Whole-life insurance policies are complicated financial instruments. Consumers should develop a thorough understanding of a policy before purchasing it. There are a wide variety of policies and while the industry offers certain “standardized” policies, each insurance provider may offer terms that are unique. Additionally, policies can have significant tax implications that should be thoroughly understood before entering into a whole-life insurance contract. Each policy should be carefully reviewed to ensure a complete understanding of the specific terms of that policy. The information discussed below is not intended to be comprehensive, nor is it intended to be used in isolation; individuals looking to purchase a whole-life insurance policy should perform exhaustive research and discuss their options with a qualified financial advisor (a lawyer, a CPA, an insurance agent, etc.). The team at InsuranceSwami.com has made an effort to make this article as informative as possible; however we do not assume any responsibility for any action that you take as a result of reading this article.
What is Whole-life Insurance?
Understand all of the types of life insurance before deciding which policy is right for you!
“Whole-life” insurance is a policy that remains in place for an individual’s entire life. Upon death, the whole-life insurance policy’s death benefit is paid to the policyholder and the contract is considered complete. Whole-life insurance policies can either involve continuous payment during the insured’s entire life, or can be weighted to earlier payment streams (even a one-time payment at inception of the contract). Whole-life insurance policies are a form of a “permanent” life insurance policy, but are different from “universal” life insurance (as well as “variable universal” life insurance).
The first life insurance policies were term life insurance policies (aka “temporary” policies) and involved coverage only for a specified period of time. If the insured passed away during the term, a benefit was paid. If the insured did not pass away during the term, the insurance company kept the premiums paid over the life of the contract and the contract was considered complete.
Creating a Permanent Life Insurance Policy
Some consumers were not content with the temporary nature of the existing life insurance policies. These consumers wanted a guaranteed payment at the time of death. The industry reacted by developing whole-life insurance policies. By transforming the contract from temporary to permanent, the insurance industry transformed the death benefit from unlikely to guaranteed. The premium was significantly increased to compensate insurance companies for the cost of a guaranteed payment. Actuaries used mortality tables that extended to certain death to calculate the odds of an individual perishing at each stage in their life. Premiums were then calculated, which would enable the insurance company to collect sufficient payments (and to invest those payments) to adequately compensate them for: the guaranteed death benefit, the risk that insured individuals died earlier than expected and for a profit margin. Over time, the popularity of whole-life insurance policies increased and a number of permutations were developed.
“Cash-Value”
In essence, for most policies, the premium on a whole-life insurance policy is comprised of two payment streams. A payment stream for assuming risk of death during the period while the insured is living (effectively a term insurance policy) and then a payment stream that is invested by the insurance company during the life of the policy to fund the guaranteed death benefit. As the policyholder makes payments during the early period of the policy, the investment component accumulates “cash-value.” The cash-value of an insurance policy is based on annuity tables developed by the insurance company. The variables underlying the annuity tables are defined at the inception of the contract (including the rate of return), though they are not disclosed to the policyholder. Over time, as premiums are paid and interest is credits to the account, the cash-value of the contract grows. Since annuity tables are used to calculate the cash-value of the policy, these balances are known throughout the life of the contract (facilitating financial planning).
At some defined maturity date, the cash-value of the policy is equal to the death benefit. At death, the insurance company pays the contractual death benefit to the policy’s beneficiaries and the policyholder (or their estate) surrenders the cash-value (i.e. the investment account balance) to the insurance company. Since the policyholder’s premiums are accumulating an asset balance, most whole-life insurance policies allow the policyholder the option to cancel the contract at will.
Cancellation results in disbursement of the cash-value balance, less fees and other charges related to cancellation. In addition, with many policies, the policyholder is able to borrow against the cash-value of their policy (though this reduces the death benefit as the borrowings must be paid back to make the cash-value of the policy whole). Borrowings are usually tax-free, but tax is due on unpaid loans in excess of premiums paid, in the event that the insured dies before repayment.
