Whole Life Insurance
Whole Life Insurance Explained: What You Need to Know
Life insurance typically offers a death benefit payout – a lump sum of money paid out to your beneficiaries – but whole life insurance comes with a few extra features. Whole life insurance is a type of permanent life insurance, which means your policy remains active until you pass away. On top of a death benefit, whole life insurance offers accumulated cash value and investment opportunities.
Each of these additional features adds value to a typical life insurance policy and can provide additional benefits to your beneficiaries and help with funding during your lifetime. In this article, we’ll explore these benefits, including how the cash value works, how it can be used for investments, the potential tax benefits, the fine print around death benefit payouts and how it differs from term life insurance.
How Whole Life Insurance Works
Whole life insurance has two main features: A death benefit payout and a cash value component. The cash value is what sets whole life insurance apart from term life insurance, and this sum is often used in further investments and savings plans. Here’s a breakdown of how whole life insurance works:
- Premium Stability: When you sign up for whole life insurance, you pay the same premium until death. The earlier you start, the cheaper the premium.
- Death benefit: The death benefit, or face value, is paid out to your beneficiaries after death. Whole life insurance includes a death benefit, like any other life insurance policy. In Canada, a whole life insurance death benefit is between $50,000 – $1mil.
- Accumulated cash value: With whole life insurance, you can allocate a part of your premium payment to a cash value account. This can take a few years to accumulate, but once the value in the account exceeds your premium payments, you can access it for investments.
With these basic features, whole life insurance offers the following benefits:
- Estate and tax planning: The death benefit payout is usually tax-free. This allows policyholders to mitigate the impact of taxes on their heirs and transfer assets smoothly.
- Financial flexibility: Since you can use the cash value of your policy for various things without excessive tax penalties, you have more financial freedom to fund education, pay for emergencies, add to your retirement savings, or anything else you need.
- Business succession: Life insurance isn’t always for families. If you’re a business owner, you can get life insurance to support the business if you pass away unexpectedly. This can help make the leadership transition smoother and help provide stability.
How you use your cash value will differ based on what the policy allows and personal preference. We explore the cash value options below.
How Does The Cash Value Work?
It’s best to use your cash value while you are still alive, however, cash has to accumulate first. This may take several years, so the sooner, the better! If you get life insurance early on, you’ll get cheaper premiums and access more cash value when you need it to send kids to university or invest in a house. However, these aren’t your only options. You can use the cash value from your whole life policy in a few ways:
- Borrowing: You can take out a loan using the cash value as collateral. These loans often have more favourable rates than conventional loans. They are also tax-free. However, like all loans, you’ll be required to pay it back with interest.
- Premium payments: If you can’t keep up with your life insurance premiums, you can use the cash value to keep the policy active without more out-of-pocket expenses. However, this option is limited and will depend on the policy.
- Earn interest on cash value: Most whole life insurance premiums will offer interest on your cash value.
- Withdrawals: In some cases, you can withdraw your cash value to use it. You can also surrender your policy to access the cash, although this may come with a fee.
- Dividends: A few insurance companies will offer dividends to clients with cash-value accounts. This means they pay a small sum of their profits to clients.
- Tax benefits: When your cash value increases due to interest and dividends, all the growth is tax-deferred. This means you won’t have to pay tax on the interest when you draw the money. When your beneficiaries get the death benefit, the amount is usually not taxed.
- Leave it to your beneficiaries: Most policies will not automatically leave the cash value to your beneficiaries. This is something you need to request or add to your policy at an additional cost. However, if you’ve accumulated a lot of value, it may be well worthwhile.
Whatever you choose to use the cash value for, make sure you don’t exceed the amount you have saved. If you die before you pay off a loan against your cash value or have outstanding debts, the value may be deducted from your beneficiary’s death benefit.
What’s The Difference Between Whole Life Insurance And Other Life Insurance?
Whole life insurance is a good long-term investment. However, not everyone is ready to commit to a lifetime of insurance payments. Luckily, there are several other options to choose from. These are outlined below.
Term Life Insurance
Term life insurance is straightforward and economical. It’s usually cheaper than whole life insurance and provides coverage for a set period (10 to 30 years). It doesn’t accumulate cash value and is more of a safety net than a tool for investments and savings. This type of insurance is ideal if you only have temporary insurance needs. For example, couples with young children or people with outstanding debts may take out term life insurance to protect their loved ones if the worst happens.
