Whole life insurance is one of the most popular, yet least understood financial vehicles. There are definitely times when it makes sense, but you need to know what you’re getting into.
There are a variety of different life insurance policies available for people who want to provide financial security for their family.
Whole Life Insurance is one of your options, but is it a good fit for you?
Let’s take a look at this type of policy and explain how it works, its pros and cons, sample whole life insurance quotes, and who should buy it so you can make an informed decision.
Table of Contents:
What Is Whole Life Insurance?
Whole life insurance is a type of cash value life insurance designed to provide death benefit protection for your entire life.
Many individuals and businesses also use it for their tax-favored cash accumulation and access to cash value for you or your loved ones.
Key Features of Whole Life Insurance:
- Guaranteed Level Payments
- Guaranteed Tax-free Death Benefit
- Cash Value Growth with Guaranteed Minimum Interest Rates
- Tax-free Access to Cash Value via Policy Loan
Cash Value Definition: Whole life policies come with a sort of savings account, known as cash value, which earns a guaranteed minimum interest rate.As it grows, it can be used to pay policy premiums or the funds may be borrowed tax-free.
If you really want to dive deep, a whole life insurance definition is not where to start. It’s all about the benefits.
Whole Life Insurance Benefits
Whether you’re interested in life insurance protection for your family or your business, whole life offers a few key benefits that help in either situation.
Some of these benefits are a guaranteed death benefit for life, the ability to build cash value, and the opportunity to earn dividends.
#1 Coverage for Your Entire Life
Unlike term, whole life offers guaranteed protection for your loved ones that lasts a lifetime.
Payments (premiums) are guaranteed to stay level as long as you pay on time, and your death benefit is guaranteed for life as well. Your death benefit may even grow if you buy “paid-up additions.” (See further down)
To lock in the best whole life insurance rates for your entire life, we recommend Health IQ.
#2 Tax-Free Death Benefit
While few things in life are truly tax-free anymore, life insurance proceeds to your heirs are one of them.
According to the IRS, “life insurance proceeds you receive as a beneficiary due to the death of the insured person are not generally includable in gross income, and you don’t have to report them.”
Please note if your estate exceeds certain limits, it may owe estate/death taxes, but the limits are generally very high. Currently (2019), at the federal level, your estate must exceed $11.4 million before it owes estate taxes.
… and you can DOUBLE that for married couples.
#3 Cash Accumulation with Loan Access
A portion of your premium is set aside and invested by the insurance company in an interest-bearing account known as your “cash value.”
Over time, the investment portion accumulates in value through the interest earned. Like the death benefit, the interest that accrues is tax-advantaged, as it grows tax-deferred, and even can be withdrawn tax-free if taken as a loan.
The cash value generally has a minimum guaranteed rate of interest and can be borrowed against or used to pay premiums if you find yourself in a stringent financial situation.
Benefits to Your Family:
- Protection for Life
- Supplemental Retirement Income
- Pay Final Bills and Expenses
Benefits to Your Business:
- Protect Business Income if a Key Person Passes
- Retain Key Performers
- Easy Plan Set-Up
Benefits of Cash Value:
- Grows Tax-Deferred
- Guaranteed Minimum Interest Rate
- Tax-Free Access to Funds via a Loan
Types of Whole Life Insurance
Guaranteed Issue
For individuals with a terminal disease, they can buy a policy that is basically guaranteed acceptance. While these are technically whole life policies, they are 100% approval plays and not used for their cash accumulation.
We recommend American National for guaranteed issue whole life.
View Rates with American National
Final Expense
Many companies have policies with small death benefits ($1,000 to $20,000) that require no exam and limited questions to qualify.
These are final expense policies and like guaranteed issue, are not really cash accumulation plays. They’re all about quick and easy approval.
Straight Whole Life
This is your most traditional type of whole life policy. It’s your vanilla policy that covers you for life with level premiums for life.
Note: most policies allow you to stop paying premiums at age 100 but you still get the full death benefit at the insured’s death.
Single-Premium, 10-Pay, 20-Pay
Whole life policies may have various payment plans. You’ll enjoy the same benefits as straight whole life but get “paid-up” faster. This is a good option if you don’t like the idea of paying premiums for the rest of your life.
For exceptional cash value growth using 10-pay and 20-pay strategies, we recommend a Guardian whole life policy via our partner, Policy Genius.
Whole Life Insurance for Children
A valuable gift you can provide to your child or grandchild is the gift of life insurance.
