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Death is an eventuality that nobody wants to think about but everyone needs to prepare for, especially if you have a family that depends on you.
According to the 2018 Insurance Barometer Study from Life Happens and LIMRA, 35 percent of households would be financially affected within one month of the primary wage earner’s death.
A life insurance policy is one of the best things you can do to negate that impact and ensure the financial security of your loved ones long after you’re gone.
Of course, choosing to buy a life insurance policy is an easy decision that leads to more complicated ones. Now you have to sort through dozens of options to figure out which type of policy is best suited to meet your financial needs.
Life insurance falls into one of two overall categories: term insurance or whole insurance.
Before you can choose a specific policy, you need to decide which of these two you want.
This guide will help you choose by providing you with everything you need to know about the whole insurance option. For information on your other choice, read our companion guide to term insurance.
Read on for a complete overview of whole life insurance, its many variations, some average rates, and situations when it might be a better option than a regular term policy.
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What is whole life insurance?
Term insurance provides coverage for a specified period, usually between 10 and 30 years. Once that period expires, the insurer cancels the coverage unless you opt to renew or convert the policy.
Term policies are generally meant to cover final expenses and outstanding debts if an unexpected death occurs, so those left behind won’t be burdened.
On the other end of the spectrum, whole insurance (sometimes called permanent insurance) provides coverage for as long as you live. There are no set time limits.
As long as your premiums are current, the insurer will pay a guaranteed benefit upon your death, whenever that may be.
For example, if a 30-year-old man buys a $500,000, 30-year term policy, that policy expires at age 60. If he dies at age 61, the insurer doesn’t pay a benefit, regardless of how many premiums he paid over three decades.
Now imagine that he bought a whole policy instead. When he dies at age 61, his beneficiaries receive $500,000.
A simple way to look at it is that term policies are designed for those who want to plan for an unexpected death, while whole policies are made for those who want to plan for an eventual one.
Who Should Buy Whole Life
Because whole life has a guaranteed death benefit (whereas a term policy might expire before an insurer has to pay a claim), 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.
Whole policies are often marketed as investments rather than insurance because they allow you to save while paying for a life insurance policy that 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 401(k) or individual retirement account (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 a better choice for a majority of families.
They advise buying a term policy and then investing the difference in a traditional retirement or savings account.
That said, whole life can be beneficial to people with specific financial goals.
If you’re leaving behind a large estate, your heirs might be faced with a large tax bill. The current maximum estate tax rates are nearly 40 percent.
That amount is due nine months after the date of death. If you aren’t leaving behind accessible cash, your heirs may have to use their own money to cover the tax debt.
Fortunately, proceeds from life insurance policies are typically tax-free. Your beneficiaries can use the death benefit from a whole policy to pay the taxes and preserve the value of the estate.
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.
Establishing a trust:
Like asset protection, the proceeds from a whole life insurance policy can be used to establish a strong trust. Trusts are commonly used to transfer large assets like real estate or businesses.
If you own a business, the proceeds from a whole life policy can be used to cover any financial losses resulting from your death. It can also provide the funds needed to keep it running into the future.
Whole life insurance policies aren’t subject to contribution limits like an IRA or 401(k). You can pay as much additional premium as you’d like to increase your cash value.
If you’ve already reached your maximum contribution to a traditional retirement savings account, you can take advantage of tax-deferred growth through your whole life policy.
Establishing long-term care:
If you’re the primary caregiver for a spouse or loved one with special care 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) that you want to pay for after your death. They include:
- Income replacement
- Spouse’s retirement
- Emergency savings fund
- Children’s college tuition
Cash Value & Dividends
Most whole policies include a savings component. Every month, part of your premiums is 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 an 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 part-owners of the company and entitled to profit sharing.
Those dividends are often added to the cash account or used to pay policy premiums.
Average Cost of Whole Life
There is no industry-standard price for life insurance. Rates vary for everyone. Your personal premiums are determined by several factors, including:
- Age: Age is one of the most important factors in determining your rates. The older you are, the closer you are to death. Every year you wait to buy a policy can mean a higher premium.