Universal Life Insurance
Universal life insurance is another form of permanent life insurance but with a flexible premium and death benefit structure. Life can change quickly, and universal life insurance allows you to adjust your policy with the circumstances. This makes it ideal for long-term financial planning. Like whole life insurance, it includes a cash value component as well as the standard death benefit.
Variable Life Insurance
Variable life insurance is like whole life insurance, except you can invest your cash value in securities. This means you can get higher returns than the standard interest rate, but you also risk a volatile market. This type of insurance is perfect if you’re familiar with investing and can reliably make safe investment choices for the best rewards.
Variable Universal Life Insurance
Variable universal life insurance allows you to adjust your premium payments and make changes to your policy while also allowing you to invest the cash value. This means you can grow your funds and have maximum control and flexibility over your insurance policy. You can use this insurance as part of a broader financial portfolio.
Here’s a table summarizing the different policies:
| Whole life insurance | Term life insurance | Variable life insurance | Universal life insurance | Variable universal life insurance | |
|---|---|---|---|---|---|
| Is there a death benefit? | Yes | Yes | Yes | Yes | Yes |
| Is there cash value? | Yes | Yes | Yes | Yes | |
| Can you change and update the policy with time? | No | No | No | Yes | Yes |
| Can you invest the cash value? | If you take out a loan first | No | Yes | Yes | |
| Do you accumulate interest on the cash value? | Yes | No | Yes | Yes | Yes |
| Can you borrow against the value of the cash value? | Yes | No | Yes | Yes | Yes |
Other Life Insurance Options
Sometimes, it’s unclear whether a term or whole life insurance option is better. Perhaps it’s too soon to tell, or you don’t like how expensive whole life insurance is compared to term life insurance. Maybe you don’t need life insurance but want to use it to invest. Luckily, there are a few options available if you’re in this position:
Term Conversion Options
Depending on the insurer, you can convert a term life insurance policy into a whole life insurance policy at the end of the term. Since term life insurance is temporary, it may expire before your death, leaving your beneficiaries with nothing if you die. To avoid this and retain cheaper premium rates, you can convert your existing policy into a permanent one. To do this, you may need to go through medical underwriting, a process where your insurer examines your medical history.
Retirement planning
If you’ve maxed out your other tax-advantaged accounts, such as 401(k) and IRAs, you can use a whole life insurance policy as part of your retirement planning. However, this option is mainly applicable to high earners. For basic coverage at a lower cost, term life insurance is still a good option.
How To Choose The Right Whole Life Insurance Plan
If you’re still not sure what life insurance will work best for you, here are a few tips to find the right plan for you.
- Insurer reputation: Not all insurers are equally reliable or secure. When looking for insurers, make sure they’ll reliably pay the death benefit and take care of your beneficiaries even when you’re no longer around.
- Financial stability: Consider your financial stability. Do you see yourself going through multiple jobs and life changes in the next few years? In that case, a flexible policy such as universal life insurance may be right for you.
- Age and Cost: Life insurance premiums go up the older you get. Therefore, starting when you’re still young is a smart financial choice, especially for whole-life insurance premiums. You can lock in an affordable rate and continue to pay it comfortably for your lifetime rather than waiting until you’re older.
- Riders: Policy riders are extra policy features you can add to most life insurance policies. If no policies seem to work for you, customizing it with a rider may help. For example, an accelerated death benefit rider can help you access funds if you’ve been diagnosed with a terminal illness. Adding this rider to a term life insurance policy may be able to save you money and provide extra funds and peace of mind even in the worst circumstances.
- Coverage amount: Perhaps there’s a minimum amount you want for your death benefit. Not all insurers will offer coverage over a million dollars, so make sure you know what you want before seeking out an insurer.
Remember, life insurance is mainly for your beneficiaries. So keep them in mind as you go over the options. For example, if your family relies on your income, a death benefit can help them pay for funeral and living expenses as they grieve and work to find other income. A death benefit should also be able to pay off any outstanding debts to ensure your beneficiaries have one less thing to worry about when you’re gone.
Conclusion
Whole life insurance acts as a safety net for your beneficiaries, such as family and business partners. However, the benefits don’t stop there. With the cash value component, whole life insurance can add value to your life as well. Whether it’s leveraging the policy for tax advantages, estate planning, taking out a mortgage loan, or investing in the stock market, whole life insurance is great for saving goals. If you use it wisely, the increased premium costs and long-term commitment will be well worth the benefits. Ultimately, life insurance is there to help your beneficiaries recover after you die. In this case, whole life insurance can ensure that you are covered up until your death and that your beneficiaries are well taken care of in your absence.
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