What’s Whole Life Insurance? Pros, Cons & Costs

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Does whole life insurance deserve the bad press it continually gets from investment advisors that tell their clients it’s wiser to buy term life insurance and invest the difference? Or are the life insurance agents who tell prospects to purchase whole life because of the cash value component’s tax advantages more accurate?

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This article will provide you with enough information on whole life insurance that will allow you to decide if it’s the correct type of insurance for you to buy. We’ll compare it to other kinds of life insurance, look at situations in which it works for people, how much it costs, and more. 

Definition of Whole Life Insurance 

Whole life insurance is a type of permanent life insurance that is part of a whole life insurance policy. A whole life insurance policy is an agreement between a life insurance company and a policyholder that a death benefit will be paid out to a beneficiary, or beneficiaries, upon the policyholder’s death, provided that premium payments had been paid and the policy was in force.

What’s the Difference Between Whole Life Insurance and Other Types of Life Insurance? 

The type of life insurance that whole life is most often compared to is term life insurance. Let’s first compare those two and then look at how whole life stacks up against universal life insurance, indexed universal life insurance, and variable universal life insurance.

Whole Life vs. Term Life

If whole life insurance had a nemesis, it would be term life insurance. Term life is less expensive than whole life and pays a death benefit just like whole life does. So what does whole life have that term life doesn’t that would make so many people pay higher premiums for the same amount of life insurance coverage?

To make a fair comparison between the two, it will be helpful to take a quick look at what term insurance is. Here are the highlights:

  • The life insurance policy is in force for a fixed term (1,10,20,30 years)
  • Pays a death benefit to a beneficiary if the insured dies during the term
  • Pays no death benefit if the insured outlives the term
  • The policy can be converted to a whole life policy if the insured proves they’re still insurable
  • Premiums increase with term insurance 
  • Term life accumulates no cash value

How does whole life differ from some of those features (pros and cons)? 

Whole life stays in force for a person’s entire life as long as they pay the premiums on time. Unlike term insurance, there is no expiration date that could leave a family in a tenuous financial situation.

Whole life premiums remain level for the life of the policy. Whereas term life insurance gets more expensive each year you get older, whole life premiums are calculated at your age when you apply for the policy and never increase unless you increase the death benefit.

A whole life policy builds cash value. This is the primary differentiator between whole life insurance and term life insurance. So let’s explore it in a little more detail.

Cash value can be compared to a money market fund or a savings account. A portion of every premium dollar paid is deposited into the cash value account and earns interest. The remainder of the premium pays for the life insurance protection.

Because of the interest compounding over time of the current balance and new money being added to the cash value regularly, the amount of money in the cash value part of the policy can grow into a substantial sum over time.

After a certain period of years, the policy owner can borrow or withdraw money from the cash value. If it’s borrowed in the form of a loan, the loan amount is not taxed by the IRS. However, if the money is withdrawn from the cash value and doesn’t need to be repaid, the policy owner will have to pay income tax on the withdrawal amount.

Even though it’s more advantageous tax-wise to take a loan against the cash value, there is one major drawback: if the insured dies and some or all of the loan hasn’t been repaid, the outstanding amount will be subtracted from the death benefit of the policy.

For example, John owned a whole life policy with a death benefit of $500,000. He borrowed $100,000 of cash value from the policy and died before paying it back. His beneficiary received $400,000 ($500,000 death benefit - $100,000 unpaid loan).

Whole Life vs. Universal Life 

These two types of life insurance are part of the permanent life insurance family. They both have an initial death benefit, have level premiums, and accumulate cash value. However, there are several differences between the two.

Death Benefit – whole life insurance has a level death benefit. When the insured passes away, the policy’s face amount is paid out to the beneficiary. Universal life has a choice of two death benefits called Option A and Option B

Universal life’s Option A pays the death benefit stated in the policy, minus any unpaid policy loans (same as whole life). Option B also pays the death benefit stated in the policy, but it also pays the beneficiary any cash value left in the policy when the insured dies (whole life doesn’t have this option).

An example of Option B: Steve was issued a universal life policy with a death benefit of $200,000. He died five years later with $45,000 of cash value in the policy. His beneficiary would receive both the death benefit and the cash value for a total payout of $245,000.

Whole life insurance does not offer Option B.

Premiums — like whole life insurance, universal life has level premiums for the policy owner’s entire life, except for one exception. If the owner borrows from the cash value and has been using the cash value to pay the premiums, they may be required at a future date to pay more than their initial premium to keep the policy in force.

Premiums are also very flexible with universal life. The policy owner can pay a lump sum in addition to their regular premium or increase their regular premium every month. Any of the extra money from those deposits that didn’t go towards the insurance cost goes into the cash value account.

Whole life doesn’t allow you to pay any additional premiums to help build the cash value.

