how whole life insurance works
whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level regularly due premium payments the policy includes a savings portion called the cash value alongside the death benefit in the savings component interest may accumulate on a tax deferred basis 1 growing cash value is an essential component of whole life insurance to build cash value a policyholder can often remit payments greater than the scheduled premium to purchase extra coverage known as paid up additions or pua policy dividends can also be reinvested into the cash value and earn interest over time the dividends and interest earned on the policy s cash value will provide a positive return to investors growing larger than the total amount of premiums paid into the policy the cash value offers a living benefit to the policyholder meaning the policyholder can access it while the insured is still alive to access cash reserves the policyholder requests a withdrawal of funds or a loan withdrawals are tax free up to the value of the total premiums paid 1interest is charged on policy loans with rates varying per insurer but the rates are generally lower than you d get with a personal loan or home equity loan however withdrawals and unpaid loans also reduce the cash value of the policy depending on the policy type and the size of its remaining cash value a withdrawal could chip away at the death benefit or even wipe it out entirely whole life insurance is different from term life insurance which only provides coverage for a certain number of years rather than a lifetime term life does not have a cash savings component and only pays out a death benefit whole life insurance cash valuea cash value life insurance policy is similar to a retirement savings account in that it allows investments to accumulate tax deferred interest part of each premium payment goes toward the policy s cash value which can be withdrawn or borrowed against later in life the cash value of a life insurance policy grows quickly when the insured is young but because more of the premium is needed to cover the cost of insurance as the insured ages the cash value grows more slowly as they get older due to the higher risks associated with age the insured can access their policy s cash value by borrowing against it the cash value or by withdrawing money in a partial cash surrender surrenders will reduce the final death benefit of your policy you can also use the cash value to cover your monthly premium payments instead of paying out of pocket or you can surrender the whole policy to receive the entire available cash value minus any surrender fees however the policy will be terminated and the death benefit will no longer be available to your beneficiaries some companies in the u k and australia offer insurance bonds with their policies which provide some tax advantages whole life death benefitthe dollar amount of the death benefit is typically specified in the policy contract but it can be changed in some instances some policies are eligible for dividend payments and the policyholder may elect to use the dividends to buy paid up additions to the policy which will increase the amount paid at the time of death death proceeds are non taxable to the beneficiary 1the death benefit can also be affected by certain policy provisions or events as mentioned before unpaid policy loans including accrued interest reduce the death benefit dollar for dollar alternatively many insurers offer voluntary riders for a fee that secure or guarantee coverage including the stated death benefit two of the most common such riders are the accidental death benefit and waiver of premium riders which protect the death benefit if the insured becomes disabled or critically or terminally ill and is unable to remit premiums due beneficiaries may also have decisions to make about how the death benefit is paid the default option is to receive a lump sum payment but some policies also allow beneficiaries to choose to get the death benefit in installments or to convert it to an annuity an annuity may pay out for a set amount of time until the death benefit is exhausted or it could pay out for the life of the beneficiary the death benefit continues to earn interest until it is paid and that interest may be taxable 1as is the case with any kind of permanent policy it s important to thoroughly research all insurers being considered to ensure they re among the best whole life insurance companies currently operating uses of whole life insuranceas with any kind of life insurance a whole life insurance policy gives individuals and their families financial security against the loss of a breadwinner for families that rely on the income of a single person a whole life policy can provide financial security against the sudden loss of an income provider but unlike term life whole life can also be used as an investment once the cash value has grown big enough you may be able to withdraw or borrow from it to pay for large purchases such as a home some people also use whole life cash value to supplement their income in retirement when markets are low whole life insurance is also useful for businesses as a contingency plan for the loss of a key employee or partner if a key employee passes away a whole life policy can provide a financial offset to the loss of their skills or expertise if the deceased is part owner of the company a whole life policy can provide the remaining owners with enough capital to buy out the deceased partner s share of the business types of whole life insurancethere are several main types of whole life insurance categorized based on how premiums are paid whole life insurance policies are further distinguished as participating and non participating plans with a non participating policy any excess of premiums over payouts becomes profit for the insurer however the insurer also assumes the risk of losing money with a participating policy any excess of premiums is redistributed to the insured as a dividend this dividend can then be used to make payments or increase one s policy coverage limits however dividends are not guaranteed and often vary each year as they are primarily based on the company s financial performance whole life insurance vs term life insurancewhole life insurance is similar to term life insurance in that both types of policies offer a payout upon the death of the insured however there are important differences while whole life insurance offers a guaranteed death benefit for the entire lifetime of the insured a term policy only pays out if the insured dies within a certain time frame usually 10 20 or 30 years there are other considerations as well in order to provide greater benefits a whole life policy requires significantly higher premiums than a term policy with the same coverage limit whole life premiums are typically fixed throughout the policy duration while term rates increase at each renewal as the insured grows older advantages and disadvantages of whole life insurancelifetime coveragecash value you can use for loans withdrawals or premium paymentsguaranteed death benefit amountpredictable premium paymentstax free loansmore expensive than term lifecash value may grow slower than with other policiesno flexibility to adjust the premiumlimited ability to adjust the death benefitadvantages explaineddisadvantages explained