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What Is Whole Life Insurance & How Does It Work?

Life Insurance
Father and daughter at park dancing and holding hands after dad purchased whole life insurance

Like many important yet sensitive personal matters, life insurance is a topic people rarely want to discuss. Yet conversations around life insurance can help you figure out the best options for protecting your loved ones.

That's why understanding the basics of the different types of whole life insurance can help you decide which policy is right for you. So, if you're wondering how whole life insurance works, or have some questions about your existing policy, you can review the fundamentals here.

What Is Whole Life Insurance?

Whole life insurance is a type of insurance policy that's designed to last your whole life, rather than a specific term. As long as you make your premium payments on time, your policy will not expire. The premiums on whole life insurance also remain the same throughout your life.

What Does Whole Life Insurance Cover?

After you qualify for a policy, whole life insurance provides a death benefit when you die as long as scheduled payments are made. There may be some causes of death that are excluded and those details will be laid out in your policy. Common exclusions include death from illegal activities, fighting in a war and suicide.

In addition, you need to truthfully list out your health status and lifestyle on your life insurance application. If someone makes false statements or leaves out information, such as a pre-existing condition, and then they die from that cause, the whole life insurance policy may no longer cover them.

What Are the Potential Advantages of Whole Life Insurance?

First, after you sign up for whole life insurance, the premium stays the same for the rest of your life. Then you don't have to worry about your insurance getting more expensive as you get older. Your policy may also include a guaranteed death benefit that will either stay the same or increase as you pay into the policy.

Another potential benefit of whole life insurance is that it does not have an expiration date. As long as you keep making the premium payments, your coverage will continue. Finally, some whole life insurance policies offer an additional benefit: cash value. This is money you can withdraw or borrow while you're still alive. However, loans will accrue interest. Loans, withdrawals and advances will also reduce the death benefit and cash surrender value, and may cause the policy to lapse.

What Are the Different Types of Whole Life Insurance?

There are a few different types of whole life insurance based on how you pay for the policy.

Level Premium Whole Life

This is the standard type of whole life insurance policy. After you sign up, the amount you owe per year (the premium) stays the same for your entire life. You'll likely make more premium payments over your lifetime than the other types of life insurance, but the amount you owe per year tends to be lower because you spread the cost over a longer period of time.

Limited Payment Whole Life

With limited payment whole life insurance, you only owe premiums for a set amount of time. When you reach the end of that time frame, you won't owe anything more, but will keep your coverage for the rest of your life. Since you're making fewer payments, you'll likely need to pay more each time to get the same amount of coverage as a level premium policy.

Single Premium Whole Life

With a single premium whole life insurance policy, you only make one lump sum payment for your coverage. After that, you have guaranteed insurance coverage for the rest of your life without having to make any other payments. There are two types of single premium life insurance policies available.

What Is the Difference Between Whole & Term Life Insurance?

The major difference between whole and term life insurance is how long they last. Term life insurance is temporary coverage, so it only lasts for a set number of years. If you outlive this period, your coverage will end. With whole life insurance, you're covered for your entire lifetime, as long as you maintain the policy, rather than a set term.

In exchange, whole life insurance tends to start with a more expensive premium than term life insurance. However, the premium always stays the same. If you renew term life insurance after the policy ends, it will likely get more expensive when you renew because you'll be older. Finally, whole life insurance can build cash value but term life insurance does not.

What Is Cash Value in Whole Life Insurance?

Some whole life insurance policies accumulate cash value, which is money you can spend and borrow against while you're still alive. The cash value benefit increases every year as you contribute premiums to the policy, and some insurance companies also pay interest on your cash value balance.

Cash value loans accrue interest, however, and may generate income tax liabilities (along with withdrawals). In addition to reducing the cash value, loans and withdrawals can also reduce the value of the death benefit and may cause the policy to lapse.

One key difference between whole life insurance and other insurance plans is the length of time you are given to make payments. At some point, your whole life policy will be paid in full — this could be in 20 years, or it might be paid off once you turn 65. If you're interested in a policy that can be paid off quickly, your monthly payments have the potential to be larger. It's ultimately a matter of preference — and your stage in life. Just keep in mind that tax limits and contractual provisions can limit the amount of premium that can be paid.