- Gender: Statistically, men have a shorter life expectancy than women. Because of that, women typically pay lower premiums.
- Health history: Healthy people live longer. Longer life expectancy translates to lower premiums. To determine your overall health, insurers may need a complete medical exam and ask you to submit 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: Insurers will inquire about high-risk habits such as mountain climbing, flying, or any other regular activity that has a high potential for injury or death.
- Tobacco use: The most common high-risk habit that insurers look for is tobacco use. Smokers almost always 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, permanent insurance is always more expensive than temporary insurance.
While the premiums are much more expensive, whole life comes with the benefit of more flexibility than term life.
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 you have little to no premiums to pay later.
Keep in mind that though you don’t have to pay on a set schedule, you do need to pay a minimum amount annually so 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 the next 10-20 years so that you aren’t paying premiums during your retirement years.
In addition to paying extra premiums, you can sometimes reduce or stop your premiums by using your cash value to pay them, instead.
This is useful if you run into unexpected financial hardships. You can pause your payments without losing your policy.
How much coverage do you need?
As previously discussed, a life insurance policy needs to cover two types of obligations: immediate and future.
If your family depends on your income, that future obligation needs to include as many years’ worth of salary as it will take for them to adjust to the new status quo.
A life insurance agent or financial planner can help you determine exactly how much coverage you’ll need to cover all those obligations. In the meantime, there are simple 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
Adding up your total obligations in those four categories will give you the minimum face value you need.
Here is a simple example using the method.
A husband and father of a high school student is the majority wage earner for his family, with an annual salary of $75,000.
The family has a remaining mortgage balance of $70,000. They also have $8,000 in outstanding credit card debt.
He plans to leave five years’ worth of his salary to his wife to cover expenses until their child leaves for college, after which she plans to downsize and work until retirement.
He would also like to set aside at least $25,000 to cover that college tuition.
After factoring in an average funeral cost of around $7,500, his insurance needs are as follows:
- Debt: $8,000 credit card + $7,500 funeral costs = $15,500
- Income: $375,000
- Mortgage: $70,000
- Education: $25,000
- Total need: $485,500
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 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 set cutoff age. You can also decrease your coverage to a minimum amount without forfeiting your policy.
Types of Whole Life Insurance
Whole life insurance has the following variations:
- Traditional whole life
- Universal life
- Variable life
- Variable universal life
- Guaranteed universal life
Each is unique in how they grow their cash value and in their flexibility.
Traditional Whole Life Policy
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 like 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).
Because you are always guaranteed to see positive growth in your cash value, it is the option with the least risk. Other forms of whole life depend on market factors that could lose you money if things go south.
While it is the simplest and safest, traditional whole life is also the least flexible. You often can’t change your death benefit or adjust your premium payments.
Universal Life Policy
Universal life 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, like 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 Policy
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 since they don’t guarantee growth, 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 a more stable, traditional savings account.
Variable Life Policy
Variable policies allow you to invest your cash value in stocks, bonds, and money market mutual funds, like an IRA or 401(k). 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 even see your face value decrease.
However, some policies do come with minimum death benefit guarantees.
Variable Universal Life Policy
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 Policy
Guaranteed universal life policies strike a balance between a term policy and a traditional whole life policy. They offer fixed premiums and guaranteed no-lapse coverage.
Unlike most permanent life insurance policies, guaranteed universal policies don’t 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 Universal Life Policy
Guaranteed accepted universal 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. Guaranteed acceptance also means no medical exam. Everyone qualifies.
Like guaranteed universal policies, guaranteed acceptance policies do not accumulate a cash value.
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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 that you buy. For example, on a $100,000 policy, your beneficiaries will be paid a minimum of $100,000.
The second component is the cash value. The cash value is the interest your premiums have earned through the policy’s savings or investment component.
