Whole Life Insurance – What Is It & Should You Buy It?

Life insurance is one of the best financial decisions you can make when you have people who depend on you. But life insurance is complex and confusing. It can seem daunting when trying to decide how much you need and what to buy. There are dozens of different types of insurances and each insurance company has its own unique products. Whole life insurance is one of the more basic types of permanent life coverage.

But what is whole life insurance, how does it work, and is it right for you?

What Is Whole Life Insurance?

Whole life insurance is a traditional, permanent life insurance policy. It will provide death benefit coverage until you die, no matter how long you live. Additionally, whole life (WL) has a cash value account component. The cash value account is like a savings account that grows on a tax-deferred basis within your policy.

There are 2 main types of life insurance: Term insurance and permanent insurance. Term insurance only covers you for a set period of time, your ‘term’. It will eventually expire and if you outlive it, you typically get no money back from the insurance company.

(Although, there are options to extend your term insurance. Make sure to read about term conversion riders and post-level term before making a term purchase decision.)

Permanent insurance will cover you no matter how long you live as long as you pay your scheduled premiums. However, since the insurance company will pay out a benefit to you, the cost of permanent insurance tends to be 5 to 15 times more expensive than term.

How Much Life Insurance Do You Need?

The first question to answer, before which products to purchase, is how much life insurance do you need?

The short answer is, you need enough life insurance to provide for your loved ones in case you unexpectedly pass. Everyone is unique and the answer is specific to you. However, there are 5 methods that can be used to calculate a starting point:

• Income multiplier
• DIME Formula
• Human Life Value / Future Projected Income
• Percent of Income Spent on Premium
• Future Expected Expenses (DEEM Formula^TM)

Once you have a starting number, you can adjust it to fit your actual needs.

How Does Whole Life Insurance Work?

There are 2 components of whole life insurance, the death benefit and the cash value account. In exchange for these, you will pay premiums to the insurance company. Most WL policies have flat premiums over a set period of time.

It is very common to have a ‘pay through 65’ design where you pay a fixed amount through age 65. At age 65, your policy is ‘fully paid-up’ and you no longer need to pay premiums and the policy will be inforce until you die.

However, working with your insurance agent, you can design your product for other designs like a single-premium to an all-pay design. You can also have increasing or decreasing premium patterns.

A common WL design is to use your premium and policy dividends to purchase ‘paid-up additions (PUA)’. PUA is a purchase of small, fully-paid additional coverage. This results in an increasing death benefit over time. Additionally, as you purchase more coverage through PUA, you are eligible for higher future dividends. The end result is similar to a dividend reinvestment plan (DRIP) on dividend-paying stocks.

Death Benefit of Whole Life Insurance

The death benefit is paid out to your named beneficiary if you die while the policy is inforce. WL policies typically pay dividends based on your cash value and you can elect to ‘reinvest’ these dividends into the policy.

Death benefits are generally tax-free to your beneficiary, although some states do tax death benefits.

How Cash Value Feature of Whole Life Insurance Works

The cash value feature of a whole life policy functions like a high-yield savings account. A portion of each premium will go into the cash value account and gets credited interest each period. Over time, this cash value will build-up. This is ‘your money’ that you can use for many purposes:

• A living benefit to the policyholder to withdraw from
• Take a loan against your cash value

It is important to note that any withdrawals or loans will reduce your death benefit and may have tax consequences.

Paid-Up Additions (PUA) and Whole Life Insurance

Paid-up additions are additional insurance coverage that a whole life policyholder purchases using the policy’s dividends. When you elect to reinvest the WL dividends as PUA, that additional coverage then also earns future dividends. The value compounds over time leading to a higher death benefit and progressively larger dividends.

PUA are an optional feature on most policies. When you elect a PUA rider, you can still access the money through policy loans.

Each paid-up addition is fully paid-up and don’t increase future premiums. It is equivalent to buying small additional whole life coverage with a single-premium.

Each PUA has its own cash value and death benefit component. And since it is fully-paid up, there are no charges taken out of it allowing for accelerated compounding.

Overtime, your paid-up additions can grow your death benefit significantly. If you elect a shorter premium payment period, your PUA can lead to doubling or more of your death benefit over the life of the policy.

Should You Purchase Whole Life Insurance?

Your life insurance purchase decisions are unique for your specific situation. Whole life insurance can fit in many different personal financial plans.

The cash value component of whole life is a good way to force savings. The after-fee return on the premiums you pay is modest, however you get tax-advantaged growth.

Additionally, whole life offers a death benefit to help cover your loved ones. Life insurance is a key component of the protection bucket in the 5 pillars of personal finance. And WL can fill a portion of your life insurance needs.

However like all permanent insurance, whole life insurance can be expensive. WL is often 5 to 15 times as expensive as a similar sized term insurance product. It often makes sense to use term insurance as an inexpensive way to meet all your life coverage need. Utilizing strategies like a term insurance ladder or buying term & investing the difference (BTID) makes financial sense, especially when starting out.

Luckily, you can have as many insurance policies as you can get approved for. You can combine a smaller whole life policy with a larger term strategy. This can allow you a high amount of life insurance coverage when you are younger, while retaining permanent lifetime coverage and building up a cash value reserve.

Loans & Withdrawals

The cash value you build up in a WL policy is money you can access. To use this money, you request a withdrawal of funds or a loan. When taking a policy loan, you will be charged interest. However, this interest is often very close to the interest the insurance company credits your account. And, you pay the interest back to yourself. The net result can be a relatively cheap loan.

