Whole life insurance is a type of permanent life insurance that accumulates cash value. In addition to paying a death benefit, whole life insurance also contains a savings component in which cash value may accumulate. Interest accrues at a fixed rate and on a tax-deferred basis. Whole life insurance policies will cover you in cases of accidental death, death from natural causes, pandemic illness, etc.
The cash value component grows as the insurer pays policyholders dividends, a portion of the insurance company’s revenue that is paid to policyholders. Policyholders may be able to withdraw from or borrow against the cash value portion of their policy to fund expenses while they are living.
How Does It Work?
Whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level, regularly-due premium payments. The policy includes a savings portion, called the “cash value,” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis. Cash value growth is an essential component of whole life insurance.
To build cash value, a policyholder can remit payments more than the scheduled premium. Policy dividends can also be reinvested into the cash value and earn interest. The cash value offers a living benefit to the policyholder. Over time, the dividends and interest earned on the policy’s cash value will often provide a positive return to investors, growing larger than the total amount of premiums paid into the policy.
To access cash reserves, the policyholder requests a withdrawal of funds or a loan. Interest is charged on loans with rates varying per insurer. Also, the owner may withdraw funds tax-free up to the value of the total premiums paid. Unpaid loans will reduce the death benefit by the outstanding amount. Withdrawals and unpaid policy loans reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could moreover chip away at the death benefit or even wipe it out altogether.
To enroll in a whole life insurance policy, you will need to:
- fill out the application: most insurance companies will require you to fill out an application that asks for personal and medical information. You may also be required to undergo a medical exam.
- pay the premium: once you have been approved for coverage, you will need to pay the premium to activate the policy. Premiums for whole life insurance policies are typically higher than those for term life insurance, but the coverage is permanent and may include a savings component
Death Benefit And Choosing Beneficiaries
When you buy a policy, you will choose a life insurance beneficiary to receive the death benefit. You don’t have to split the payout equally among beneficiaries. You can designate the percentage for each, such as 75% for Mary and 25% for John. It is also a good idea to designate one or more contingent beneficiaries. These beneficiaries are like your backup plan in case all the primary beneficiaries are deceased when you pass away.
Designating beneficiaries is an important task, as is keeping your designation up to date with your wishes. The life insurance company is contractually obligated to pay the beneficiaries named on the policy, regardless of what your will says.
You can tap into cash value with a withdrawal or a loan, or also by surrendering the policy. If you take a loan, it’s tax-free, and you can pay it back, with interest. There are no taxes as long as your withdrawal is less than the portion of your cash value that’s attributable to premiums you’ve paid. If your withdrawal is greater, you will owe taxes on the difference because those are investment gains. Outstanding loans and withdrawals will both reduce the amount of death benefit paid out if you pass away. That’s not necessarily a bad thing. After all, one of the reasons to buy a whole life insurance policy is to get cash value.
Example Of Whole Life Insurance
For insurers, the accumulation of cash value reduces their net amount of risk. For example, T65 Solutions issues a $25,000 life insurance policy to Mr. Grey, the policy owner and insured. Over time, the cash value accumulates to $10,000. Upon Mr. Grey’s death, T65 Solutions will pay the full death benefit of $25,000. However, the company will only realize a loss of $15,000, due to the $10,000 accumulated cash value. The net amount of risk at issue was $25,000, but at the death of the insured, it was $15,000.
Whole Life Insurance Costs
The cost of insurance varies and is based on several factors, such as age, occupation, and health history. Older applicants typically have higher rates than younger applicants. Insureds with a stellar health history typically have better rates than those with a history of health challenges. The face amount of coverage also determines how much a policyholder will pay; the higher the face amount, the higher the premium.
Interestingly, certain companies have higher rates than others, independent of the applicant and their risk profile. It doesn’t matter that for the same amount of coverage, a whole life insurance policy will be more expensive than a term life policies.
Factors that affect Whole life insurance premiums are but are not limited to: age and gender; height and weight; previous and current health conditions; health history of your siblings; nicotine and marijuana use; substance abuse; having a credit, criminal history, or driving record, and being part of dangerous hobbies and activities.
For example, premium rates can often range from 243$ to 288$ a month for a 35-year-old non-smoker if the coverage amount is 250 000$.