Depending on the type of benefit you choose, the money in that cash account could be paid to your beneficiaries along with the face value after your death.
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.
Some policies also allow you to take out personal loans against your cash value. These loans operate like home equity lines of credit. You aren’t simply withdrawing from your savings account. You have to repay the loan with interest.
Any outstanding balance at the time of your death will be deducted from your cash account and your face value, which could decrease your beneficiaries’ benefit 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 the payout is always equal to the initial face value.
For example, if the cash value on a $200,000 policy grows to $20,000, the premiums will level out, so the insured is paying for $180,000 of coverage.
Once they die, that $20,000 cash value is added to the decreased $180,000 face value so that the beneficiaries receive the guaranteed $200,000.
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 $200,000 grows to $20,000, the premiums will remain the same, so the insured is still paying for the full coverage amount.
Once they die, the $20,000 cash value is added to the face value, resulting in a $220,000 death benefit.
An increasing benefit costs more over time, but also comes with the potential for a much higher claim.
Changing Your Policy
As touched on earlier, most whole life policies allow you to make changes to your policy. The most common changes are as follows.
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 opposite is not true of whole life plans.
You can’t downgrade your plan to temporary coverage if your financial situation changes during the life of your policy.
In that situation, your only option would be to can do is cancel your policy and buy a new, cheaper term plan. Just know that 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 ages. If you do, you’ll likely have to take a new medical exam.
You can also decrease your face value to an established minimum without forfeiting the policy. Again, this change could come with surrender fees.
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.
Buying Whole Life
Once you’ve decided which type of whole life is best for you and your family, there are some things to keep in mind as you set out to buy one.
The basic life insurance medical exam process is as follows:
- The customer fills out a medical questionnaire
- The insurer schedules an in-home medical exam
- The medical examiner conducts a brief interview
- The examiner measures height, weight, and vitals
- The examiner takes a urine sample, blood sample, and oral swab
- Lab results are sent to the underwriter for review
- The insurer assigns a risk classification and informs the applicant of final premiums
Some whole life insurance policies use the fact that they don’t require a medical exam as a selling point. That may sound more appealing than the process outlined above, but you’ll most likely pay for that convenience.
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.
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.
Depending on your health, taking the exam could place you in a lower risk category than you’d otherwise be with a no-exam policy.
Tips for Finding the Best Policy
Before you start shopping for a whole life insurance policy, here are some tips to keep in mind.
#1 – Buy from a Reputable Company
Make sure the company you’re considering buying from is reliable. 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. You can also do your own research in those areas by using the following resources.
J.D. Power’s annual U.S. Life Insurance Study measures overall customer satisfaction in four areas: annual statement and billing, customer interaction, policy offerings, and price.
The Better Business Bureau uses 13 factors such as time in business, open complaints, resolved complaints, and legal action against a company to assign one of 13 letter ratings, A+ through F.
The National Association of Insurance Commissioners Complaint Index lists the number of complaints registered against an insurer each year and compares it to that of other companies.
All these resources can help you decide if a company is reputable.
#2 – Compare Policies
Compare the policy offerings of each company to find the one that best meets your financial needs. 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.
#3 – 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.
|Age||$100,000 – Male||$100,000 – Female||$250,000 – Male||$250,000 – Female||$500,000 – Male||$500,000 – Female|
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To give you an idea of just how much a whole policy might cost, the table above includes average monthly sample rates from some of the top 10 insurers by market share for non-smokers at key ages.
Pros & Cons
There are both benefits and drawbacks to choosing a whole life policy over a term life policy. Here are some of the biggest to consider.
- 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
Whole life is a more complex and expensive insurance option. There are costs and risks involved that many might want to avoid.
The average family that only wants to protect itself from financial hardship if an unexpected death occurs would probably benefit more from term life insurance than permanent coverage.
However, if you’re a higher wage earner or one of those with specific situations requiring a guaranteed death benefit no matter how long you live, whole life policies have unique benefits worth talking about with a life insurance agent or a financial advisor.
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