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UPDATED: Oct 1, 2020
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If you’re reading this, there’s a good chance you’ve already decided you need a life insurance policy. You probably also quickly realized that was the easiest decision among the many you now face.
Next comes the daunting task of sorting through the myriad of options available to you and figuring out which is best suited for your financial needs.
Your second decision comes quickly because the path toward a life insurance policy starts at a fork in the road. Life insurance falls into one of two categories: term insurance or whole insurance. Before you can choose a specific policy, you need to decide which of these marketplaces you’ll be shopping in.
This guide is designed to make your life insurance shopping experience as stress-free as possible by providing you with everything you need to know. Buying life insurance is always the best decision for you and your spouse.
Read on for a complete overview of whole life insurance: its many variations, average rates, and when it might be a better option than a basic term policy.
What is whole life insurance?
As the name implies, term insurance provides coverage for a specified period, usually between 10 years and 30 years. Once that period expires, the insurer cancels the coverage unless you opt to renew or convert the policy (if you qualify to do so).
Term policies are generally meant to be a stop-gap measure to cover final expenses and outstanding debts in the event of an unexpected death, as not to burden those left behind.
On the other hand, whole insurance provides coverage for as long as you live, with a few extreme exceptions.
Some policies have age limits at 100 years and beyond. Other than that, there are no terms. As long as your premiums are current, the insurer will pay a guaranteed benefit upon your death, whenever that may be.
For example, imagine two 30-year-old twin brothers born on the same day and with the same life expectancy. Both are in the market for life insurance.
Brother A buys a $500,000, 30-year term policy (the typical maximum). Brother B buys a $500,000 whole policy. At age 60, Brother A’s term policy expires.
Brother B’s beneficiaries receive a $500,000 payout, and possibly more.
Simply put, term policies are designed for those who want to plan for an unexpected death, while whole policies are for those who want to plan for an eventual one.
Cash Value & Dividends
Whole policies are also unique in that most also include a savings component. Every month, a portion of your premiums are placed into an interest-bearing account.
Those funds accumulate and build cash value in addition to the face value of your policy. You have the potential to leave behind a significant additional benefit on top of your guaranteed death benefit.
Some policies also pay annual dividends. Many whole life insurers are mutual companies, meaning that policyholders are essentially partial owners of the company, and therefore entitled to profit sharing.
Those dividends are often added to the cash account or used to pay policy premiums.
Types of Whole Life
Whole life insurance has the following variations:
- Traditional Whole Life
- Universal Life
- Variable Life
- Variable Universal Life
- Guaranteed Universal Life
- Guaranteed Acceptance Whole Life
Each is unique in how they grow their cash value (if at all) and their flexibility.
Who Should Buy Whole Life
Because whole life is guaranteed to pay out whenever you die (versus a term policy which might expire before an insurer has to pay), it is naturally the more expensive of the two options. A whole policy will always cost more than a term policy with the same face value.
Although they are more expensive, whole policies are often touted as a good investment tool, as they allow you to save while paying for a life insurance policy you were going to buy anyway.
While true, the returns on whole life policies can often be smaller than those of more traditional retirement options such as a 401k or IRA and can have additional related costs.
Because of that, some financial planners and consumer advocacy organizations, such as Consumer Reports, suggest that a term policy is sufficient for a majority of families.
They advise buying a term policy and then investing the difference in a traditional retirement or savings account.
However, there are some people for whom a whole life policy could be a good option.
People planning an estate: If you’re leaving behind a large estate, your heirs could be on the hook for a significant tax bill. The current maximum estate tax rates are nearly 40 percent.
That amount is due in cash within nine months of your passing. If you aren’t leaving behind any liquid assets, your heirs may have to use personal funds to cover the tax debt.
However, proceeds from life insurance policies are typically tax-free. That means your beneficiaries could use the death benefit to pay the taxes, and thereby preserve the overall value of the estate.
People with assets to protect: If you need to protect your assets against liens and creditors, life insurance could be a useful part of your strategy. Laws vary from state to state, but most consider the proceeds from a life insurance policy to be uncollectible assets.
People who want to establish a trust: Similar to asset protection, the proceeds from a whole life insurance policy can be used to establish a strong trust. This can be an effective way to transfer large assets like real estate or businesses.
Business owners: If you own a business, the proceeds from a whole life insurance policy can be used to cover any financial losses resulting from your death. It can also provide the liquidity necessary to keep it running and grow into the future.
Maximum contributors: Whole life insurance policies aren’t subject to contribution limits like an IRA or 401k. You can contribute as much premium as you’d like to increase your cash value.
If you’ve already reached your max contribution on a traditional retirement savings accounts, you can take advantage of tax-deferred growth through your whole life policy.
