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What Is Whole Life Insurance Explained – Definition & Benefits

By Evan Pierce

whole life insuranceHaving spent 20 years on Wall Street, I was fortunate enough to meet many intelligent people – and on Wall Street, intelligent people become rich. So when I was speaking recently to my old boss, I asked him about the stock market and what he was buying. He told me he hadn’t bought a stock in 10 years.

What’s this? Everybody on Wall Street has a couple of favorite stocks that they love to brag about. So where on earth was he putting his money? His answer: “Whole life insurance.”

That answer could not have been more surprising, but after an hour he had me totally engrossed in the concept. He had done so much research and analyzed all of the components so thoroughly, I knew that he was right on the money. This is what smart, wealthy people are doing with their money, and they’re getting wealthier. Why? Because they are taking advantage of built-in savings options, tax advantages, and dividends.

What Is Whole Life Insurance?

Whole life is a type of life insurance contract that provides insurance coverage of the contract holder for his or her entire life. Upon the inevitable death of the contract holder, the insurance payout is made to the contract’s beneficiaries. These policies also include a savings component, which accumulates a cash value. This cash value is one of the key elements of whole life insurance.

Similarities & Differences to Term Life Insurance

  • Just like term life insurance, beneficiaries exist in a whole life insurance policy. They receive the death benefit upon the contract holder’s death.
  • The most obvious difference, at least superficially, is cost. In some cases, whole life insurance premiums are three to five times as much as term life premiums, at least at the onset. However, term life insurance lasts a “term”: a specified period, usually 10 or 20 years, before the policy expires. The younger you are and the better health you are in, the lower the cost. When the term is up, you can renew the policy, generally at a much higher premium, and depending on your age and health. Whole life insurance premiums, while higher initially, never go up – this is key. The policy is structured to last your entire life, and as long as you keep paying the premiums, the policy will be in force regardless of age and health.
  • The premiums in whole life policies go towards a cash value as well as a death benefit – term life has just a death benefit.

Are the Higher Premiums Worth the Cost?

Are the higher premiums worth the cost? In a word, yes.

The first key advantage of whole life insurance is that the cost of the premiums paid to the policy never increases, as long as you make sure to pay the premiums and the policy doesn’t lapse. The reason why this is important is because with term policies, your rates rise over time. This is due to the changes in your health and age. As you get older, your chances of dying increase. Since the life insurance company takes on that risk, they increase the cost of premiums.

With whole life insurance, the premium cost stays the same as long as the policy is in force. Even if you become gravely ill, the cost never changes. It’s guaranteed – as long as you pay your premiums. In fact, as the years go by, the policy actually gets cheaper. This is because of inflation, which erodes the value of money. By having a premium that never changes, you are essentially paying for the policy with “cheaper dollars.”

The cost of term life polices, on the other hand, is only guaranteed until the end of the term – usually 5, 10, or 20 years. After this point, term policy premiums can be raised based not just on your age and health, but also on the rise in inflation.

whole life insurance covers you throughout your entire life

Cash Value, Taxes, and Dividends

In whole life policies, the premiums paid go toward increasing the cash value and, if you are willing to pay more, increasing the death benefit. Further, your cash value earns interest similar to a savings account.

Your cash value and death benefit can never decrease in value unless you start withdrawing the cash value from the policy, or unless you stop paying your premiums. In this way, your whole life policy is akin to a savings account: When you pay your premium, part of the money goes toward the insurance costs, while the rest goes towards increasing your cash value. This cash value earns interest, which is guaranteed by the insurance company, as is the death benefit. The guarantee is as strong as the company that holds your policy, so financial stability is a key element in choosing an insurance company.

Tax Advantages

When you put money into your 401k or traditional IRA, you are only deferring taxes, as you pay taxes on all of the money when you withdraw it during retirement. With a whole life insurance policy, you pay the premiums with after-tax dollars. The cash value grows without taxation. You would only be taxed if your withdrawals from the policy exceed what you put into it, and you have the ability to remove gains tax-free by taking a loan off the policy.