Whole-life Insurance Offers Financial Flexibility
These features provide policyholders financial flexibility and many policyholders use whole-life insurance policies as a form of investing for retirement. Additionally, the cash-value of some policies can be used as collateral, assuming the policy is structured in a way that facilitates policy liquidation. Generally, upon disbursement of the cash-value of a policy, taxes are only due on the gains of the cash-value account (i.e. the disbursement less the sum of the premiums paid into the account). Taxes are not due on the death benefit of life insurance policies.
Most whole-life insurance policies require the policyholder to make payments throughout the life of the contract (i.e. while the insured is still living). There are policies that allow for alternate payment streams, such as one-time payments of a single large premium or accelerate payments over a shorter term.
Whole-life insurance can be a valuable instrument for retirement planning.
Types of Whole-life Insurance Policies
As mentioned, whole-life insurance policies can be structured in different ways. Standard policies though lead to efficiencies of scale, and allow for lower cost policies. Additionally, many insurance companies, including some of the top insurance companies in the world, choose to streamline their operations and only offer certain standard whole-life insurance policies. Some of the more common whole-life policies include:
“Non-participating” life insurance policies are characterized by pre-definition of the terms of the policy. In other words, all of the policy’s characteristics are established at the inception of the policy and do not change during the life of the policy. The generic policy discussed in the early part of this article is a non-participating policy. These policies are based on actuarial tables involving mortality rates and annuity rates. Since the terms are all defined at the inception of the policy, the insurance company assumes all of the risk of performance. If the insured dies before the actuarial estimates, the insurance company loses money. If the insured lives longer than intended, or the insurance company is able to generate a higher rate of return than originally estimates, then the insurance company profits.
“Participating” policies differ in that the insured shares in the risks that the actuarial estimates are inaccurate. Variances from estimates either result in increased premiums (if the actuarial rates prove to be to the cash-value’s detriment) or reduced premiums (if the actuarial rates prove to be to the cash-value’s benefit). Rather than reducing premiums, policyholders can also choose to receive dividends or reinvest the funds to increase the cash-value and/or death benefit.
“Limited pay” policies are whole-life policies where the premiums are only paid over a pre-defined term, not the insured’s entire life. They are normally participating, in that the policyholder shares in any over or under-funding of the cash-value (which may include reduction of the death benefit). Since the premium payment stream is shortened, the premiums are higher than under a policy that requires premiums to be paid throughout the contracts existence. Some limited pay policies involve a one-time (substantial) payment at the inception of the policy, whose cash-value builds over time. The contract can be structured so that the death benefit is fully funded at a pre-determined age.
Pros and Cons of Whole-life Insurance
Whole-life insurance policies are valuable in that they offer policyholders permanent life insurance; their beneficiaries are guaranteed a benefit payment upon the insured’s passing. In addition, whole-life insurance policies offer financial flexibility to the policyholder, allowing them to access the cash-value of the plan during their lifetime. This can have great value if there are life events that significantly alter the policyholder’s objectives or as a retirement tool, whereby the cash-value can be drawn upon tax free as the insured ages (and/or their beneficiaries age). Since many people purchase life-insurance to protect those they leave behind (their beneficiaries) as the beneficiaries age or their financial needs lessen, the whole-life cash-value account can be drawn down, providing current period tax-free income.
While the benefits of whole-life insurance policies are significant, there are drawbacks. The first drawback is that the premium payment on a whole-life insurance policy is significantly greater than the premium payment on a term policy with the same death benefit. While much of the incremental premium is used to fund the guaranteed death benefit, some of that incremental payment is simply profit to the insurance company (or another way to think about it is the management cost of investment management of the cash-value account).
Additionally, because the whole-life insurance policy’s cash-value increases according to internally generated actuarial tables, the cost of purchasing the guaranteed death benefit may be well in excess of what a market price of a similar investment might cost. In other words, an individual who invests an amount similar to the premiums associated with a whole-life insurance policy may create an asset that is worth considerably more than the death benefit that would have accrued under the insurance contract. However, policyholders trade this possibility for the guarantee that the insurance company provides. In other words, they are paying the insurance company to assume “market risk” for those investments.