Caregivers: If you’re the primary caregiver for a permanently disabled spouse or loved one with special needs, the proceeds from a whole life policy can be used to set up a long-term care plan.
What Whole Life Covers
In addition to the scenarios listed above, life insurance is generally used to cover two types of obligations: immediate and future.
Immediate obligations are the things that need to be paid soon after your death. These include:
- Funeral costs
- Medical bills
- Mortgage balances
- Personal loans
- Credit card debt
Future obligations are all the expenses (either planned or unexpected) you want to pay for after your death. They include:
- Income replacement
- Spouse’s retirement
- Emergency savings fund
- Children’s college tuition
Average Cost of Whole Life
There is no industry-standard or universal price for life insurance. Rates vary for everyone.
That said, your personal premiums are determined by several factors, primarily the following.
Age: Age is one of the most important factors in determining insurability. Statistically, the more time has passed, the closer you are to death. The older you are when you apply for a policy, the higher your rate will be.
Gender: Statistically, women live longer than men. For that reason, men typically pay higher premiums.
Health History: The healthier you are, the longer you’re likely to live, which translates to lower premiums – another reason to keeps tabs on body weight and other vitals. To determine your overall health, insurers may require a complete medical exam and bloodwork.
Family Medical History: Because many diseases are hereditary, most insurers will also examine the health history of your immediate family.
Occupation: By nature, some jobs are more dangerous than others. The more dangerous the profession, the more likely an insurer is to pay out an early death benefit, which means higher premiums.
High-Risk Habits: Similarly, insurers will inquire about high-risk habits outside of your occupation, such as mountain climbing, flying, or any other regular activity that has a high potential for injury.
Tobacco Use: The most common high-risk habit that insurers look for is tobacco use. Smokers almost universally pay higher rates than their non-smoking counterparts in every demographic.
Once the insurer determines your rate based on these factors, it is typically fixed, meaning that it will not change for any reason over the life of the policy.
As previously discussed, whole policies are always more expensive than their term policy counterparts.
To give you an idea of just how much more expensive, here is a look at how the premiums for a 20-year, $100,000 policy with top-10 insurer State Farm compares with a $100,000 whole life policy for non-smokers at key ages.
|Age||Term: Male||Term: Female||Whole: Male||Whole: Female|
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While the premiums are much more expensive, they do come with the benefit of more flexibility than those for term policies.
Universal policies allow you to change the amount and frequency of your premium payments. For example, you can pay higher premiums or a lump sum early in the year so that you have little to no premiums to pay later.
Keep in mind that, even though you don’t have to pay on a set schedule, you do need to pay a minimum amount annually so that you don’t lose your policy or risk a reduced benefit when you die.
Some policies also come with a limited pay option. They allow you to pay for the policy in full over 10–20 years so you aren’t paying premiums during your retirement years.
In addition to paying additional premiums, you can sometimes reduce or stop your premiums by using your cash value to pay them, instead. This feature can come in handy if you ever face any unexpected financial hardships and don’t want to lose your policy.
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Whole Life Death Benefits
The death benefit is the money the insurer pays to your beneficiaries upon your passing, as long as your premiums are current. Once your beneficiaries file a claim, the benefit is typically paid within 30 days.
How the Death Benefit Works
The death benefit for a whole life policy has two components.
The first is the face value. The face value is the guaranteed amount of coverage you purchase. For example, on a $500,000 policy, your beneficiaries will be paid a minimum of $500,000.
The second component is the cash value. The cash value is the interest your premiums have earned through the policy’s built-in savings component.
Depending on the type of benefit you choose, any money in the cash account at your time of death could be paid to your beneficiaries along with the face value. The amount of that cash value depends on both how well your investments have performed and whether you accessed any of those funds during your lifetime.
As discussed, most policies allow you to use your surplus cash value to pay your annual premiums. The more you’ve done that, the less there will be for your beneficiary upon your death.
Many policies also allow you to take out personal loans using your cash value as collateral. These loans operate similarly to home equity lines of credit. You must repay them with interest.
Any outstanding balance at the time of your death will be deducted from your cash account and your face value, which could significantly decrease your beneficiaries’ payout depending on the size of the loan and accumulated interest.
Types of Death Benefits
With most universal and variable policies, you have the option of choosing one of two benefit types: fixed or increasing.
Fixed Death Benefit
With a fixed death benefit, the policy premiums decrease over time as the cash value increases, so that the payout is always equal to the initial face value.
For example, if the cash value on a $100,000 policy grows to $10,000, the premiums will level out, so the insured is essentially only paying for $90,000 of coverage. Once they die, that $10,000 cash value is added to the decreased $90,000 face value so the beneficiaries receive the promised $100,000.
