Whole life insurance is a type of permanent life insurance. Permanent insurance is designed to remain in force for the policyholder’s entire life, unlike a term life insurance policy, which is designed to remain in force for a specific period of time (the term). The premiums for whole life insurance in the early years are higher than they are for term policies, but are generally less expensive then term in the later years.
Whole life insurance provides the most significant guarantees of any life insurance policy. The death benefit, the premiums and cash value of the policy are all guaranteed.
Whole life policies build cash values, which growth is tax-deferred under current tax law. The cash value build up in these policies is the main reason premiums remain fixed for the life of the policy. Because whole life premiums in the early years are higher than the actual cost of insurance, the build-up of the cash value in the policy reduces the risk to the insurance company, allowing for lower premiums in later years than would be paid in a term life policy.
In addition to the guaranteed cash value, a participating policy’s cash value can also include dividends declared by the company, which the policyholder can choose to receive in cash or to reduce premiums, or to add to the policy’s cash value growth. These dividends can also be used to purchase additional insurance through what’s typically referred to as paid up additions.
The cash value of these policies can be withdrawn or borrowed against at very attractive rates. Policy loans can be taken income tax-free because they are not considered distributions. The ability to accumulate this cash value on a tax-deferred basis and borrow from it without any income tax consequences has made whole life insurance a popular option for many.
Typically, a whole life insurance policy’s premiums are set up to be paid until the policy endows (typically at age 100). A policy endows when the cash value equals (and becomes) the death benefit. However, because many people prefer to pay the policy off long before endowment, other payment options have been established. A few common options are paid up at 65 and 10-payment or 20-payment. There is also a single pay option, in which the total premium is paid in one lump sum. Doing so, however, changes the income tax consequences of withdrawals and policy loans. For this reason, the single-pay option is not a popular one.
Because of the permanent coverage, the guarantees, tax-deferred growth and liquidity these policies offer, whole life insurance has remained extremely popular over many years. And because of the market risk and low interest rates we are experiencing at the time of this writing, whole life insurance is being considered a viable asset class by many looking for safety and liquidity.