Compare Life Insurance Quotes
To overcome some of the lack of visibility associated with whole-life policies and the underlying actuarial tables and financial models, life insurance quotes can be compared to ensure that you are receiving the lowest cost policy. Be sure to fully understand the terms of the policies under review. Each policy will be unique to that insurance provider and subtle differences will account for some of the difference in cost between policies. By understanding these differences and determining the features you want or need, you will maximize your chance of purchasing the right insurance policy for your specific needs.
Also, remember that a life insurance policy is only part of a larger insurance strategy. Be sure to make sure that you carry an adequate auto insurance, homeowners insurance (or renters insurance) policy to master peace of mind through financial security.
Whole-life insurance policies are complicated financial instruments. Consumers should develop a thorough understanding of a policy before purchasing it. There are a wide variety of policies and while the industry offers certain “standardized” policies, each insurance provider may offer terms that are unique. Additionally, policies can have significant tax implications that should be thoroughly understood before entering into a whole-life insurance contract. Each policy should be carefully reviewed to ensure a complete understanding of the specific terms of that policy. The information discussed below is not intended to be comprehensive, nor is it intended to be used in isolation; individuals looking to purchase a whole-life insurance policy should perform exhaustive research and discuss their options with a qualified financial advisor (a lawyer, a CPA, an insurance agent, etc.). The team at InsuranceSwami.com has made an effort to make this article as informative as possible; however we do not assume any responsibility for any action that you take as a result of reading this article.
What is Whole-life Insurance?
Understand all of the types of life insurance before deciding which policy is right for you!
“Whole-life” insurance is a policy that remains in place for an individual’s entire life. Upon death, the whole-life insurance policy’s death benefit is paid to the policyholder and the contract is considered complete. Whole-life insurance policies can either involve continuous payment during the insured’s entire life, or can be weighted to earlier payment streams (even a one-time payment at inception of the contract). Whole-life insurance policies are a form of a “permanent” life insurance policy, but are different from “universal” life insurance (as well as “variable universal” life insurance).
The first life insurance policies were term life insurance policies (aka “temporary” policies) and involved coverage only for a specified period of time. If the insured passed away during the term, a benefit was paid. If the insured did not pass away during the term, the insurance company kept the premiums paid over the life of the contract and the contract was considered complete.
Creating a Permanent Life Insurance Policy
Some consumers were not content with the temporary nature of the existing life insurance policies. These consumers wanted a guaranteed payment at the time of death. The industry reacted by developing whole-life insurance policies. By transforming the contract from temporary to permanent, the insurance industry transformed the death benefit from unlikely to guaranteed. The premium was significantly increased to compensate insurance companies for the cost of a guaranteed payment. Actuaries used mortality tables that extended to certain death to calculate the odds of an individual perishing at each stage in their life. Premiums were then calculated, which would enable the insurance company to collect sufficient payments (and to invest those payments) to adequately compensate them for: the guaranteed death benefit, the risk that insured individuals died earlier than expected and for a profit margin. Over time, the popularity of whole-life insurance policies increased and a number of permutations were developed.
“Cash-Value”
In essence, for most policies, the premium on a whole-life insurance policy is comprised of two payment streams. A payment stream for assuming risk of death during the period while the insured is living (effectively a term insurance policy) and then a payment stream that is invested by the insurance company during the life of the policy to fund the guaranteed death benefit. As the policyholder makes payments during the early period of the policy, the investment component accumulates “cash-value.” The cash-value of an insurance policy is based on annuity tables developed by the insurance company. The variables underlying the annuity tables are defined at the inception of the contract (including the rate of return), though they are not disclosed to the policyholder. Over time, as premiums are paid and interest is credits to the account, the cash-value of the contract grows. Since annuity tables are used to calculate the cash-value of the policy, these balances are known throughout the life of the contract (facilitating financial planning).