With a fixed death benefit, the better your investments perform, the less you pay out of pocket for your coverage further down the line.
Increasing Death Benefit
With an increasing death benefit, the premiums and face value remain the same over time. As the cash value increases, the overall death benefit increases.
Using the same example, if the cash value on a $100,000 policy grows to $10,000, the premiums will remain the same, so the insured is still paying for the full coverage amount.
Once they die, the $10,000 cash value is added to the face value, resulting in a $110,000 death benefit.
An increasing benefit costs more over time, but also comes with the potential for a much higher payout.
How much coverage do you need?
As mentioned earlier, a life insurance policy needs to cover two types of obligations: immediate and future.
If your family depends on your income, that future obligation should include how many years’ worth of salary you want to leave for them.
A life insurance agent or financial planner can help you determine exactly how much coverage you’ll need to cover all of those obligations. In the meantime, there are some formulas you can use to give yourself a rough estimate.
One popular method used by many online insurance calculators is the DIME method. DIME is an acronym which stands for the following:
- D: Debt
- I: Income
- M: Mortgage
- E: Education
You determine your minimum face value by adding up your total obligations in those four categories. Here is a simple example using the method.
A husband and father of one is the majority wage earner for his family, with an annual salary of $70,000. His wife also works fulltime.
The family has a remaining mortgage balance of $60,000. They also have $5,000 in outstanding credit card debt and a $5,000 remaining balance on a home improvement loan.
The mortgage is the most significant annual expense. Once it is paid off, the wife will need less overall income. Therefore, he plans to leave only five years’ worth of his salary to cover daily expenses and establish a savings fund.
He would also like to establish a college fund of $30,000 for the child. After factoring in an average funeral cost of around $7,500, his insurance needs are as follows:
- Debt: $5,000 credit card + $5,000 home loan + $7,500 funeral costs = $17,500
- Income: $350,000
- Mortgage: $60,000
- Education: $30,000
- Total need: $457,500
That total means he would need a life insurance policy with a face value of around $500,000.
What if your coverage needs to change?
If either your future financial obligations or current situation changes during the life of your policy, you have some options for adjusting your coverage.
Most universal policies allow you to increase the face value of your policy before a specified cutoff age. You can also decrease your coverage to a minimum amount without forfeiting your policy.
Choosing a Type of Whole Life
All whole life insurance policies are the same in that they come with the promise of coverage for as long as you live and a savings account that builds a cash value.
Where they most differ is in how they grow cash value. Here’s a brief overview of how (or if) they do that.
Traditional Whole Life
A traditional whole life policy (sometimes called ordinary life) is the most common form of permanent insurance. It is also one of the simplest.
Your cash account operates similarly to a traditional savings account. A portion of your annual premiums is placed in an account that grows at a fixed interest rate (typically around 3–8 percent).
This makes it the least risky option as you are always guaranteed to see positive growth in your cash value.
It isn’t dependent on any market factor that could experience a downturn and lose your money.
That simplicity and safety do come at the cost of flexibility. You often cannot change your death benefit or adjust your premium payments.
Universal policies offer the flexibility to set monthly premiums, change coverage amounts, and make lump-sum payments to keep premiums low while maximizing cash value.
That cash value grows at a fixed rate, similar to an ordinary life policy.
These policies offer more flexibility than the traditional option, but less than other universal and variable options, particularly when it comes to your investment.
Indexed Universal Life
Indexed universal life policies offer all the flexibility of a universal policy, with the added benefit of choosing how you invest your premiums.
These policies allow the owner to allocate the cash value amounts to an equity index account such as the S&P 500 or the Nasdaq 100, rather than growing at a rate set by the insurer.
They are riskier in that growth is not guaranteed, but they do come with the potential for higher returns than a traditional whole or universal policy.
Some also come with the option to take a break from the index and temporarily invest in the stable, traditional savings account.
Variable policies allow you to invest your cash value in stocks, bonds, and money market mutual funds, similar to an IRA or 401k. These policies come with the greatest risk, but also some of the highest growth potential.
Depending on how the stock market performs, you could lose a significant portion of your cash value and possibly even see your face value decrease.
However, some policies do come with minimum death benefit guarantees.
Variable Universal Life
As you can probably guess from the name, variable-universal policies combine the benefits of a universal and a variable policy.
You get the flexibility of adjustable premiums and face values, along with the potential investment rewards of a variable savings account. Of course, that also means they come with the same risks.
Guaranteed Universal Life
Guaranteed universal life policies fall somewhere between a term policy and a traditional whole life policy. It offers fixed premiums and guaranteed no-lapse coverage. Unlike most permanent life insurance policies, guaranteed universal policies do not accumulate a cash value that you can access.
