What Is Whole Life Insurance?

Whole life insurance provides coverage throughout the life of the insured person. In addition to paying a tax-free death benefit, whole life insurance also contains a savings component in which cash value may accumulate. Interest accrues on a tax-deferred basis.

Whole life insurance policies are one of several types of permanent life insurance, meaning they cover you for your entire life. Universal life, indexed universal life, and variable universal life are others. You can choose a whole life insurance policy that works for you from one of these best life insurance companies.

Key Takeaways

• Whole life insurance lasts for an insured's lifetime, as opposed to term life insurance, which is for a specific amount of years.

• Most whole-life policies feature level premiums, meaning the amount you pay every month won’t change.

• Whole life insurance has a cash savings component, known as the cash value, which the policy owner can draw on or borrow from.

• The cash value of a whole-life policy typically earns a fixed rate of interest.

• Withdrawals and outstanding loan balances reduce death benefits.

How Whole Life Insurance Works

Whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level, regularly-due premium payments. Some policies include a savings portion, called the “cash value,” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis.1 Growing cash value is an essential component of whole life insurance.

To build cash value, a policyholder can often remit payments greater than the scheduled premium to purchase extra coverage (known as paid-up additions or PUA). Policy dividends can also be reinvested into the cash value and earn interest. Over time, the dividends and interest earned on the policy's cash value will provide a positive return to investors, growing larger than the total amount of premiums paid into the policy.

Types of Whole Life Insurance

There are several main types of whole life insurance, categorized based on how premiums are paid.

• Level Payment: Premiums remain unchanged throughout the duration of the policy.      This is the most common type of payment plan.

• Single Premium: The insured pays a one-time large premium, which funds      the policy for life. But this type of policy is almost always a modified endowment contract, which has tax consequences.

• Limited Payment: As the name suggests, you pay a limited number of payments.      Premiums will be higher than they would be in a level-payment situation,      but you’ll only pay them for a certain number of years.

• Modified Whole Life Insurance: The opposite of a limited payment policy, this type of whole life      insurance offers lower premiums than a standard policy in the first two or      three years, and higher-than-standard premiums in the later years. It is      more expensive in the long run.

Whole life insurance policies are further distinguished as participating and non-participating plans. With a non-participating policy, any excess of premiums over payouts becomes profit for the insurer. However, the insurer also assumes the risk of losing money.

With a participating policy, any excess of premiums is redistributed to the insured as a dividend. This dividend can then be used to make payments or increase one's policy coverage limits. However, dividends are not guaranteed and often vary each year, as they are primarily based on the company’s financial performance.

Advantages and Disadvantages of Whole Life Insurance

Advantages

• Lifetime coverage

• Cash value you can use for loans, withdrawals, or      premium payments

• Guaranteed death benefit amount

• Predictable premium payments

• Tax-free loans

Disadvantages

• More expensive than term life

• Cash value may grow slower than with other      policies

• No flexibility to adjust the premium

• Limited ability to adjust the death benefit

Advantages Explained

• Lifetime coverage: As with all permanent insurance, whole life insurance provides      coverage until the insured’s death.

• Cash value you can use for loans, withdrawals, or      premium payments: Part of each premium payment accumulates as cash      value, which you can withdraw or borrow against during your lifetime.

• Guaranteed death benefit amount: Your death benefit is established when you sign up for your policy      and stays the same while the policy remains active.

• Predictable premium payments: Your premium is also fixed at issue and will not typically vary      over your lifetime (unless you choose a non-level premium option).

• Tax-free loans: While      withdrawals of more than you’ve contributed to the cash value are taxed,      policy loans are not.3

Disadvantages Explained

• More expensive than term life: Premiums of a whole life policy are usually significantly higher      than term premiums because the policy accumulates cash value and covers      you for your whole life.

• Cash value may grow slower than with other  policies: The growth rate of your whole life policy’s cash value is fixed when you buy it, while returns on other types of permanent coverage (such as universal life) vary based on such factors as investment returns and interest rate fluctuations, so they could be      higher.

• No flexibility to adjust the premium: Unlike universal life policies, whole life plans do not allow you to change your premiums.

• Limited ability to adjust the death benefit: Your death benefit is also established when the policy is issued. While you cannot directly increase the original death benefit, you can use dividends to purchase additional coverage.