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 than term insurance in the later years.
Whole life insurance provides the most significant guarantees of any life insurance policy.
- The policy will remain in force for the lifetime of the insured as long as the premiums are paid. This means the insurer cannot cancel your coverage for any reason other than non-payment.
- Once your policy is issued, your insurance company cannot increase your periodic premium even if you become terminally ill or forced to live in a nursing facility or hospice.
- Your insurance policy will build cash value over time that you will have access to via policy loans, withdrawals, or policy surrender.
With whole life insurance, the policyholder owns their life insurance rather than renting it for a specific period of time like term insurance.
What is Cash Value?
Whole life policies have a cash value component where a portion of your periodic premium is diverted. This cash value account also earns a minimum amount of interest that is specified in your insurance contract. The funds in your cash value account accumulate on a tax-deferred basis under current tax law.
The cash value accumulation 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.
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The cash value of these policies can be withdrawn or borrowed against at very attractive rates.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.
What are the Payment Options?
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, 10-year payment or 20-year 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.
The Death Benefit
The death benefit in a whole life insurance policy is usually an amount that is specified in the policy contract. If the policy is eligible for dividend payments, the policyholder may choose to use the dividends to purchase additional death benefit, which will increase the death benefit at the time of the insured’s death. Conversely, unpaid outstanding loans taken against the cash value will decrease the death benefit.
Many insurance companies offer policy riders that serve to protect the death benefit in the event the insured becomes disabled or becomes critically or terminally ill. Other riders that are typically available include an accidental death benefit and waiver of premium riders.
What is a Settlement Option?
Life insurance policies always have a designated beneficiary who will receive the death benefit from the insurance company when the insured person passes away. There can be multiple beneficiaries on a policy but the insured needs to indicate to the insurer how much of the death benefit each beneficiary will receive. The amount each beneficiary will receive is typically listed as a percentage of the death benefit or a portion of the death benefit.
For example, if John Smith has a $100,000 insurance policy and wants the death benefit paid to his three grown children, John would have to specify how the $100,000 will be divided. His options would be to leave a percentage of the death benefit (ex: 33%), an amount of the death benefit (ex: $33,000) or he can use the term “share and share alike.” Either way will work as long as all shares add up to the total amount of the death benefit.
The Settlement Option describes the manner in which a beneficiary will receive the death benefit they are entitled to. Although many beneficiaries elect to receive the benefit in one lump sum, there are multiple options that the beneficiary can choose:
Interest Income Option: Using the interest income option, the life insurance company holds the funds and will pay a specified amount of interest on the funds. The interest can be disbursed on a monthly, quarterly, semi-annual, or annual schedule. When selecting this option, the beneficiary will have the capability to get a portion or all of the proceeds when needed.
This option is typically chosen when a beneficiary prefers to receive the life insurance proceeds at future date, for example, if the money was to be used for a child’s college education expense a number of years in the future.
Life Income Option: The life income option is comparable to an annuity. When deciding on this insurance settlement option, the policy’s beneficiary will be promised to get an income for the balance of his or her life – irrespective of how long it may be. The amount of the life income payout will depend on the amount of the death benefit and the age and gender of the beneficiary.
Joint and Survivor Life Annuity Option: If using the joint and survivor life income annuity option, the beneficiary will be permitted to annuitize the death benefit payments structured upon two or more individual lives.
This would mean that the benefit payments will be dependent on the amount of benefit proceeds, as well as the life expectancy of the named beneficiary who is anticipated to live longer. The payout of the benefit proceeds will consequently continue to pass from one beneficiary to the other up until the last beneficiary has died.
Specific Income Option: When a beneficiary chooses the specific income option, they will get an equal measure of income each year for a specific number of years up until all of the benefit proceeds have been paid out and if the beneficiary should die before all of the benefit income has been collected; another person could be chosen to accept the balance of the benefit payments until all benefit payments have been paid.
Fixed Period and Fixed Amount: The fixed period option will pay out both an amount of principal plus interest to the beneficiary during a stated time frame. If the primary beneficiary should die before the whole amount of the proceeds have been paid, the balance of the funds will be paid to the contingent beneficiary that was identified in the insurance policy.
Using the fixed amount settlement option, the death benefit proceeds will be dispersed in a fixed amount over time until both the principal and interest have been totally paid out to the beneficiary.
More than just a Death Benefit
Permanent life insurance like Whole Life Insurance provides more solutions than just a death benefit. There are other financial solutions that can be utilized during the lifetime of the policyholder.
Tap Into the Cash Value – As we mentioned above, your whole life insurance policy will accumulate cash value over time that you can access, and you don’t need a reason. There are three ways you can open the vault of your cash value account:
Policy Loan: Although the rules may differ by insurance carrier, most companies will allow the policyholder to take out a loan that may or may not be repaid. Keep in mind that any outstanding loans and unpaid interest will reduce the death benefit.
Accelerated Death Benefit: Most whole life policies issued today include an Accelerated Death Benefit. This benefit provides for the insurer to advance a portion of the death benefit to the insured in the event they are diagnosed with a terminal illness, a chronic illness, or need long-term care. The benefits available will depend on the policy you purchase and will typically be deducted from the death benefit that is eventually paid to the beneficiary.
Sell Your Insurance Policy: Life settlements provide a financial option for policyholders who want to get cash from their life insurance before death. This can be accomplished by selling your policy to an investor who is willing to pay more than the cash value but less than the death benefit for your insurance policy. After the transaction, the new owner will take over the premium payments and become the beneficiary on the policy. The investor’s profit is the difference between what they paid for your policy and the death benefit they receive when you die.
What we Recommend
Whole Life insurance is a financial product that offers several financial guarantees and can deliver both living benefits and a death benefit for the policyholder. Although whole life insurance is considered the cornerstone product of the insurance industry, it is likely not the best fit for everyone. We recommend that you contact one of our experienced and reputable independent agents to discuss your situation, and find out if whole life insurance is the best solution for your insurance needs.