Updated May 17, 2019

What is Whole Life Insurance?

Read more about Life Insurance

Whole life insurance is about insuring your life while you're living AND when you're gone. Is it the right coverage for you? Read on.

It's one of two choices you have when considering life insurance—the other being term life insurance. More on the differences between the two later.

What is Whole Life Insurance?

Whole life insurance, also known as permanent life insurance and ordinary life insurance, provides coverage for your entire life. Upon your death, it pays a death benefit to the beneficiaries named on the policy.

It also earns cash value, providing you with a savings vehicle that you can use while you're alive.

Personal life insurance sold to individuals is different from group life insurance, such as coverage offered through an employer or an association. This article focuses on personal whole life insurance.

Whole life insurance is the most common type of permanent insurance, according to the Insurance Information Institute.

Types of Whole Life Insurance

Whole life insurance offers four options:

  1. Traditional Whole Life Insurance
    Combines a death benefit with a savings feature.

    With this type of life insurance policy, you choose an amount of coverage and pay the applicable premium amount. The savings aspect comes from dividends paid out to you by the life insurance company.

    Who Is It Good For: This type of coverage is good for those who already have a savings and investment plan elsewhere and would like to get some extra cash now and then.

  2. Variable Life Insurance
    This also combines a death benefit with a savings feature, but you can invest the savings in stocks, money market mutual funds and bonds to grow the value of your policy.

    However, you also face the risks of the stock market, which could decrease the value of your policy and death benefit.

    Who Is It Good For: This type of policy is good for young people who want to invest for their future and can handle the risks of the stock market.

    Some variable life insurance policies include a guaranteed minimum death benefit, so regardless of the performance of your investment, the value of your policy will not fall below this amount.

  3. Universal Life Insurance
    Also called adjustable life insurance, universal life is a more flexible type of policy. You have the option of increasing the death benefit during the life of the policy, as long as you pass a medical exam.

    It also includes a savings feature in the form of interest, usually at the money market rate. You have the option of using the accrued interest to lower your premium payments.

    Who Is It Good For: Young couples who need to increase their coverage as their family grows or anyone who wants to save for the future without having to do anything.

    Despite its name, the money market is not actually a market like the stock market. Rather, it's a network of financial institutions, banks, brokers, etc., that sets rates and trades in short-term lending.

  4. Variable Universal Life Insurance
    This type combines aspects of variable life insurance with universal life insurance. You can change the amount of your death benefit, invest the savings, and lower your premium amount with the accrued earnings.

    Who Is It Good For: Anyone looking for flexible life insurance and choices in how they can invest the savings.

Why Should You Consider Whole Life Insurance?

Think of whole life insurance as a component to your financial planning. It helps you take care of your affairs now and offers support when you're gone.

While you're alive, whole life insurance is good for:

  • Creating an inheritance to leave for your loved ones.

  • Growing savings and investing for retirement through its savings features.

  • Building a nest egg when you're young to pay for events later in life, such as a wedding, college tuition, a new home, etc.

When you die, whole life insurance is good for:

  • Replacing your income after you're gone so it provides your loved ones with financial security. Loved ones include anyone you are responsible for, including children, aging parents, siblings, etc.

  • Paying your funeral and burial costs so as not to burden your loved ones.

  • Covering any probate court, attorney, or estate planning fees or taxes associated with your will.

  • Paying off any mortgages and debts that don't die with you or medical expenses not paid by your health insurance. This includes debts that someone cosigned for you, such as a school loan or car loan.

  • Creating a fund for your children's college education or other needs.

How Does A Whole Life Insurance Policy Work?

A whole life insurance policy never expires. As long as you keep paying premiums, the policy remains in effect. Let's take a look at how a whole life insurance policy works by following it through its lifecycle.

  • Stage 1
    Your whole life insurance policy is born. You purchase the amount of coverage you want, such as $50,000, $100,000, $500,000, etc. After going through underwriting, your premium is determined and your policy is issued.

    The premiums remain the same throughout the life of the policy, plus you have more time to build up your policy's savings account for later in life.

  • Stage 2
    You pay the premium amount due on your permanent life insurance policy according to the established payment schedule, e.g., monthly, biannual, or annual. Part of this premium goes toward your death benefit, while part builds the cash value of your policy.