Dividends

The whole life policy pays a dividend. The key thing here, again, is that these dividends aren’t taxed, but are considered returns of premium. So, if at the end of the year the insurance company pays out $1,000 in dividends on your policy, you don’t pay taxes on that money. You can take that money in the form of a check, reinvest it in the cash value of the policy, or use the dollars to purchase additional, paid-up insurance. Those dollars will buy more life insurance, provide a bigger death benefit, and earn interest.

Borrowing Against Your Policy

It is possible to borrow against the cash value of your whole life insurance policy. For example, if you ever find that you are in need of cash, perhaps to help pay for a child’s education, you can borrow money from the cash value of the policy. You do pay interest to the insurance company on this loan, but the loan rates are very competitive with regular bank rates on home equity lines. In most cases, the loan balance can be repaid at the time of death by deducting it from the death benefit.

Also, there’s the potential for tax-free income. By borrowing against the policy, you can take money out of the policy tax-free. Though you will pay interest on the loan, depending on your income tax bracket, it can be substantially lower than what you’d pay in taxes. This also allows individuals younger than 59 1/2 to access income for an early retirement without having to pay hefty taxes and penalties.

Lastly, and particularly appealing to the very wealthy, is the fact that in some states, all or most of the money in a whole life policy is exempt from creditors. In these states, if you are ever sued, that money is viewed as protected because it is intended to benefit someone else: the beneficiary.

The Strength of the Insurance Company

Since whole life insurance policies are a true long-term investment, your relationship with the insurance company will literally last a lifetime. Picking a company with the highest ratings both for financial stability and customer service is the key. Do your homework and make sure that you feel comfortable with your insurance broker. Remember, the guarantees offered in whole life policies are only as strong as the companies who make them.

The highest rated overall insurance companies according to ConsumerSearch.com are as follows:

choose an insurance company you are comfortable with

Disadvantages of Whole Life Insurance

While there are many positive aspects to whole life insurance, there are also some disadvantages to consider:

  1. The cash value of a whole life insurance policy will not start to build until two to three years of continual premium payments.
  2. Whole life is much more expensive than other types of life insurance, such as term life. Make sure that the cash value and permanence of the insurance policy justify the excess premiums relative to a term policy with the same death benefit.
  3. Whole life policies can be extremely complicated and there are subtle differences between policies. Careful research, a solid relationship with the insurance agent, and a clear understanding of your insurance needs and priorities are keys to getting the right policy
  4. Whole life policies have a “surrender period”: A length of time that you must keep your money with the insurance company before withdrawing it. If you wish to withdraw it before the end of the surrender period, you pay a surrender charge, usually around 10% of the account value. Commonly a surrender period is 5 to 10 years, but you should read the policy carefully to make sure you understand how long this period is on your particular policy.
  5. Loans are not immediately available. Most policies have a minimum cash balance (typically at least $10,000) and a period of time you must have the policy (typically five years or more) before you can borrow against the policy. Once you have reached these milestones, you can typically borrow up to 75% of the cash value.

Final Word

The key to deciding whether whole life insurance works for you is to decide why you are buying insurance. In short, if you have a long-term insurance need and you want to supplement your retirement savings and long-range financial flexibility, a whole life policy is a great product.

The key to whole life insurance is to map out exactly what your overall financial picture is before going down that road. Once you have decided to invest in whole life, commit to it and understand its benefits and limitations so you can best utilize the policy to achieve your financial goals. Also be sure to consult a financial professional who is aware of all of your needs and concerns before making this decision.

Do you have a whole life insurance policy? What are some of the benefits that you’re most attracted to?

(photo credit: Shutterstock)

Evan Pierce
Evan Pierce has spent nearly 20 years as a commodity trader and market analyst. He is registered with the National Futures Association as a Commodity Trading Advisor (CTA) and has written and edited his own newsletter, The Position Sheet. He grew up in New Providence, New Jersey and now lives in Norwich, Vermont with his wife, three children, and their two Golden Retrievers.

