What is Whole Life
Whole life, also known as permanent life or ordinary life insurance, is a type of life insurance that is designed to last a lifetime and offers a guaranteed accumulation fund that grows tax deferred.
Unlike term or universal life insurance, whole life has a fixed guaranteed premium and a fixed guaranteed death benefit for the insured’s lifetime. Additionally, permanent life insurance builds guaranteed cash values. With most whole life policies, premium payments are required until the earlier of the insured’s death or to their age100. At age 100, the insured receives the policy’s cash value account which equals the policy’s face amount. At that time, the policy is said to endow and the life insurance coverage ends.
Permanent life insurance premiums are primarily determined by the number of years between an insured’s current age and their age 100. As mentioned, premiums for whole life are guaranteed to remain level for the life of the policy. In order to guarantee level premium payments, the insurance company requires a higher premium in the policy’s early years to balance the significantly higher insurance costs at older ages. Therefore, whole life insurance is the most expensive form of life insurance in the short-run but may be the most cost effective over the long-run. With whole life, you are actually self-funding your life insurance policy.
Whole life insurance policies build guaranteed cash values that grow tax deferred. In the first few years, due to sales fees and early policy costs, cash value growth is very low. However, over time guaranteed cash values can become significant. Actual cash value growth will depend on the face amount of the insurance policy, the amount of the premium payment and how long the policy has been inforce. In general, the larger the policy’s face amount, the higher the required premium and the larger the cash value growth. Furthermore, policies that have been in effect for a longer time period will also have better cash growth.
Additionally, the insurance company's investment, earnings and claims experience also has an impact on cash value growth. Permanent life insurance can be classified as either participating or nonparticipating. With a participating whole life policy, after all the claims and expenses of the insurance company have been paid for a given policy year, the policy owner is entitled to “participate” in any surplus that remains. This surplus payment is known as a policy dividend and is considered to be a return of excess policy premiums. Dividends are not guaranteed and there are no income taxes paid on life insurance policy dividends. On the other hand, nonparticipating policies do not pay policy dividends. If you are considering whole life insurance, a participating policy is always the best choice.
Policy cash values may be accessed in the form of withdrawals, policy loans or policy surrender. Tax free withdrawals can be made up to the basis of the policy and then cash values accessed via policy loans. The policy basis is the total amount of policy premiums paid to date. Any withdrawal up to the basis is considered return of premium and no taxes are payable. Any withdrawals beyond the policy basis would be subject to income taxation. Once cash values have been withdrawn up to the policy’s basis, a tax free policy loan can be used to draw down cash values. Policy loans are charged a market interest rate and accrue interest over time. As long as the policy retains enough cash value to pay insurance premiums, taxes can be avoided using the withdrawal to basis then policy loan approach. At the insured’s death, any loan balance will be deducted from the policy’s death benefit.
There are many variations of whole life insurance including: participating life, adjustable life, modified life, single-pay life, variable life, and survivorship life or second-to-die insurance. The most important consideration when choosing a whole life policy is to make sure that the policy you choose is a participating policy with good financial ratings.
Advantages of Whole Life:
|Guaranteed coverage for life|
|Premiums are fixed for the life of the policy|
|Guaranteed cash values|
|Tax deferred growth of cash value|
|Policies may pay non taxable dividends|
Disadvantages of Whole Life:
|Too expensive over the short-run|
|May not be able to afford the coverage needed|
|Policies are not as flexible as other options|
|Returns on cash value may be lower than expected|
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