Withdrawals and policy loans aren’t risk-free though. Both will reduce the cash value on your policy. This will hinder future cash value growth from compounding.

Additionally, depending on the amount taken, you could see a reduction in your death benefit or even completely wiping out the death benefit. Some policies take proportional death benefit reductions, meaning a small withdrawal can lead to a decrease in death benefit many time larger than cash received.

Typically, withdrawals are tax-free up to the value of total premiums paid while loans are tax-free.

Lastly, unpaid policy loans & accrued interest can reduce the death benefit paid out to your beneficiary. It is important to review any policy decisions to ensure you aren’t unintentionally reducing benefits you want.

Additional Policy Riders

An insurance rider is an additional stand-alone feature you can purchase in addition to your base policy. The feature ‘rides’ on your base insurance policy, hence the name ‘rider’.

Life insurance policies typically offer a handful of riders. Two of the most common riders on WL are:

• Accidental death benefit
• Waiver of premium

Accidental death benefit riders will pay a larger death benefit if the insured dies due to accidental causes. The waiver of premium benefit rider will waive all future premiums if the insured becomes disabled or critically / terminally ill. This will help if you become injured and unable to make your premium payments.

The rider documents will define what incidents qualify under the rider. And both of these riders can be ‘free’ riders that come attached to the policy or may be purchased for a small additional fee.

Whole Life Insurance vs Term Life Insurance

Both whole life and term insurance are ‘traditional’ insurance products that have been around for a long time. They both offer a payout to your beneficiary upon the death of the insured.

However, there are major differences between term and whole life.

Whole life insurance offers a guarantee of a death benefit no matter how long you live. As long as you pay the required premiums, you can not outlive a whole life policy. Whereas term insurance has a maximum maturity date. When you purchase term insurance, you select a level-payment period where you pay a flat premium. Term usually comes in 10, 15, 20, or 30 year policies.

Whole life insurance also have a cash value component. If you surrender the policy or want to access the money while living, you can. While term insurance offers no cash value and when the policy matures or lapses there is no money received from the insurance company.

Lastly, whole life insurance is significantly more expensive than term to pay for the additional features it offers. Typically a similar sized whole life policy will be 5 to 15 times more expensive than term.

Whole Life Insurance vs. Universal Life Insurance

A common alternative to whole life insurance is universal life insurance. Both whole life and universal life (UL) are permanent insurance products, meaning you can’t outlive the policy. Additionally, both have a cash value component that can grow overtime.

However, there are some key differences between WL and UL:

1. Flexible Premiums: UL products have flexible premiums. You can pay any amount at any time and it is up to you to keep your policy account positive and policy inforce. WL policies are on a fixed premium schedule.
2. Flexible Death Benefits: UL contracts allow for more flexibility in increasing or decreasing the policy death benefit, while WL insurance has a more scheduled death benefit change.
3. Cash Value Usage: UL products share the ability to withdraw and take loans against your cash value. However, UL withdraws charges and fees directly from the cash value account, allowing you to alter or skip premiums based on the underlying cash value performance.
4. Secondary Guarantees: UL products often come with secondary accounts to offer secondary guarantees. For example, a no-lapse guarantee (NLG) shadow account that can keep the policy inforce even if your cash value account goes to zero
5. Investment Options: There are many different types of UL policies that allow for investing in different sub-accounts. For example variable UL policies typically allow for investing in equities giving a higher potential account value growth.

Universal life policies tend to be more complex and require more active involvement from the policyholder.

Lastly, WL tends to be sold by mutual companies whereas UL is sold by stock companies. Therefore, depending on where you go to purchase insurance you may only see one or the other available there.

(You can learn more about all the types of life insurance here)

Advantages of Whole Life Insurance

Whole life insurance comes with many advantages. When reviewing your insurance purchase decisions you should consider the benefits and downsides of WL. The advantages of whole life insurance are:

• Lifelong coverage that never expires or needs to be renewed.
• Fixed premiums at the schedule you choose. The premium won’t differ from plan if you follow the premium schedule and don’t take withdrawals or loans.
• Accumulation of cash value that you can use as a living benefit or to access funds.
• ‘Forced’ savings method in the cash value account that grows tax-deferred.
• Tax-free or low-tax way to estate plan.
• Tax-advantaged policy loans.
• Paid-up additions that can materially grow both your death benefit, future dividends, and cash value through the power of compounding.
• Life insurance typically avoids any probate court or claims by creditors.

Disadvantages of Whole Life Insurance

However, whole life also has some less beneficial aspects. Common disadvantages of WL are:

• Price – WL is expensive relative to term insurance, often costing 5 to 15 times more for a similar sized policy.
• Less flexible premiums than universal life as you have a set schedule.
• Accessing your cash value through loans and withdrawals may result in significantly larger decreases in death benefit than money received.
• Cash value growth is slower than expected with many other types of investments

The Final Word – Whole Life Insurance

Whole life insurance is a simple permanent life insurance product. WL is able to provide a benefit for your loved ones if you were to die, no matter how long you live. And having a cash value component is a way to force savings while having that life protection.

Although WL is more expensive than term, it can be a wonderful tool for you to use for life coverage and estate planning. Talk to an advisor and see if whole life is right for you.

Frequently Asked Questions (FAQs)