Whole Life vs. Indexed Universal Life

Indexed universal life insurance has more significant potential for the growth of cash value than whole life does. The reason is how the interest rate applied to the cash value is calculated. 

Life insurance companies set the interest rate for a whole life policy. It typically ranges from 3% to 6%; universal life is similar.

On the other hand, indexed universal life uses a stock market benchmark to determine the interest rate credited. The most commonly used benchmark is the S&P 500 stock index. The potential upside for indexed universal life is greater than it is for whole life, or universal life, because the index has the potential to rise higher than the standard 3–6% the other two policies offer.

For example, if the S&P 500 has a total increase of 8% for a given year, the indexed universal life policy owner will have 8% credited towards their cash value. The owner is protected from the index having a negative year and losing cash value through a minimum guaranteed interest rate (typically 3%). However, the interest rate credited is usually capped at 10% by life insurance companies.

Whole Life vs. Variable Universal Life

Variable universal life is basically the same product as universal life, except for how the cash value grows. Unlike whole life’s fixed rate set by the insurer, the cash value of a variable universal life policy is determined by the performance of individual mutual funds that are part of the stock market. 

Using mutual funds has the advantage of tremendous gains if the stock market performs well and the mutual funds follow suit. For example, the past twelve months have shown an increase of over 17% in the Dow Jones Industrial Average. Many mutual funds tied to that average have also performed that well, which translates to considerable growth in the cash value of owners of variable universal life policies that owned those mutual funds. 

However, if the Dow Jones Industrial Average was to drop below zero in a given period, the policy owner could suffer a loss of some or all of their cash value. 

Though whole life insurance has fixed interest rates and has nowhere near the potential of variable universal life, many people prefer it because they want to keep their life insurance and investments separate.

Who Typically Buys Whole Life Insurance?

Whereas there are many different types of people who buy term life insurance because they have temporary needs, the buyers of whole life are somewhat similar. These are characteristics of somebody who buys whole life insurance:

Risk-averse: The whole life buyer wants predictable, steady growth of their cash value and no change in the death benefit or premium. They may own some investments individually, but they want no risk tied to their life insurance.

Older: Though some people in their 20s and 30s will buy whole life, most whole life buyers are aged 40+ because they are more established financially and can afford the higher premiums that come with whole life. 

Conservative: Whole life buyers want guarantees, and they are attracted to the product because it offers three types of guarantees:

  1. A guaranteed minimum rate of return on the cash value
  2. The promise that premium payments will never be increased
  3. A guaranteed death benefit that won’t go down

How Much Does Whole Life Insurance Cost?

Like all types of life insurance, the price is going to depend on several variables:

  • Age
  • Gender
  • Tobacco use
  • Health history
  • Coverage amount

Lifestyle is also taken into account when you apply for a whole life policy: family history, criminal record, driving record, and occupation and activities also are factored in.

If you get quotes on both term life and whole life at the same time, you’ll find whole life to be as much as 6–10x more expensive than a similar whole life policy. Here is a comparison of the two:

Average cost of term life insurance by age

These annual life insurance rates are based on a $500,000, 20-year term life insurance policy for super preferred applicants.

Age

Average annual rate for men

Average annual rate for women

30

$225

$186

40

$336

$285

50

$839

$653

60

$2,364

$1,674

70

$9,298

$8,267

Source: Quotacy, lowest three rates for each age averaged, as of Sept. 13, 2021.

Average cost of whole life insurance by age

These annual life insurance rates are based on a $500,000 policy for super preferred applicants.

Age

Average annual rate for men

Average annual rate for women

30

$4,308

$3,802

40

$6,388

$5,467

50

$9,875

$8,347

60

$15,878

$13,487

70

$27,137

$23,678

Source: Quotacy, lowest three rates for each age averaged, as of Sept. 13, 2021.

How Do Premiums and Payouts Work With Whole Life? 

Premium payments for a whole life policy are very straightforward. They can be paid monthly, quarterly, semi-annually, and annually. They can also be paid up-front with one very large premium check; this is called a single-premium whole life policy.

Payouts for whole life policies are standard life insurance payouts. Most beneficiaries choose to receive their payout in one lump sum. Others prefer to have the benefit paid out in installments over time because they aren’t confident that they are fiscally responsible enough to not spend all of their money in a short period of time.

How long it takes to get a life insurance payout will vary by insurer; the average payout without any investigation into a possible crime typically takes 10–14 days. Each state’s insurance commissioner limits how long insurance companies can take until death benefits are paid to beneficiaries.

What Do You Think?

Now that you’ve read up on whole life, do you think it’s the right product for you, or would one of the other options we discussed be better for you? There is no correct answer to that question; different people have different needs.

Things like how much life insurance you need, how long you need it, and your budget make a difference when buying life insurance. Many online resources can help you make a solid decision for yourself and your family. Do your due diligence, and you’ll end up with the protection you need.

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