At some defined maturity date, the cash-value of the policy is equal to the death benefit. At death, the insurance company pays the contractual death benefit to the policy’s beneficiaries and the policyholder (or their estate) surrenders the cash-value (i.e. the investment account balance) to the insurance company. Since the policyholder’s premiums are accumulating an asset balance, most whole-life insurance policies allow the policyholder the option to cancel the contract at will.
Cancellation results in disbursement of the cash-value balance, less fees and other charges related to cancellation. In addition, with many policies, the policyholder is able to borrow against the cash-value of their policy (though this reduces the death benefit as the borrowings must be paid back to make the cash-value of the policy whole). Borrowings are usually tax-free, but tax is due on unpaid loans in excess of premiums paid, in the event that the insured dies before repayment.
Whole-life Insurance Offers Financial Flexibility
These features provide policyholders financial flexibility and many policyholders use whole-life insurance policies as a form of investing for retirement. Additionally, the cash-value of some policies can be used as collateral, assuming the policy is structured in a way that facilitates policy liquidation. Generally, upon disbursement of the cash-value of a policy, taxes are only due on the gains of the cash-value account (i.e. the disbursement less the sum of the premiums paid into the account). Taxes are not due on the death benefit of life insurance policies.
Most whole-life insurance policies require the policyholder to make payments throughout the life of the contract (i.e. while the insured is still living). There are policies that allow for alternate payment streams, such as one-time payments of a single large premium or accelerate payments over a shorter term.
Whole-life insurance can be a valuable instrument for retirement planning.
Types of Whole-life Insurance Policies
As mentioned, whole-life insurance policies can be structured in different ways. Standard policies though lead to efficiencies of scale, and allow for lower cost policies. Additionally, many insurance companies, including some of the top insurance companies in the world, choose to streamline their operations and only offer certain standard whole-life insurance policies. Some of the more common whole-life policies include:
Pros and Cons of Whole-life Insurance
Whole-life insurance policies are valuable in that they offer policyholders permanent life insurance; their beneficiaries are guaranteed a benefit payment upon the insured’s passing. In addition, whole-life insurance policies offer financial flexibility to the policyholder, allowing them to access the cash-value of the plan during their lifetime. This can have great value if there are life events that significantly alter the policyholder’s objectives or as a retirement tool, whereby the cash-value can be drawn upon tax free as the insured ages (and/or their beneficiaries age). Since many people purchase life-insurance to protect those they leave behind (their beneficiaries) as the beneficiaries age or their financial needs lessen, the whole-life cash-value account can be drawn down, providing current period tax-free income.
While the benefits of whole-life insurance policies are significant, there are drawbacks. The first drawback is that the premium payment on a whole-life insurance policy is significantly greater than the premium payment on a term policy with the same death benefit. While much of the incremental premium is used to fund the guaranteed death benefit, some of that incremental payment is simply profit to the insurance company (or another way to think about it is the management cost of investment management of the cash-value account).
Additionally, because the whole-life insurance policy’s cash-value increases according to internally generated actuarial tables, the cost of purchasing the guaranteed death benefit may be well in excess of what a market price of a similar investment might cost. In other words, an individual who invests an amount similar to the premiums associated with a whole-life insurance policy may create an asset that is worth considerably more than the death benefit that would have accrued under the insurance contract. However, policyholders trade this possibility for the guarantee that the insurance company provides. In other words, they are paying the insurance company to assume “market risk” for those investments.
Compare Life Insurance Quotes
To overcome some of the lack of visibility associated with whole-life policies and the underlying actuarial tables and financial models, life insurance quotes can be compared to ensure that you are receiving the lowest cost policy. Be sure to fully understand the terms of the policies under review. Each policy will be unique to that insurance provider and subtle differences will account for some of the difference in cost between policies. By understanding these differences and determining the features you want or need, you will maximize your chance of purchasing the right insurance policy for your specific needs.
Also, remember that a life insurance policy is only part of a larger insurance strategy. Be sure to make sure that you carry an adequate auto insurance, homeowners insurance (or renters insurance) policy to master peace of mind through financial security.
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