Whole Life Insurance 101: A Simple Guide to These Complicated Policies

Life insurance is one of those touchy subjects no one likes to talk about, let alone research or recognize its existence. In a world that’s all about living your best life, life insurance just doesn’t fit. 

We’re here to tell you that not only is it OK to talk about life insurance, but finding the right type of policy can provide you with peace of mind.

One option to consider is whole life insurance.

What Is Whole Life Insurance, and How Does Cash Value Work?

So what is whole life insurance?

Whole life insurance is a type of permanent life insurance that pays out a benefit to the individual(s) you list as the recipients for your policy when you die. 

But part of your policy goes toward a cash value component, which is basically a tax-deferred savings account you can take advantage of later in life.

You can use the cash value to:

• Pay your premiums.
• Take out loans at lower interest rates than you’d get from a bank.
• Supplement your income, especially in retirement.
• Create a new investment portfolio.

Whole life insurance is a guaranteed payout that you can’t outlive. Your beneficiaries will receive the payout upon your death unless you fail to make payments or cancel your policy (and pay expensive cancellation costs), or if your cause of death is excluded in your policy. 

When you die, your heirs receive the listed death benefit — but not the cash value that rose while you were alive and making payments. Any remaining cash value goes to the insurance company, so it’s a benefit to take advantage of while you’re still alive.

Term vs. Whole Life Insurance

The biggest difference between term and whole life insurance policies is the amount of time that you are covered.

Term life insurance provides coverage for specific amounts of time, usually for set periods of anywhere from five to 30 years. But whole life insurance, as discussed above, is going to pay out eventually when you die as long as your premiums are paid. 

When you choose term life insurance, you can get more coverage for lower premiums. Why? Because you’ll likely outlive your term, and the insurance company won’t have to pay out a death benefit. It also has no cash value.

Most people choose a set term life insurance, knowing they are paying a low premium purely on a policy that’s solely for financial protection in the case of their untimely death. If you look at it from a purely insurance standpoint, it’s like buying car insurance your whole life but never using it because you were never in a car wreck. 

Your premiums for personal whole life insurance are considered a personal expense, so they aren’t tax-deductible.

5 Types of Whole Life Insurance Policies

There are five main types of whole life insurance. Here’s a brief overview:

Traditional whole life insurance: Your premiums stay the same as long as you keep making them. 

Single premium whole life insurance: One large lump payment you make upfront takes care of this policy. 

Limited whole life insurance: You pick a set period, such as 20 years, for this whole life insurance option. You’ll still be insured your whole life, but you’ll only make payments during the set period, which means your payments are higher than they would be for traditional whole life insurance.

Modified premium whole life insurance: You pay lower premiums upfront, but they get more expensive as you age. 

Survivorship life insurance: These policies allow you to insure two people and are popular among spouses. The catch? It pays out only after both policyholders have died. The benefit? It’s less expensive than paying for two separate whole life insurance policies. 

What Happens When a Whole Life Insurance Policy Lapses or Is Surrendered? 

A whole life insurance policy lapses when the policyholder stops making monthly premium payments on time. The life insurance contract is labeled as no longer active, and the cash value built up on the policy is surrendered. Death benefits will no longer be paid out for these surrendered policies. 

Some companies allow policyholders to restart their policies within a certain grace period and get their lapsed payments paid within this time frame. Read the fine print to make sure you understand the rules of your whole life insurance policy lapse clause. Typically, reinstatements cost more than one month’s premium payment. 

Whole Life Insurance Pros and Cons

When you’re deciding whether a whole life insurance policy works for you, you have to weigh the pros and cons. The hard part? Decide what works best for you in your current financial situation while also weighing what works best in the long term for your beneficiaries.

What’s Good About Whole Life Insurance

Whole life insurance is appealing for several reasons, including:

• It’s guaranteed and permanent. That means your beneficiary will receive a payout upon your death, no matter when you die, as long as you’ve made your payments and your cause of death isn’t excluded from the policy.
• It’s a good option if you have dependents who will need a source of income after you die. The guaranteed payout makes it an appealing option for people with a disabled child, for example.
• Your payments are usually fixed throughout the life of the policy. There are options to choose limited whole life insurance policies that have a set term limit or policies that change once you turn 65. 
• You can take advantage of the cash value while you’re still alive. Just keep in mind that the cash value takes a long time to build up, meaning you’ll likely be much older before you can take advantage of this benefit.

What’s Bad About Whole Life Insurance

Here are a few drawbacks to consider if you’re thinking about whole life insurance:

• Higher premiums: You pay more for the guaranteed payout and lifelong coverage than you would for a term life policy.
• The cash value is lost upon your death. While some people make the case that whole life insurance can be used as a long-term personal finance retirement planning tool, the fact that money is lost when you die doesn’t help this argument.
• You’ll pay large fees to cancel the policy and withdraw the cash value. You’ll also pay income taxes on any earnings on the policy beyond what you paid for your premiums.

How to Choose Between Whole Life Insurance vs. Term Insurance

We get it. This is a difficult task no matter what. Life insurance company terms and conditions and the products and services they offer are complicated and difficult to digest. But here’s a quick summary of when to consider whole life insurance vs. term insurance.

Consider term insurance if:

• You want to replace your income during a specific amount of time, e.g., while you’re raising children, paying off your mortgage, etc.
• Need the lowest premiums.
• You want a permanent life insurance option but just can’t swing the cost right now. (You might be able to transfer your term insurance to a whole life insurance policy later on, though this is costly.)

Choose whole life insurance if:

• You need to set money aside for family members.
• You expect to have expenses such as estate taxes that will need to be paid.
• You have children with lifelong special needs.

Are you trying to figure out what is whole life insurance? If you’re looking for a life insurance policy that has consistent monthly policy payments and allows you to draw off its rising cash value while you’re still alive, this might be an option for you. If you’re still not sure, a financial adviser can help you figure out what type of life insurance is right for you.

Kurt Schultheis is a Florida-based writer.

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