They are more like term policies that don’t expire as long as you pay your premiums. That could be a drawback for someone who wants to use their policy as an investment.
Guaranteed Acceptance Whole Life
Guaranteed accepted whole life policies are commonly referred to as final expense policies or burial insurance.
They are special whole life policies with low face values meant only to cover funeral expenses and perhaps some small financial obligations such as credit card debt.
Your payments never go up, and your coverage never goes down as long as you live. Face values typically range from $2,000–$25,000. Because the face values are so low, they are often the most affordable permanent life insurance policies. They offer guaranteed acceptance with no medical exam.
Like guaranteed universal policies, guaranteed acceptance policies do not accumulate a cash value, which could be a drawback for someone who wants to use their policy as an investment.
Changing Your Policy
As discussed, whole life insurance often allows you to make significant changes to your policy. There are just a few things to keep in mind if you do.
Converting Whole Life
Many term life plans can be converted to whole life plans at certain points throughout the term, as well as at the end of it. Unfortunately, the inverse is not true of whole life plans.
If your financial situation changes during the life of your policy and you no longer need permanent insurance, you can’t convert to a term plan. The best you can do is cancel your policy and purchase a new, cheaper term plan. However, doing so will likely come with surrender fees.
Changing Your Death Benefit
With universal and variable universal policies, you can increase the face value of your coverage before specified cutoff years. To do so, you will often be required to take a new medical exam.
You can also decrease your face value to a set minimum without forfeiting it. However, if you do, there’s a chance you could be charged surrender fees against the cash value of your policy.
Surrender fees are charges imposed on a policyholder for early withdrawal of funds or cancellation of a policy. For example, many insurers charge fees if you cancel your policy within the first 20 years.
Surrender fees are assessed against the cash value. If you cancel your policy completely, the insurer will pay you a surrender value, which is your cash value minus any surrender fees.
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Buying Whole Life
Once you’ve settled on a type of whole life policy, there are a few things you should keep in mind as you set out to purchase one.
Upon applying for a whole life policy, insurers will require you to fill out a health questionnaire and may request your medical records. Most will also require a complete medical exam and bloodwork.
While the thought of undergoing a complete medical exam can sound burdensome (and even intimidating), the process is fairly simple.
The basic life insurance medical exam process is as follows:
- The customer fills out a life insurance application and medical questionnaire
- The insurer schedules an in-home medical exam
- The medical examiner conducts a brief oral interview
- The examiner measures height, weight, and vitals, then takes a urine sample, blood sample, and oral swab
- Lab results are sent to the underwriter for review
- The insurer will assign a risk classification and inform the applicant of final premiums
Some whole life insurance policies don’t require a medical exam, but it might be in your best interest to take one.
A no-exam policy represents a more significant risk to the insurer. They pass that risk along to you in the form of higher premiums. Taking an exam could show them that you belong in a lower risk category.
A young, healthy person might not notice a significant increase in premiums between an exam and no-exam policy, but older people can expect a much higher cost.
Tips for Finding the Best Policy
Before you start shopping for a whole life insurance policy, here are some tips to keep in mind.
Buy from a reputable company: Make sure to buy a policy from a reliable company. A good place to start is with the top insurers by market share. From there, read reviews on each that focus on policy offerings, financial stability, and reputation.
Compare policies: Compare the policy offerings of each company to find the one that best meets your financial needs. It’s important to make sure you compare policies of the same type.
A whole policy has different benefits and drawbacks than a term policy of the same face value. The same is true of a traditional whole life policy versus a universal policy, a universal versus a variable, etc.
Get quotes: Compare prices between companies and policies by getting quotes. Quotes are available online through convenient quote tools or local insurance agents.
Try to find the policy with the greatest benefit for the lowest annual cost.
Pros & Cons
As with anything, there are both benefits and drawbacks to choosing a whole life policy over a term life policy. Here are some of the biggest.
- Guaranteed death benefit with no term
- Policy has a built-in cash value
- Guaranteed minimum interest return on many policies
- Tax-deferred growth
- Tax-free access to your funds via policy loans
- Not subject to contribution limits like an IRA or 401(k)
- More expensive
- More complicated
- Not convertible to term
- Surrender fees for early termination
- Can lose coverage from missed premiums
- Some policies can expire at advanced ages
The Bottom Line
Whole life policies are complicated and expensive compared to basic term policies.
Families who are only looking to protect themselves against financial hardships resulting from an unexpected death would probably benefit more from a temporary life insurance solution than a permanent one.
However, higher wage earners, those with specific situations requiring a guaranteed death benefit, and those who want to make a life insurance policy part of a larger investment plan should take a look at all the benefits whole life policies have to offer.