Trying to find the right life insurance policy can feel a bit overwhelming. Not only do you have to shop around, but you also have to understand the benefits of whole life insurance compared to those of term life or universal life.
In fact, 35 percent of consumers have procrastinated over buying life insurance, according to a 2016 study by industry groups LIMRA and Life Happens. While some consumers feel relatively well-informed about term life insurance, whole life policies are often subject to misconceptions.
Understanding what to expect from a whole life insurance policy could help you make the right choice for your needs. Here's what you need to know about the benefits of whole life insurance.
Coverage for a Lifetime
A whole life policy is a permanent life insurance that offers a lifetime of coverage for a fixed-level premium. This means the premium and death benefit amount will remain the same throughout your life, as long as you pay the premium.
This lifetime coverage is the reason whole life insurance premiums are generally more expensive than the premiums for term life insurance. Term life insurance expires after a period, such as 10, 15, 20 or 30 years. Once the term ends, it could be more expensive to renew the policy because you will be older and your health may have changed in the interim.
The Cash Value Advantage
Of course, whole life insurance offers more than just lifetime coverage and peace of mind. The benefits of whole life insurance also include the cash value of the insurance policy. Here's how it works: Your insurer invests your premiums, which means your policy could accumulate a cash reserve, which is known as cash value.
In general, your life insurance company could promise you a minimum level of interest on your cash value, after insurance costs and expenses are deducted, which will be credited to your account each year. If the investments do better than projected, you could earn more than the guaranteed minimum level of interest.
And once you've built up a cash value in your policy, there are a number of ways you could use those funds:
- Pay your premiums: Paying premiums with the cash value could be a big help to retirees who want to maintain their whole life policy without having to pay the premium out of pocket each month. However, if the cash value does not cover the premium at any time, you would need to start paying premiums out of pocket again to keep the policy in force.
- Withdraw your basis: The basis is the amount in the cash value account that you've paid in via premiums. You could withdraw that amount tax-free. You could also withdraw more than your basis, although you would pay tax at your ordinary rate on anything above that basis amount. If you choose this option, your death benefit would be reduced by the amount you withdraw.
- Borrow against your policy: When you've built up a cash reserve, you have the option of borrowing money from your insurance company, which uses your policy as collateral. In this case, you would pay no taxes on the money you borrow, and your interest rate would depend on market rates and the type of policy you have. If you do not pay back the loan before you pass away, however, the amount you owe will be deducted from the death benefit. It's important to note that withdrawals from and loans against the cash value may generate income tax liability, cause the policy to lapse and reduce the value of the account and death benefit.
- Exchange it for an annuity: The Internal Revenue Service allows whole life policyholders with cash values to convert their life insurance policies into annuities using something called a 1035 exchange. Such a conversion does not require you to pay taxes on your gains at the time of the switchover, though you would pay taxes on a portion of each payout, depending on the proportion of your basis to your gains. You would also be giving up your death benefit by making this exchange.
Finding the right life insurance policy for your needs doesn't have to be overwhelming. Learning more about each insurance type — and exploring the benefits — could help you make the right choice for your needs.