Another difference between policies is that some whole life insurance options don't offer cash value, and only pay out a death benefit after you pass away. In exchange, these plans charge a lower monthly premium. This can make them a good option if you simply want insurance protection for your beneficiaries.

Can I Withdraw Money From My Whole Life Insurance?

Yes, if your whole life insurance policy builds cash value, you typically can make withdrawals from the balance, but value will only be available after an extended period or if you increased funding through paid-up additions. If your total withdrawals end up totaling more than what you paid in premiums, you will owe income tax on the gain. However, if the policy is a modified endowment contract (MEC), the withdrawals are taxed as if the gain is withdrawn first. In addition, withdrawing money from whole life insurance will reduce the future death benefit for your beneficiaries.

You can also take money out through a loan. You do not owe income tax for taking out your gains, and you have the option to pay the money back into your policy, but you will owe interest to the life insurance company on the outstanding loan. If the policy is an MEC, the withdrawals are taxed as if the gain is withdrawn first. When you pass away, your whole life policy death benefit will pay off any outstanding loans and your beneficiaries will receive what is left.

What Happens to Cash Value in a Whole Life Policy at Death?

If you die with a whole life insurance policy, the insurance company keeps your cash value balance. In exchange, they pay your beneficiaries the death benefit, which will likely be more than what you had in cash value.

What Happens if You Stop Paying Whole Life Insurance Premiums?

If you stop paying your premiums, the insurance company will likely first see if you have cash value in the policy. They may use this balance to keep covering your premiums until the funds run out. At this point, the insurance company may give you a grace period to make up the missed payments and keep your coverage. After that, your coverage will end. Most term products, however, offer optional riders and options that could allow you to renew or covert your policy.

The insurer may offer a reinstatement period, where you can reapply to restart your old policy. In exchange, you'll need to catch up on the missed payments and might need to pass medical underwriting again.

How Much Does Whole Life Insurance Cost?

The cost of whole life insurance depends on several factors. First, your age will likely impact the cost. Chances are that the older you are when you apply for a policy, the more expensive it will be. Second, if you have any pre-existing medical issues or other health issues, that can increase the cost.

The size of the death benefit is another factor. For instance, a $500,000 policy will be more expensive than a $100,000 policy. Finally, the number of premiums payments you plan on making can have an impact on the overall cost. If you make payments over your whole life, the annual premium will be less than for a single premium or limited premium payment because you are spreading the cost over a longer amount of time.

Since all these factors change on a case-by-case basis, the only way to know for sure how much whole life insurance will cost for you is by meeting with a financial representative. After you formally apply and go through medical underwriting, the insurance company will give you the official cost and then you can decide whether to purchase a policy.

When Could Whole Life Insurance Be a Good Fit?

Whole life insurance could cover your final expenses or provide an inheritance — among other things. For these reasons, you don't want a policy that could expire, as there's a possibility that your coverage will terminate right before you pass away — leaving your beneficiaries with nothing.

For example, Steve is a 61-year-old mechanic who's approaching retirement. His kids have all completed college. He had a term life insurance policy when they were younger, but that policy just lapsed. Steve replaces his old plan with a $100,000 whole life policy. He decided it would be adequate to cover his final expenses, while leaving a small inheritance for his adult children.

Whole life insurance can also be a great fit for people who want to secure permanent coverage and set aside money for the future.

For example, Susan is a 31-year-old architect. She doesn't have any children but wants them in the future. After reviewing her options, she decides to purchase a $250,000 whole life policy. She likes the idea of accumulating cash value and knows permanent life insurance is a good way to help protect the future of her family. Since she's purchasing her policy while she's young, she'll be guaranteed a low price for the rest of her life.

Is Whole Life Insurance Right for Me?

Whole life insurance has a different cost structure than term life insurance. So, it's important you think carefully about what your life insurance needs are, and consider a policy that matches your needs. In addition, make sure the option you choose has an adequate death benefit to help meet your coverage needs. Consider which policy will best suit your lifestyle to find the best one for your long-term objectives.

Once you're ready to purchase a policy, be sure you can make a long-term commitment and that you understand how whole life insurance works. Remember: whole life insurance is a purchase that can improve over time. The longer you maintain your policy, the more you'll benefit from locking in a low premium and building cash value.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.