What is Whole Life Insurance?
In 2017, LIMRA Market Research revealed that 61% of new life insurance policies were Permanent while Term made up the rest at 39%. This was rather surprising to some considering people have been favoring Term life insurance over Permanent for the last few decades, mainly because it’s cheaper.
So what could have swayed people’s decisions to choose Permanent life over Term? According to LIMRA Market Research Corporate VP and Director Todd Silverhart, there were 3 key factors why these people opted for Permanent life insurance over Term:
- Replacement of income of primary wage earner – 40%
- Final expenses, Burial – 43%
- Transfer of wealth to succeeding generation – 34%
To quote Silverhart: “Permanent life insurance is appropriate when a buyer wants the coverage in force when they die, regardless of when that is. That could be for final expenses, to support dependents, to leave a legacy — many reasons. Term life is appropriate when the need is temporary, such as until a mortgage is paid off or until children are grown.”
One of the most popular types of permanent life insurance is Whole life. In this article, we’ll discuss what exactly it offers and the reasons why it could be a better choice over term life.
What is whole life insurance and how does it work?`
Whole life insurance is a subtype of Permanent life insurance. It’s a policy that gives the person a fixed amount of coverage for his or her entire lifetime. Aside from this, it also builds up a cash value that is taken as a portion of the premiums you are paying.
This cash value can be accessed during the course of the coverage which gives it more flexibility and utility compared to other basic types of life insurance.
Dividends can be reinvested into the cash value in order to build interest (for faster growth). This gives the policyholder another way to save up and build their assets outside of traditional retirement plan options like a 401k or IRA.
Types of whole life insurance
There are three main types of whole life insurance:
Traditional Whole Life Insurance
- Provides a guaranteed minimum rate of return on the cash value portion
Single Premium Whole Life Insurance
- You pay or deposit a lump sum into the policy in exchange for a guaranteed death benefit. It has the advantage of growing quickly (cash portion) since the lump sum provides a large base amount to build upon.
Interest Sensitive Whole Life Insurance
- Similar to single premium but this one offers a guaranteed minimum cash value that increases annually and matches the face value when the policyholder reaches the age of 100.
Whole life insurance pros and cons
- Provides coverage for your entire lifetime
- Has a cash value benefit (guaranteed tax-deferred growth)
- You can borrow money from your cash value
- Dividends (if your policy offers this, they are considered a return of premium and thus free from income tax
- Even if your health changes (worsens) during the course of the policy, you will not be required to take additional medical examinations
- Provides the option to surrender the policy. You can still get back the cash portion of your insurance should you opt to do this
- Costs more than term life insurance (higher premiums and fees)
- The policyholder has little or limited control over the investments where the cash value will be invested
- While guaranteed, the rate of growth of the funds in the cash portion is typically lower than other investment vehicles
Why purchase whole life insurance?
With a myriad of life insurance products out there, it can be hard to decide which one is best for you. The first question to ask yourself though is this: “Should I get Term or Permanent life insurance?”
Each has its own advantages and disadvantages. The important thing is to determine what exactly fits your needs.
A lot of people choose term for its lower cost when compared to permanent life. Whole life insurance (which is categorized as permanent life) on the other hand, has the cash value feature and the coverage lasts for the entire lifetime of the policyholder.
This makes whole life an interesting alternative to the oft-touted “Buy term and invest the difference” dogma. Sure you will pay more. But you get the savings component (another way to save money) and a fixed premium rate for a policy that will last your whole lifetime.
And as you can see on our pros and cons list above, each product has its own merits and faults. The bottom line is that you shouldn’t immediately count out whole life because. For the right person, it can be a great way to get protection and savings at the same time.
Having the option to access the funds in your insurance can help when you’re in a tough financial situation. Depending on the insurance company, this cash value can also be added to your death benefit payout, a plus for your beneficiaries.
How long does it take for whole life insurance to build cash value?
In case you’re wondering, there are some instances wherein your cash value becomes greater than your total premium. It may take some time and will depend on how much premium you’ve put in but it is possible.
The Society of Actuaries (SOA) estimate this usually occurs around years 12-20 of the policy. This may seem rather slow in terms of cash accumulation but it still works for those who are in it for the long haul.
Ways to use the cash value of whole life insurance
One of the reasons why whole life is more expensive than term is because a portion of your payments is being allocated into the cash value. This cash value usually grows at a slow rate but will start to pick up after several years. The good thing about it is that its interest grows tax-deferred. Here are 3 ways you can use it:
Use it for paying your premiums
Also known as being “paid up”. You can actually use the portion you saved as payment for the premiums.
