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By Gabriella Cruz-Martínez and Andrea Agostini
Updated: May 13, 2021 6:39 AM ET | Originally published: May 10, 2021

Whole life insurance is a type of permanent life insurance that provides a guaranteed death benefit while also allowing you to build cash value that can be used in several different ways. However, it’s also expensive, and the growth of your cash value depends on factors you can’t control, such as interest rates.

Our in-depth guide covers how whole life insurance works, its benefits and downsides, as well as its costs to help you decide if whole life insurance is the best option for you.

Table of Contents

What Is Whole Life Insurance?

Whole life insurance is a permanent alternative (over your entire life, though insurers may set a limit at age 100 or 120) to term life insurance, a simpler life insurance product that only provides coverage over a specific period of time.

These policies offer “a guaranteed rate of return on the cash value, the promise that your life insurance premiums won’t go up, and a guaranteed death benefit that won’t go down,” said Faisa Stafford, president and CEO of Life Happens, an educational nonprofit on life insurance.

Whole life insurance consists of two parts: a death benefit and a savings component called the cash value. The policyholder pays fixed level premiums to the insurance company, and this is allotted between several portions. Part goes to the death benefit, part goes to cover the insurer’s operating costs and profits, and the remainder goes to the cash value cash value account.

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Death Benefit

The death benefit of a life insurance policy (irrespective of the particular type) is the face value that will be paid out tax-free to the policy’s beneficiaries when the insured person passes away.

Cash Value

A whole life policy’s cash value amount is “guaranteed,” meaning that the insurer pledges to uphold a minimum interest rate. The cash value component serves as a living benefit for the policyholder — a savings and investment account that policyholders can access throughout their lifetime. The account will grow on an income tax-deferred or tax-free basis as you continue making payments and earning interest.

During the first years of a whole life insurance policy, a large percentage of the premiums are allocated to the cash value. Over time, this amount decreases as the cost of insuring you increases.

The cash value goes back to the insurance company when the policyholder dies — unless they’ve purchased a rider that entitles beneficiaries to receive the policy’s face value (the death benefit) as well as the cash value.

How Does Whole Life Insurance Work?

Whole life insurance coverage

Whole life insurance covers the costs associated with your death and guarantees a lump sum death benefit to your beneficiaries the moment of your passing. The policy will remain active throughout your life if payments are current, with no need to re-apply and no expiration date.

The coverage amount won’t change during your lifetime, but if you borrow money from your cash value and don’t pay it back before you die, that amount will be deducted from the death benefit.

Whole life insurance eligibility

Eligibility is determined by age, gender, employment information, medical history and lifestyle.

Insurers require a medical exam to measure an applicant’s overall health profile and find any risk factors.

If you’d rather skip this step, some companies offer an alternative no medical exam underwriting process you can look into.

Whole life insurance cost

Whole life insurance is considerably more expensive than other types of life insurance. According to Chris Huntley, life insurance consultant and founder of If You Build It, it can cost up to 10 times more than term life insurance.

Monthly premium payments for whole life insurance range from $40 to $300, but the final amount ultimately depends on your individual profile, the type of coverage, and any riders you add to your policy.

Rates for the exact same life insurance product will also vary from one insurer to the next, because life insurance companies calculate costs according to their own underwriting guidelines.

Whole life insurance policy premiums are based on:

  • Age and gender – The younger you are, the lower your premiums will be. Premiums for women also tend to be more affordable than for men.
  • Medical history – Insurance companies look at your own medical history and your parents’. Pre-existing conditions or family history of chronic conditions will drive up premiums. Expect a medical exam or health questions to assess your health.
  • Smoker Status – Your premiums could increase by as much as 20% if you smoke cigarettes or use tobacco (cigars, snuff, and chewing tobacco).
  • Hobbies – Practicing extreme sports like skydiving and rock climbing raises premiums.
  • Occupation – Working high-risk jobs (ex. police officers, construction workers, pilots and firefighters) impacts insurance premiums.

Whole life insurance dividend benefits

Some whole life insurance companies allow policyholders to earn dividends, in addition to the cash value component. These are partial refunds of premium payments that are distributed yearly.

“While your policy’s guarantees provide a minimum death benefit and a certain cash value, dividends give you the ability to receive an enhanced death benefit and increase cash balance over time,” said Stafford.

You can even apply those dividends to the policy to offset the eroding effects of inflation on the amount of coverage you’ve purchased.

However, dividends are not guaranteed. They depend on the insurance company’s overall performance and whether it earns a surplus.

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Whole Life Insurance and Your Cash Value

Most people buy permanent policies to build tax-deferred cash value over time. Used almost as an investment account, it can provide retirement income, college tuition funds or emergency funding.

There are four ways to access a policy’s cash value:

  • loans
  • withdrawals
  • surrendering the policy
  • using it to make premium payments

Nevertheless, tapping into a policy’s cash value earnings is not always a net positive, and policyholders should be aware of the potential risks involved.

