Whole life insurance

How whole life insurance actually works

Whole life insurance is permanent cover. Provided the premiums are paid, the policy does not expire and the death benefit is payable whenever death occurs, at 70 or at 100.

Two things are happening inside the contract at once. Part of each premium funds the death benefit. The rest builds cash value, a guaranteed account inside the policy that grows at a rate set in the contract and is not exposed to the stock market.

That second part is why whole life insurance costs several times what an equivalent term policy costs at the same age. You are pre-funding a benefit that is certain to be paid rather than one that probably will not be.

The premium is level for life on most policies. It does not rise as you age, and it does not rise if your health deteriorates.

What the cash value can and cannot do

Cash value accumulates slowly at first. In the early years most of the premium is absorbed by the cost of insurance and acquisition expenses, so a policy surrendered in year three usually returns very little. Whole life insurance rewards patience and punishes short holding periods.

Once it has built up, you can generally do three things with it.

Borrow against it. Policy loans do not require credit approval and are not taxable when taken. They do accrue interest, and any unpaid balance reduces the death benefit.

Withdraw from it. Withdrawals up to the amount you have paid in are usually tax-free; beyond that they may be taxable. Withdrawals permanently reduce the benefit.

Surrender the policy. You take the cash surrender value and the cover ends. Gains above your cost basis are taxable.

What cash value is not is a savings account. Access is slower, the early returns are poor, and the money is not there in an emergency in year two. Treat it as a long-term feature of the insurance, not as an investment.

Participating policies and dividends

Some whole life insurance is issued by mutual companies and is described as participating, meaning the policy may receive an annual dividend when the insurer’s results allow.

Dividends are not guaranteed. Illustrations that project decades of them are showing an assumption, not a promise, and the difference compounds. Ask for the guaranteed column of any illustration and make the decision on that.

Where dividends are paid you can usually take them in cash, use them to reduce premiums, leave them to accumulate at interest, or buy paid-up additions — small increments of extra permanent cover, which is generally the most efficient use of them.

Who whole life insurance genuinely suits

It is the right tool for a need that does not go away. Cover for a dependent with a disability who will need support for life. A lifelong estate-planning or business-succession obligation. Funding a buy-sell agreement.

It also suits people who want a permanent benefit locked in while they are healthy enough to qualify, and who can comfortably afford the premium for decades rather than years.

It is usually the wrong tool for a temporary need. If the obligation ends when the mortgage is paid or the children finish school, term cover buys several times the death benefit for the same money. And if the goal is simply to cover a funeral, a final expense policy is a smaller, cheaper form of the same permanent idea.

Whole life insurance and universal life are not the same

Universal life is also permanent, but the premium is flexible and the interior costs can rise over time. If the policy is underfunded, cash value is consumed to keep it going, and a policy bought at 45 can require far larger payments at 75 to avoid lapsing.

Whole life insurance trades that flexibility for certainty: a fixed premium, a guaranteed death benefit and a guaranteed minimum cash value. If predictability is what you are buying, that distinction is the whole decision.

Applying, and what underwriting looks at

Most whole life insurance is fully underwritten — health questions, a paramedical exam, and a review of prescription and driving records. Some carriers offer simplified issue at smaller face amounts with questions only.

Age and health set the rate class, and the rate is then locked for life. This is why applying earlier matters more with permanent cover than with term: you are fixing a price you will pay for forty years, not ten.

Answer everything accurately. The contestability period, normally two years, lets the insurer review the application if a claim arises during it.

Common mistakes with whole life insurance

Buying more than the budget can sustain. A lapsed permanent policy is the worst outcome available: years of premium spent and no cover. Buy an amount you can pay through a bad year.

Reading the illustration’s projected column as a forecast. Only the guaranteed column is contractual.

Assuming the cash value passes to your family. On most policies the beneficiaries receive the death benefit and the insurer retains the cash value. Ask which option your contract uses.

Letting a loan quietly grow. Unpaid interest compounds and can eventually consume the policy.

What happens if you stop paying

This is where whole life insurance behaves quite differently from term, and where the cash value earns its keep.

Once a policy has built cash value, it carries non-forfeiture options. Stopping payment does not simply cancel the cover.

Reduced paid-up insurance. The cash value buys a smaller permanent death benefit outright. You never pay another premium and the policy remains in force for life at the reduced amount. For someone whose income has fallen in retirement, this is usually the best of the three.

Extended term insurance. The cash value buys term cover at the original death benefit for as long as it will fund. Full benefit, but with an expiry date.

Automatic premium loan. The policy borrows from its own cash value to pay the premium. Useful for a short gap, corrosive if left running for years, because the loan and its interest reduce the benefit.

Which options your whole life insurance contract offers, and how they are calculated, is set out in the policy’s non-forfeiture table. Ask to see it before you buy rather than during a difficult year, and call us before you cancel anything — permanent cover surrendered late in life is very hard to replace.

Check any of this independently

Nothing here should rest on our word alone.

• NAIC — life insurance consumer information — from the association of state insurance regulators
• NAIC consumer tools — agent licence and complaint lookup
• USA.gov — life insurance — including how to trace a lost policy

Related guides on this site

• Life insurance overview — term, whole, universal and final expense compared
• Term life insurance and final expense cover
• Medicare Simplified — if you are also approaching 65
• Book a no-cost appointment

Or call (877) 808-2900. We will show you what whole life insurance costs at your age beside the term alternative, and we will tell you plainly when the term policy is the better buy.