  • Stage 3
    As you continue to pay your premiums, your cash value begins earning interest after two to three years, which you can invest or save. Depending on the type of your whole life policy, it may also pay you tax-free dividends.

  • Stage 4
    You make changes to your whole life policy as your life changes. Depending on the type of whole life insurance you purchased, you might decide to increase the coverage as your family grows, take out a loan against its cash value to buy a car, or invest the savings it accrues to fund your retirement.

  • Final Stage
    Your whole life policy pays out the amount of coverage (i.e., death benefits) you originally purchased to your beneficiaries upon your death.

What Is Cash Value and Why Is It Important?

Cash value, also known as the cash surrender value, is the amount your policy is worth at any given time. Cash value builds up as you pay your premiums and interest is earned on that amount.

There are two things you can do with this cash value:

  1. You can use some of it as:

    • Collateral to take out a loan.

    • Payment on your policy premiums once enough cash value has accumulated.

    • An exchange to increase your life insurance policy's death benefits.

    • Retirement income.

  2. You can cancel or surrender your life insurance policy and get the entire cash value sum.

    The amount you receive is based on how much you paid in premiums and earned in interest minus any surrender fees.

Another Option - Term Life Insurance

You can also purchase term life insurance, which provides death benefits for a specific period of time, such as 5, 10, or 20 years. When the term ends, so does your coverage.

Term also has different types: Level term insurance and decreasing term insurance.

  • Level Term Insurance
    This is the most popular type of term life coverage. Its death benefit does not change during the term of the policy.

  • Decreasing Term Insurance
    With this type of term insurance, the death benefit decreases, usually every year, over the term of the policy.

How Term Life and Whole Life Differ

Whole life insurance and term life insurance have significant differences. The biggest?

Whole life does not expire, while term insurance does.

Here are some other things to consider:

  • Whole life pays a death benefit whenever the insured dies, whereas term life only pays a death benefit if the insured dies during the term of the policy.

  • Whole life insurance provides both death benefits and a savings vehicle, whereas term life insurance provides just a death benefit.

  • Premiums remain the same for your whole life insurance policy, whereas term life insurance premiums go up if you choose to renew the term when it expires, with the increase based on your age, health status and inflation.

  • With whole life, part of your premium goes toward your death benefit and part goes toward increasing the cash value in your policy, whereas the premiums for term life are lost if you don't die during the policy term.

  • Unlike term insurance, with whole life insurance, you can borrow against your policy's cash value.

How Term Life and Whole Life Are Similar

Although they have their differences, term life insurance and whole life insurance have two things in common:

  • Both have guaranteed death benefits.

  • Beneficiaries do not have to pay federal taxes on the death benefits received.

Should You Buy Term or Whole Life Insurance?

Deciding on term or whole life insurance is a personal decision that depends on your circumstances and needs.

Generally, term life insurance is ideal for people who:

  • Only need limited coverage;
  • Cannot afford the higher premiums of whole life insurance;
  • Need more life insurance for only a specific time period, such as a growing family or when financial responsibilities are outpacing their income.

On the other hand, whole life insurance is often the better choice for people who want:

  • The security of a long-term life insurance policy that will never expire;
  • Both living and death benefits from their policy;
  • Additional funds to supplement their retirement savings;
  • The added benefit of borrowing against the cash value of the policy for life's unexpected expenses;
  • Long-term financial flexibility.

If you need help in deciding what type of life insurance is right for you, talk with a financial adviser or a life insurance agent.

Which Is Better, Whole or Term Life Insurance?

Everyone, including financial experts, has varying opinions on which is better when it comes to whole life insurance and term life insurance.

Let's look at some of the pros and cons when comparing whole life and term life insurance.

The Cost

  • Term Life
    Inexpensive to start with, leaving you with money to spend or invest as you please. However, when the term ends, your premiums will go up because you're older.

    It's possible you could end up paying as much as you would have paid for whole life insurance when you were younger.

  • Whole Life
    Expensive, as much as six to 10 times the cost of term insurance, and ties up a fair amount of your monthly income for life.

Here's an Example:
Joe is 30 years old. He budgeted $100 a month to spend on life insurance. That $100 a month would buy him a $125,000 whole life insurance policy.

For the same amount of coverage, it would cost him just $7.00 a month for term life insurance.

