Whole Life Insurance

What Is Whole Life Insurance?

Whole life insurance is one of the major types of permanent life insurance — the other being universal life.

Whole life policies provide coverage for the policyholder’s entire lifetime — so long as premium payments are kept in good standing. Unlike term life insurance, whole life policies contain a savings component, allowing the policy to build cash value over time. Under certain conditions, the policyholder is able to access these savings while still alive.

Whole life is one of the most common types of life insurance. Whole life is meant to protect you and your loved ones for your ‘whole life’ and, because of that, it can be more expensive to own. Due to the availability of the cash value, is can also be a creative saving and estate planning strategy for those with significant wealth.

Stephen Kates, CFP®Founder of Clocktower Financial Consulting

Stephen Kates is a Certified Financial Planner™ and personal finance expert specializing in financial planning and education. Stephen has expertise in wealth management, personal finance, investing and retirement planning.

Types of Whole Life Insurance

There are six basic types of whole life insurance, according to the New York State Department of Financial Services. All are based on long-term estimates of mortality, insurance company expenses and interest rates.

Types of Whole Life Insurance

Non-Participating Whole Life

A non-participating whole life policy provides a level premium and face amount across your entire lifetime. It typically has lower premiums and does not provide dividends even if the insurer has a profitable year.

Participating Whole Life

Participating whole life policies pay dividends based on the insurer’s performance over the year. You can use the dividends to reduce premiums, accumulate cash value in the policy or you can take them as immediate cash.

Economatic Whole Life

An economatic whole life policy combines participating whole life with supplemental coverage — which is paid for through dividends. This may cause fluctuations in the amount of supplemental coverage in the long run.

Indeterminate Premium Whole

These policies are similar to a non-participating whole life policy, but they provide adjustable premiums. Insurers charge a premium based on estimates of mortality, earnings on investments and operating expenses. If these estimates change, the company adjusts the premiums. But the premiums never go above the limit set in the policy.

Interest Sensitive Whole Life

The insurance company uses current changes in interest rates and the market to determine how it will allocate your premium payments. This allows the effect of interest rates to be reflected more quickly in your policy’s cash value.

Limited Payment Whole Life

These policies allow you to pay premiums for a limited time while providing lifetime coverage. Because you pay your premiums over a shorter period of time, the individual premium payments will be higher.

Single Premium Whole Life

With a single premium whole life policy, you make a single lump sum premium payment. No further payments are necessary. There are typically large penalty fees — called surrender charges — if you cash in the policy within a few years. These policies are typically seen as an investment vehicle.

Note: Any policy funded to a level that would exceed the amount required to be paid up fully in seven years is turned into a Modified Endowment Contract (MEC), which changes the tax treatment of the policy — among other changes.

How Does Whole Life Insurance Work?

Whole life policies are typically designed so that the death benefit and the premium remain level throughout the policy’s effective period.

Your premiums go toward the cost of insuring you, building cash value in the policy and fees the insurance company charges on the policy over time.

When you’re younger, the premiums you pay are more than it costs the insurance company to insure you. The company takes some of this extra money and invests it. It uses more of this excess money to defer the cost of insuring older clients — keeping premiums level for everyone throughout their coverage.

Eventually, this money builds up. Laws require that when they reach a certain level, the insurance company must put it into a savings account for the policyholder. As a policyholder, you can then borrow against this cash value of the policy under certain conditions.

Pros and Cons of Whole Life Insurance

Whole life insurance is designed to meet specific financial needs and goals. It may not be the best life insurance choice for you. Consider the pros and cons of whole life insurance when comparing it to other types of life insurance available.

Advantages of Whole Life Insurance

Whole life insurance provides lifelong coverage for as long as you live compared to term life, which only covers you for a specific period of time. It never needs to be renewed.

It also accumulates cash value — savings you can borrow against while you’re still alive making whole life insurance an investment vehicle that still pays a death benefit. The cash value is tax-deferred, meaning you don’t have to pay income tax on it as it builds.

Whole life insurance can be part of an effective estate plan strategy. The death benefit is protected from your creditors, and your beneficiaries don’t have to pay income tax on it when they receive it.

Disadvantages of Whole Life Insurance

Whole life insurance is expensive — typically much more expensive than term life insurance.

Whole life policies are also more complicated than term life and have less flexibility than universal life insurance policies.

There are also several other investment options that may offer a better return than a whole life insurance policy.

Whole Life Insurance vs. Term Life Insurance

Term life and whole life insurance are the most popular types of life insurance in the United States. They remain the most basic life insurance options, but have sharp differences from one another because they address distinct financial needs and goals of policyholders.

Differences Between Whole Life and Term Life Insurance

The biggest differences between term life and whole life insurance are the cost and the length of coverage.

Whole life does what its name says — it covers you for your whole lifetime. Term life provides coverage for the policy’s term — a specific number of years, typically one through 30. Whole life pays out no matter when you die — even if you live to be more than 100 years old.

When the term is up with term life, you lose coverage and you don’t get any of your premiums back. With whole life insurance, you build cash value that you can borrow during your lifetime or leave in the policy to increase the death benefit.

Because of the difference in length of coverage and the cash value element of whole life, whole life insurance is more expensive. You may be able to find a term life policy for a fraction of the cost of a whole life policy.

Which Is Right for You?

Whole life insurance and term life insurance are designed with different insurance and financial goals in mind. Consider your reasons for buying life insurance when deciding which type is right for you.

Term life insurance may be best if you simply want your life insured — providing a death benefit to help your family cover debt, expenses and financial goals should you die unexpectedly within a certain number of years.

Whole life will provide this coverage, but its advantages make it an investment tool as well. It can be used as a way to secure tax advantages over a simple inheritance while growing the value of your death benefit.

Whole life may also be a better choice if you have a dependent who will need financial assistance or support regardless of when you die.

Talking with an insurance expert or professional financial advisor may help you better understand which type of life insurance is best for your needs and goals.