Policy loans

Policyholders can take out a loan with the insurance company by using their cash value amount as collateral. A policy loan will give you access to tax-free cash value earnings, with a flexible repayment plan, low interest rates, and less restrictions than other types of loans.

However, a mismanaged cash value loan can lapse your policy, affect the fund’s tax-exempt status and reduce the death benefit beneficiaries would have received.

We advise that you proceed with caution when borrowing from a whole life insurance policy. It can be a good idea if you are in desperate need of funds, but you should weigh the benefits of cash now against the potential downsides.

Withdrawals or partial cash surrender

Policyholders can make withdrawals, otherwise known as partial cash surrenders, directly from the cash value. Keep in mind that all withdrawals are final and can reduce the policy’s death benefit your beneficiaries will receive. Withdrawing the full cash value amount will also trigger a policy lapse.

These are also taxable if they’re part of your investment returns. In order to be tax-free, withdrawals cannot exceed the policy basis, that is, the cumulative amount you’ve already paid in premiums.

Paying premiums

Once the cash value has grown enough, policyholders can use it to cover monthly premiums and stop making payments out of pocket.

Nonetheless, it will take several years of paying high premiums before this is possible. Further, if the cash value account is completely drained paying for premiums, the policy may lapse.

Some policies offer an optional clause called a waiver of premium, which as the name says, waives premium payments if the insured person becomes critically ill or disabled.

Surrendering policy

Surrendering a policy effectively cancels it, nullifies the death benefit, and lays claim to the remaining cash value.

Insurers will give you what is called the cash surrender value. This is what’s left after surrender charges and fees are subtracted from the full cash value.

Any cash value amount that exceeds the premiums you’ve paid is subject to taxes so it’s important to know how much taxation will affect your earnings before surrendering the policy.

Before tapping into your cash-value account, remember:

  • Withdrawals and loans that exceed the cash value amount will be subject to taxation.
  • Withdrawals and outstanding cash value loans will reduce the death benefit payout to your beneficiaries, and increase the risk of the policy lapsing.
  • Due to its low annual growth rate, it can take up to 10 years to build enough funds before you can actually borrow.

Is Whole Life Insurance Worth It?

Many people opt for whole life because they’d like a source of reliable income in case of emergency or during retirement. There are, however, other options that might serve a similar purpose, such as an annuity. This is also an insurance product that you pay into, but its purpose is expressly to provide a lifelong income stream.

Experts recommend talking to a financial advisor and taking a careful look at all of your options before purchasing a whole life insurance policy.

Fixed premium payments and a death benefit that remains the same for the life of the policy may be ideal for someone who prefers to keep their finances consistent.

However, a buyer that prefers flexibility and affordability may be better served with other types of life insurance, like a universal life policy or a variable universal life policy.

Whole Pros Whole Life Cons
Lifelong coverage High premiums
Fixed premiums Slow rate of return on investment
Investing component High initial commission fees
No expiration date Takes 10-15 years for policyholders to build enough cash value for a loan
Potential to earn dividends Cash value does not go to beneficiaries
Cash value loans or withdrawals Withdrawals may be taxable income
Loans and withdrawals have no use restrictions Outstanding cash value loans are deducted from death benefit payout

Do I Need Life Insurance?

The question of who needs life insurance is very personal, but buying coverage could make a huge difference to your survivors and dependents if you died unexpectedly.

Common reasons to purchase life insurance:

  • Parents – To ensure the financial well-being of children (fund education, build a trust for children with special needs, etc.)
  • Couples – To cover daily and future living expenses, such as mortgage payments, for a spouse or partner.
  • Seniors – To cover financial obligations, funeral costs, final expenses, and supplement Social Security Income.
  • Business owners – To ensure the operation of a business after the owner’s death or to cover debt related to its operation, especially if it’s backed by assets like a family home or the family needs to buy the shares of a partner.

Who is whole life insurance best for?

Buyers with disposable income

Whole life is an attractive option for people who have a lot of disposable income and don’t want to worry much about life insurance after they purchase it. The cash value acts as an added bonus, not their main investment fund.

Businesses that need to insure a “key employee”

Businesses purchase key man whole life insurance to insure one or several of the company’s employees. The company is both the owner of the policy and the beneficiary.

The death benefit is paid out to the business in the event of the insured’s death and serves as a buffer for any financial setbacks after the loss of an essential employee.

“A lot of businesses will fund retirement plans using whole life insurance because they can use the death benefit as a ‘key person’ insurance while the employee or key executives are still working,” said Huntley.

“The advantage being that when the employee leaves, they’ll have a cash value account that acts as a supplemental retirement plan for the owner of the business,” he added.

People who need estate planning

A whole life insurance policy gives beneficiaries a tax-free, lump-sum death benefit they can use to cover estate taxes and other death-related expenses, in case of the policyholder’s unexpected or accidental death.