The way many of these policies work is a parent or grandparent pays the premium, the policy grows (providing coverage as well), and at age 18, the child-turned-adult becomes the new owner of the policy.
At this time, she may use the cash values for whatever she wants (down payment for a house, college expenses, etc.). Or she may continue to pay the premium and keep the policy.
It’s really affordable with monthly rates as low as just $2 to $3 bucks and they’re easy to buy since there’s no medical exam.
How Whole Life Insurance Works
When you buy a whole life insurance policy, you need to have a basic idea of how it works and its components.
The first component is easy…
You’ll enjoy lifelong insurance protection as long as you pay your premiums on-time (and don’t deplete the policy of all its cash value.)
But when it comes to the cash value component, it’s a bit trickier.
Premiums, Dividends, Tax Advantages, and Access of Whole Life
It all starts with your payments (premiums).
When you pay into a whole life policy, the money goes to pay:
- Cost of Insurance
- Administrative Fees
- Policy Fees
What’s leftover goes in to fund your cash value, which typically earns a minimum guaranteed interest rate.
Premium Flexibility
While your premium schedule will be fixed either for life or for a set period like 10 or 20 years, there is some flexibility.
If you miss a payment and you have sufficient cash values, the premium will still get paid.
How?
The policy “borrows” the premium out of your cash values.
Note: You’ll be charged interest on this loan, but it’s not as if you miss a premium, your policy cancels and you lose everything. There is some flexibility.
As your cash value grows, you could elect to stop paying premiums out of pocket altogether. As long as the policy has sufficient cash to fund the premium payments, you don’t technically have to pay out of pocket.
If your policy pays dividends, they can also be used to pay part or all of your premium cost.
Last – many policies include special “riders,” policy options that allow you to stop paying premiums (waive your premium payments) if you lose your job or become disabled.
Interest and Dividends
Your policy will earn a guaranteed minimum interest rate, typically around 1.5%-4% but it may (almost always) earn more. This will be applied to your cash value (not distributed to you).
It’s important to know the interest is credited to your cash-value account. Remember that 100% of your premium does NOT make it into your cash value, however. So if you see your policy was credited with, say, 3% in a given policy year, that was 3% earned on your cash value, not your total outlay.
If your policy pays dividends, you’ll generally have these main options using them:
- Distribute dividends and take the cash (generally income tax-free)
- Leave them on deposit to earn interest
- Apply dividends to pay down your premium
- Purchase paid-up additions – this increases your death benefit without increasing your premium and builds your cash value
Remember, dividends are not guaranteed. But many long-standing companies have paid them for years without fail. So they’re not technically guaranteed, but most policyholders do expect them.
Overall, you can expect to earn between 2-4% growth of your policy on your total premium outlay.
Tax Advantages
Some of the tax advantages you would enjoy in a whole life policy are as follows:
1. No Max Annual Contribution:
The IRS imposes a max contribution limit to qualified plans such as IRA’s and 401K’s. If you exceed the limit, your additional investment may no longer qualify for tax-favored status.
However, you can pay as much as you like into a whole life policy, provided that the policy is set up properly, and enjoy all the benefits below.
2. Tax-Deferred Growth
As your cash value grows, you won’t receive 1099 for the interest credited to your account each year, as you do in a taxable account. This helps your cash value to grow without getting hit by taxes in its accumulation phase.
3. Tax-Free Dividends
The IRS treats dividends as a return of premium, and are therefore not generally taxable. Some exceptions do exist.
4. Potential Tax-Free Access to Cash Values
If your policy has sufficient cash values to sustain it, you can access your cash for any reason in the following two ways:
- Withdrawal – Cash value withdrawals can be taken tax-free up to your “cost basis,” or the amount of premium outlaid. If you take more than your basis, withdrawals of gains will be taxed as ordinary income.
- Policy Loan – Loans are not considered income by the IRS, so you could potentially access your cash values (even the growth) tax-free via a policy loan
5. Income Tax-Free Death Benefit
We have also already discussed the tax-free death benefit above. As you can see, there are several tax advantages you can enjoy in a whole life policy.
Monitoring Your Policy
Keep in mind accessing cash values (especially by loan) will affect your policy’s cash value, and may dramatically impact the long-term growth of your policy.
It’s also a tricky business. You can’t take too much cash value or your policy could implode. If you have gains in the policy, you could owe taxes on all the gains!
Be sure to run frequent illustr