The Investment

  • Term life offers no investment option. However, what you save in premiums could be invested elsewhere on your own.

  • Whole life has an investment vehicle built into it, but the return on investment could be low. However, it makes you save for the future, something most people have trouble doing.

Planning for the Future

  • With term life insurance, you have to invest on your own. If you're skittish about investing money, you might keep putting off investing for your future.
  • Whole life insurance provides steady investing through its savings component.

Tax Advantage

  • Because term life insurance does not offer a savings feature, you have to invest in your own 401(k) or IRA. In both cases, you pay taxes when you withdraw the money during retirement.

  • With whole life insurance, the cash value of the policy grows tax-free. You only pay taxes if you withdraw more than what you paid into it.

How Much Whole Life Insurance Should I Buy?

Whole life insurance is available in a wide range of amounts, from $10,000 to $1 million or more.

Since life insurance provides death benefits and replaces your income so loved ones can remain financially secure upon your death, you want to be sure you are purchasing sufficient coverage.

Insurance companies suggest buying coverage that is 6 to 10 times your annual salary.

One way to calculate how much life insurance you should buy is to take your annual salary and multiply it by the number of years left until you retire.

Here's some Examples:

  • Let's say your annual salary is $60,000 and you have 25 years left until retirement age. That means you need $1,500,000 in life insurance ($60,000 x 25 years).

    You can also use the standard of living method to estimate how much life insurance coverage you should have. With this method, multiply by 20 the amount of money your loved ones would need to maintain their current standard of living when you're gone.

  • Let's say your expenses are $6,500 a month ($78,000 a year). To maintain that standard of living, you would need life insurance coverage of at least $1,560,000 ($78,000 x 20).

Where Do I Buy a Whole Life Insurance Policy?

Your options for buying a whole life insurance policy are plentiful. Oftentimes, people check with their current health, auto, or home insurer to see if they also offer life insurance.

Some other options include:

  • A sales agent with a life insurance company.

  • An independent agent or agency in your community.

  • Online through an e-insurance company.

Shop around because coverage premium amounts vary depending on how stringent the insurance company's underwriting guidelines are with regard to risk.

Before purchasing your life insurance policy, be sure to check into the financial stability of the company, as well as the agent.

If you're buying from an agent who works independently, you want to be sure an exit strategy is in place should that person change careers or retire.

Remember: you're buying coverage with lifetime guarantees—you want to be sure the company or agent will be around to honor them.

Terms to Know

When looking into whole life insurance, you'll come across some terms describing the coverage. The most common terms associated with whole life insurance are:

Policy owner: The person who buys and manages the life insurance policy. It may or may not be the same person whose life the policy insures.

Insured: The person whose life is covered under the policy. It may or may not be the same person listed as the policy owner.

Beneficiary: The person or persons who will benefit from your life insurance policy when you die. In other words, the beneficiary receives your policy's death benefits.

Death benefit: The amount of money paid to the beneficiary of the life insurance policy. The amount of the death benefit depends on the amount of coverage taken out by the policyholder.

Accelerated death benefit: A life insurance policy feature that lets you take your whole life insurance benefits before death if you are diagnosed with a terminal illness.

Premium: This is the amount you pay to keep your policy in effect. If you fail to pay your premium, your coverage will lapse and will eventually be canceled.

Cash value: The worth of your whole life insurance policy based on how much you paid in premiums, as well as other factors.

Dividend: A feature in some types of whole life insurance policies that pays policy owners a portion of the life insurance company's profits.

Underwriting: The process that determines the premium amount for your coverage. Some underwriting factors are your

  • Health history
  • Life expectancy
  • Income
  • Lifestyle

Rider: A separate contract you can add to your whole life insurance policy that provides customized provisions. For example, supplemental life insurance is a rider to a life insurance policy.

Bottom Line

Whole life insurance is a type of life insurance coverage that also acts as a savings and investment vehicle.

While it is more expensive than term life insurance, it never expires as long as you keep paying the premiums. It also offers guaranteed benefits and ensures you are saving for the future.

Compare the various life insurance options to choose the coverage that meets your needs and the needs of your loved ones when you're gone.

Disclaimer: Opinions expressed here are author's alone. Please support CreditDonkey on our mission to help you make savvy decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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