Who may not benefit from whole life insurance?

People in average income brackets

“I don’t think it’s for the average Joe or Jane making $60,000 to $70,000 per year,” said Huntley. “The only way whole life makes sense is if you’re very wealthy and have a complex estate situation where you have a lot of assets.”

Younger people who work, have dependents, large mortgages, and other debts are best served by term life insurance, which offers the most protection at the lowest cost.

Seniors who need to boost their retirement

Seniors should look into other life insurance for seniors and consult with a financial advisor before considering a whole life policy.

Cash value will grow at a very slow rate, and you will pay extremely high premiums without seeing a significant return on investment.

Buyers looking for investment opportunities

Whole life is attractive because of its stability and usefulness as a tax shelter, not because of its performance.

You’re better off maxing out your 401(k) and IRA contributions before considering whole life insurance for its investing benefits.

The cash value of a whole life insurance policy resembles money in a savings account. The money is safe and secure, but it won’t earn impressive rates.

Alternatives To Whole Life Insurance

A whole life insurance sounds good on paper and appears to offer more peace of mind, but there are other life insurance options that can better fit your personal and financial goals.

Term life insurance policy

Different from permanent, term life insurance policies offer a high, albeit temporary, life insurance coverage amount for less money. It works for people looking for affordable life insurance for a limited amount of time.

Premiums are based on your age, health, and when you choose to purchase or renew your policy.

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Permanent life insurance policies

There are other types of permanent life insurance policies, besides whole life, despite the fact that both titles are sometimes used interchangeably.

The following permanent coverage policies include a savings component and have their own set of rules that set them apart from traditional whole life insurance:

Universal Life Insurance Survivorship Life Insurance Variable Universal Life Insurance
Lifelong coverage Covers two policyholders and pays off after the second individual’s death Cash-value accounts can be invested in a number of sub-accounts
Flexible premium options Beneficial for families with special needs considerations These make profits when the market is doing well or incur losses when the economy is down
Cash value components subject to market fluctuations The principal policyholder can include a Special Needs Trust in their estate plans

FAQs

What is whole life insurance?

Whole life insurance is a type of permanent policy that offers a death benefit and a cash value component, the latter of which grows and earns interest over time.

The policy does not expire if payments are up to date. Premiums are more expensive than term life insurance, but they won’t change during the lifetime of the policy and the death benefit is guaranteed.

What is the difference between term and whole life insurance?

Whole life insurance has a guaranteed lifelong death benefit, cash value component, fixed premium prices, and may pay out annual dividends. Premiums are significantly higher than term life.

Term life offers a death benefit for the duration of a term, but the death benefit is lost if the policyholder outlives the term (10-130 years). This type of policy offers significantly lower premiums, but they may increase with time. There is no cash value component and it is not eligible for dividends.

How much life insurance coverage do I need?

The general advice is that you purchase a policy that covers up to 10 to 15 times your annual income, but it may be more if you have dependents, financial circumstances and goals.

To better determine how much life insurance coverage to buy, consult a financial advisor or a certified financial planner to go over your options — especially if you’re thinking about whole life insurance.

What are the best whole life insurance companies?

The best whole life insurance companies will have good financial strength as rated by A.M. Best and other credit agencies.

Northwestern Mutual, New York Life, and State Farm top our list of the best life insurance companies.

You can get life insurance quotes online but keep in mind this is still a traditional business, so some of the best coverage requires speaking directly with an insurance agent.

Does Covid-19 affect my whole life insurance policy?

Insurance companies legally cannot change the terms of an active policy, so even if you get Covid-19, or are at a high exposure risk, the policy’s coverage won’t change and premiums will remain the same.

If the policy is active, and you die from coronavirus-related complications, your beneficiaries will still be entitled to the full death benefit.

Covid-19 survivors looking to purchase a policy may need to provide additional medical records and evidence of recovery. New applications are also experiencing longer wait periods and higher life insurance rates.

Covid-19 may affect the underwriting process of life insurance in the future, as companies study the data on the long-term consequences of the virus. This could result in higher premiums for COVID-19 survivors, but nothing is set in stone yet.

Bottom Line

Life insurance isn’t for everyone, but it provides a financial safety net for any loved ones you leave behind, or have a business or charity that you care about.

Life insurance can fall into two categories: term or permanent life. Those seeking lifelong protection, are interested in investing in an income tax-deferred cash-value account, and can afford to pay a much higher premium may consider whole life insurance.

A whole life plan will guarantee your dependents are taken care of in the event of your death, as long as the premiums are current.

If you accumulate enough cash value, you can take advantage of its living benefits, too. You can borrow money from that account to cover expenses such as funding college tuition for a child, purchasing your first home, or having a nest egg for your retirement.

Before shopping for whole life insurance, consult a financial planner so they can help you determine if whole life insurance is right for you.

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