Take a loan against it
In case you need an additional source of funds (for financial emergencies, for example), you can take a loan against your cash value. In most cases, the interest rate is lower than what is offered in banks.
The important thing to remember is that even while you are not obliged to pay it back, the money you owe plus the interest will be deducted from the death benefit when you pass away.
Option for full or partial withdrawal
Some whole life policies offer the option to partially or fully withdraw the cash value in your insurance. Should you use this feature, they will deduct the same exact amount (can be greater than what you took out on some policies) from the death benefit. Make sure to check with your insurer how much it will be before you decide to proceed.
Reasons for choosing whole life insurance over term life
If you’ve been checking online for information on life insurance, you’ve probably stumbled upon the “Term vs. Whole Life” argument. At its core, the “one thing” that term life has going for it is its significantly lower premium price. It’s considered by many as the best choice for people looking for a low-cost solution and needs it only for a certain period of time.
Whole life insurance, on the other hand, has the following benefits that some people consider absolute must-haves when getting life insurance:
It lasts for your entire lifetime
Most term life insurance coverages last 10, 20, or 30 years. This means that after it expires, your two main options are either to renew it or purchase a new one. Both options will have you paying a more expensive premium compared to your original policy.
Some insurance companies also allow their policyholders to convert their term life into whole or permanent. This might be a good alternative for people who took a term policy early in life and now want something that will last until they die.
Cash value component
Aside from its non-expiring coverage, the one thing that separates whole life from permanent life is its cash value feature. In a nutshell, the insurer takes a portion of your premium and invests it for a guaranteed return. The premiums allocated into the cash value are usually higher in the first few years of the contract in order to build it up faster so it can benefit from the interest.
In addition, you can borrow small amounts over the course of your policy which can be handy when you’re in a bind. Most people consider the cash value component as a useful add-on for boosting their savings or retirement funds.
Option to add riders during the course of the policy
Think of riders as optional features you can purchase when buying a new car. Things like navigational systems, sunroof, backup camera, and others are some examples. In a similar fashion, riders are optional add-ons you can purchase that you might find useful during the course of your coverage. Here are some of the most popular whole life insurance riders:
- Critical Illness Rider- The ride provides the policyholder diagnosed with a critical illness with the necessary funds for treatment.
- Accelerated Death Benefit Rider– Gives the policyholder the option to access a portion of their death benefit funds should they become terminally ill.
- Rider for long term care – Gives the policyholder the option to access a portion of their death benefit for use for long term care expenses.
There are plenty of other optional riders out there as well. While term life prides itself for being the least-expensive option, it is considered mainly a barebones solution. People looking for a more robust and flexible coverage might find these riders useful depending on their situation.
Guaranteed benefit for your loved ones
As long as you’re paying the necessary premiums, whole life insurance isn’t going to expire. If you’re a parent with a special needs child, for example, this gives you peace of mind since you know that your child will receive the benefit should you pass away.
This lasting coverage also lets you skip the decision-making process that term policyholders need to make when their coverage expires: “Should I renew or buy new life insurance?” As you know, renewing your term life insurance when you’re older is going to be more expensive than your previous one.
What whole life insurance is best for
Now that you know what whole life insurance is all about and how it compares versus term, you’re probably asking, “Is whole life insurance the best choice for me?”
It all depends on this one main question: “What is your financial goal?”
If you’re looking for life insurance coverage for a specific amount of time only (say, until your kids graduate from school), term life insurance might be your best bet. It’s pure insurance protection at a significantly lower price when compared to whole life.
If you’re looking to leave a legacy (create an estate), wish to pay level premiums, want to make sure you’re beneficiaries will be covered for your entire lifetime, and find the cash value benefits useful, whole life insurance can be a great option.
Should you wish to know more if whole life insurance is best for you, you can seek help from a professional so they can assess and provide you with choices that fit your preferences and needs. Even if you already have existing life insurance, it’s still a good idea to reflect on your current and future situation to determine if what you have still fits your needs.
As Silverhart says, “Policyowners must reassess their current need for death coverage. That assessment is critical in order to be able to determine which product type (or option with current policy) will best meet their needs moving forward”.
If you don’t have life insurance yet, don’t waste time. Everyone needs protection, and it’s a smart idea to start as early as you can.