What Is Whole Life Insurance?
Whole life insurance, commonly known as standard life insurance, provides the insured with a guaranteed death benefit for the rest of his or her life. Whole life insurance has a savings component that can accumulate monetary value in exchange for paying a death benefit. Interest is compounded at a fixed rate and is tax-deferred.
One sort of permanent life insurance is whole life insurance. Others include universal life, indexed universal life, and adjustable universal life. Whole life insurance is the first sort of life insurance, but it is not the same as permanent life insurance because there are many different types of permanent life insurance.
KEY TAKEAWAYS
- In contrast to term life insurance, which is only for a set number of years, whole life insurance lasts for the entire life of the insured.
- When a person dies, whole life insurance pays out to a beneficiary or beneficiaries if the policy is still active.
- Whole life insurance has a cash savings component that the policyholder can use to withdraw or borrow from.
- A whole life policy’s cash value usually earns a predetermined rate of interest.
- Loan principle and interest are deducted from death benefits.
Understanding Whole Life Insurance
In exchange for regular, level premium payments, whole life insurance assures payment of a death benefit to beneficiaries. Along with the death benefit, the policy provides a savings component known as the “cash value.” Interest may build on a tax-deferred basis in the savings component. Whole life insurance has a cash value that grows over time.
A policyholder can pay more than the monthly premium to increase cash value (known as paid-up additions or PUA). Dividends can also be re-invested in the cash value of the policy to earn interest. The policyholder receives a living benefit from the cash value.
The dividends and interest earned on the cash value of the insurance will often give a positive return to investors over time, rising larger than the entire amount of premiums paid into the policy. It is, in essence, a source of equity.
The policyholder must request a withdrawal or a loan to gain access to cash reserves. On loans, interest is imposed at different rates depending on the insurer. In addition, the owner is allowed to withdraw cash tax-free up to the number of premiums paid. The death benefit will be reduced by the amount of unpaid loans.
The cash value of the insurance is reduced by withdrawals and unpaid policy loans. A withdrawal could also reduce or even eliminate the death benefit, depending on the policy type and the quantity of the remaining cash value. While some policies reduce the death benefit by the same amount as the amount withdrawn, others (such as some conventional whole life policies) may reduce the death benefit by an amount greater than the amount removed.
Special Considerations
The death benefit is usually a predetermined amount specified in the insurance contract. Some plans are eligible for dividend payments, and the policyholder can choose to have the dividends used to acquire extra death benefits, increasing the amount paid at death. The beneficiary is not taxed on the death proceeds, thus they are not included in taxable gross income.
Certain policy provisions or incidents can also affect the death benefit. Unpaid policy debts, which include accrued interest, for example, diminish the death benefit dollar for dollar. Many insurers, on the other hand, charge a price for optional riders that assure or guarantee coverage, including the specified death benefit.
The accidental death advantage and waiver of premium riders, for example, protect the death benefit if the insured becomes incapacitated or seriously or terminally sick and is unable to pay the premiums due.
Many policies allow the policyholder to specify that the proceeds of the policy be held in an account and delivered in installments rather than in one lump amount. Interest earned on the retaining account is taxable, and the beneficiary must report it. Also, if the insurance policy was sold before the insured died, the proceeds of the sale may be subject to taxes.
As with any type of permanent coverage, it’s critical to conduct extensive research on all potential insurers to guarantee they’re among the best whole life insurance firms currently in operation.
Example of Whole Life Insurance
The accumulation of cash value minimizes the net amount of risk for insurers. For example, ABC Insurance issues S. Smith, the policy owner, and insured a $25,000 life insurance policy. The cash value grows to $10,000 overtime. ABC Insurance will pay the full death benefit of $25,000 upon Mr. Smith’s death. However, due to the $10,000 cumulative cash value, the corporation will only lose $15,000. The net amount of risk at issue was $25,000, although it was only $15,000 at the time of the insured’s death.
History of Whole Life Insurance
Whole life insurance was the most popular insurance product from the conclusion of WWII to the late 1960s. Policies provided money to relatives in the case of the insured’s untimely death and aided with retirement planning. Many banks and insurance businesses became more interest-sensitive with the passage of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1982.
Individuals considered the advantages of buying whole life insurance versus investing in the stock market, where annualized return rates for the S&P 500 were 14.76 percent in 1982 and 17.27 percent in 1983, adjusted for inflation.
Instead of whole life insurance, the majority of people began investing in the stock market and term life insurance.
What’s the Difference Between Term and Whole Life Insurance?
Term life insurance, as the name implies, pays out a death benefit for a set period of time. Unlike a whole life policy, this type of life insurance does not include a savings component. The policy expires at the end of the term. Some insurers will let you convert your term insurance to a whole life policy or renew it for a longer period of time. Whole life insurance is a sort of permanent life insurance that covers the insured’s entire life. A whole life insurance policyholder can also accumulate cash value in the policy’s savings component.
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