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  • http://www.swimupstreamtowealth.com/ Kirk Kinder

    Evan – I am new to your site so I haven’t read much, but I totally disagree with this article. Usually, the beneficiary only gets the life insurance benefits, not the benefits plus cash value. Certainly, you can pay a rider to get both, but I rarely see customers with that option. The returns on whole life policies rarely do better than short term bonds. This is going to become even more true as many of the insurance companies that were holding 30 year bonds from the 80s are reinvesting at today’s low rates. Also, over 70% of these policies lapse within ten years so it is clear that these policies are pushed on customers and not useful to the client.

    Insurance should be used to cover risks you can’t afford to take yourself. If you want tax deferred growth, buy an annuity from Vanguard or another low cost provider. Then buy term for as many years as you can. The savings in insurance going into your annuity or other investments will eventually reduce or completely eliminate your need for insurance.

    Certainly, there are cases for whole life such as ILITs or business partnerships, but I don’t think promoting whole life as insurance is prudent for the vast majority of Americans.

  • http://www.facebook.com/people/Myrtle-Bobby/100002332665168 Myrtle Bobby

    Whole life as an investment is strictly for the wealthy with disposable income to spare and who can afford the hefty premiums for million dollar policies.

    For the average Joe or Jane, Universal Life is a far better type of low cost permanent life insurance policy with virtually all the benefits of both term and whole virtually non of the disadvantages.

    Best bet for young families is a combination of term plus universal.

  • http://twitter.com/thedebtfreebaby Ryan DeLeon

    I have never seen a case where buying term and investing the difference isn’t the better plan.

    • Vincent L.

      Ryan, taking into account that 90% of baby boomers cant produce enough income, 40k/yr to live and they have lived though one of the most prosperous times our nation has ever seen. I think the case is simple, by term and invest the different does not work. Also when you say “Invest”, I am assuming you mean 401k, stocks, mutual funds, etc. unfortunately that is just a crap shoot with little guarantees to the individual investor.

  • Mlewis1945

    Evan,
    In my experience, most people are way under insured. Few could afford the cost of adequate insurance coverage if they used whole life. The only supposed benefit that I might recognize is that the forced savings in order to keep the insurance, but that conflicts with the need to have an adequate amount in the first place.

  • Frank

    Interesting article. Thank You for sharing Your knowledge.

  • http://www.reisagency.com/ Samuel

    Kirk raises some good points. Likewise, that’s a good point about inflation negative affect on the dollar’s value. That could be a significant factor since the Federal Reserve has pumped up the money supply to such large extremes.

    • WF

      Speaking of inflation’s effect on the buying power of the dollar, you have to also apply this concept to the value and buying power of the death benefit. You see, an insurance company does not expect to pay out a death benefit until decades later in the vast majority of cases. Think about what the buying power of that death benefit is 20, 30, 50 years from when the policy was first purchased. Whole Life does not have an answer for this inflation risk. Buying paid up additions is not really an answer to inflation risk either because dividends are not guaranteed and you do not get enough additional insurance to have your death benefit keep up with normal inflation. That is why buying paid up additonal insurance is a rip off. You are buying something with present value money that is going to be worth less and less as time goes by. It is better to just take the dividends and invest it or use it to pay for part of your premium. These are my criticisms of WL.
      A better solution today is the Index Universal Life policy. Not only does it have a solution for the inflation risk of the death benefit (by taking advantage of the Corridor Rule), there are valuable accelerated benefits riders that give you the ability to make use of the death benefit while you are still alive if you meet certain triggering conditions that are health related.

  • q22222

    This is a foolish was to go. There is no real investment component. The best life insurance is “Private Placement Variable Life” , which has a real cash buildup using a choice of hedge funds
    which is rapped by the insurance and the grow this tax free and with the right structure is tax free of estate taxes in an ILIT.

    Companies like Philadelphia Life, American General, Prudential, John Hancock have it.

  • woogroove

    dose anyone know what the rider plan means with the whole life insurance???

  • Vincent L.

    Evan, great article, right to the point on benefits of cash value whole life insurance. Anyone with an income should have this. This is a true asset and closest thing to guaranteed as you can get.

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