your policy in a cash account bucket.
Cash value grows over time as premiums are paid and interest and, in participating whole life insurance cases, dividends, are accrued.
The Insurance Law specifies the minimum cash value of a policy in relation to the premiums paid after accounting for the expenses and claims experienced by a company.
At your request, an insurance company will make available to you a projection of the growth of your cash value over the lifespan of the policy.
The face value of a whole life insurance policy, especially in the first years of its existence, is typically larger than the cash value.
If a policy is surrendered the insurance company will pay you the cash value and not the face value of the policy.
The cash value you receive will be reduced by any loans or premium payments outstanding when the policy is surrendered.
The ability to withdraw or take a loan on your cash value allows you to use these funds to augment your income if the need arises or to make premium payments once you have retired.
Additionally, many people use whole life to practice infinite banking.
The main idea behind infinite banking with whole life insurance is that the policy acts as your personal bank. With infinite banking using whole life, you are empowered to take back control of your money and finances.
You build up early cash value in the policy and use policy loans against the cash value to pay down debt or purchase investments.
You then pay back your loan to your personal banking system and repeat the process over and over (i.e. infinite times).
The primary benefit of infinite banking is that instead of taking a loan from a bank or some other finance company and paying them, you are in a sense paying yourself when you make payments to the insurance company on a loan taken against your own cash value.
Additionally, if the interest rate the insurance company charges on the loan is lower than the return you earn on the borrowed money, you can create a favorable arbitrage on these funds.
Tax Treatment of Whole Life Insurance
The death benefits paid to the beneficiaries of a whole life insurance policy are typically received tax-free.
Additionally, the tax-favored status of insurance products enables your cash value to grow tax-deferred, enabling a greater build-up of funds due to unimpeded compound interest growth over time as compared to fully taxable accounts, all else equal.
Additionally, as your cash value grows, most policies allow you to access these funds via a policy loan or by a partial surrender of the policy.
The policy contract will typically specify the interest rate to be charged on any loans taken from the policy.
As long as you don’t take out withdrawals in excess of the amount you have contributed to the policy, such withdrawals can typically be taken free of taxes.
If you do take out a whole life insurance loan it’s important to make sure that it doesn’t cause the policy to be designated a modified endowment contract (MEC), which can cause it to lose its tax-favored status.
Most whole life policies are designed to avoid being classified as MECs, but it is nevertheless recommended to check the status of any policy you are considering purchasing in this regard.
You should also be cautious of taking out a significant policy loan if there is a chance you won’t be able to make payments on the loan down the line.
In such cases, if there isn’t enough cash value remaining in the policy to make premium payments, the insurance policy may lapse, which can result in taxes being owed on “phantom income” created by loans taken from the policy.
Rich Man’s Roth
Whole life insurance is also known as the Rich Man’s Roth due to its similarities with the Roth IRA.
For one, like a Roth IRA the money contributed to the whole life policy is after tax income.
But more advantageous than a Roth IRA is the ability to borrow funds free of taxes that can make whole life insurance an attractive vehicle for individuals looking to set aside tax-favored savings that they can access if needed without paying the hefty penalties typically associated with withdrawals from retirement plans prior to age 59 ½.
Additionally, unlike a Roth IRA, there is no government regulated cap on how much money you can contribute to your whole life insurance policy, nor an income earning limit. Rather, the amount of insurance coverage you can get is determined by your income or net worth.
In conclusion, the ability to access living benefits such as this while retaining a death benefit for your beneficiary or beneficiaries makes whole life insurance attractive to a wide range of individuals, which helps explain the continued popularity of whole life insurance over the years.
The trick then becomes…
Understanding what “Kind” of life insurance policy will be the “Best” for a particular client. Which is something that we here at I&E take very seriously and understand that it is not up to us to decide what is best for our clients, it’s up to us to make sure that our clients are well educated of their options so that they can make this decision for themselves.
Our role is…
To provide our clients with their options and quotes and then help “guide” them to which insurance company we feel with give them the greatest opportunity for success because remember, life insurance is something that you will need to be able to qualify for.
This is why…
We have chosen to remain an independent life insurance brokerage that is able to work with dozens of the top-rated life insurance companies in the industry so that when it comes time to helping our client find the best product at the best price, we’ll have plenty of options to cho0se from!
So, what are you waiting for? Give I&E a call today and see what we can do for you!