How Does Whole Life Insurance Work?

Life insurance is just that – it insures your life for a particular amount of money, and if you pass away, that amount is paid to a beneficiary. Sounds pretty simple, right?

The concept might be simple, but there are different types of life insurance that are available, based on your needs. We’ll focus on whole life insurance here, describing the basics of whole life insurance, the types of whole life insurance, common riders, and some frequently asked questions, to help answer the question “How does whole life insurance work?”

What Is Whole Life Insurance?

Let’s start at square one. What is whole life insurance? Whole life insurance provides two benefits – insurance on your life, and a cash value account that can be used as savings.

First, as the name implies, a whole life policy provides coverage for your whole life. When you first apply for coverage, you agree to pay fixed premiums each year to an insurer, and the insurer agrees to pay your beneficiary a certain amount of money (the death benefit) when you pass away. If the premiums are paid, the death benefit will be paid. The premiums are determined based on your age and health at the time the policy is issued, and then remain the same throughout your life, regardless of health changes down the road.

In addition, the policy has an account that builds up over time, tax-deferred, called the “cash value”. The cash value account is a substantial benefit for whole life insurance policyholders.

What Is The Cash Value?

Over time, the premiums you pay into your policy generate a cash value, which can be used in the future to pay your premiums, or withdrawn as a loan. It’s similar to when you buy a house and have a mortgage – as you pay your mortgage payments, over time you build equity on the house that can be used for a home equity loan. This is the same concept – the policy builds up cash value, which you can borrow from as a loan.

You can borrow from your policy for any reason, there are no restrictions other than on the amount that you can borrow. You’re responsible for paying the loan back – if you don’t, when you pass away, the insurer will deduct the loan balance from the death benefit, paying your beneficiaries a lesser amount.

A whole life policy is sometimes viewed as an investment vehicle because of the cash value accrual. True investments are heavily regulated, so you shouldn’t view the policy as such – however, it’s important to note that loans are available from the cash value at any time, for any reason, and the loans have no tax consequences. That’s right – you wouldn’t have to pay any taxes on the loan that you take – unlike a withdrawal from a market account, where you may be subject to capital gains taxes.

Types Of Whole Life Insurance

Although all whole life policies build a cash value and are designed to cover your whole life, there are a few different types that can be issued.

• Ordinary whole life: level premiums over your lifetime.
• Limited payment whole life: level premiums for a specific period (i.e., for 20 years, or to age 65).
• Single premium whole life: policy is paid up after one large initial payment.
• Modified premium whole life: lower premium initially for an agreed-upon period of time, higher premiums thereafter.
• Survivorship life: “Second to die” insurance, insures two lives (usually spouses) and pays the death benefit upon the death of the second person. Less expensive than insuring two lives under separate policies.

Whole Life Riders

A “rider” on an insurance policy adds features and/or benefits to the underlying policy. For some, there is an additional cost; with others, the insurance company may include it at no charge.

There are four common riders for whole life policies:

• Waiver of premium rider: If you become disabled, this rider ensures that the premium is paid, and the policy doesn’t lapse.
• Accelerated death benefit rider: Also called a “living benefit” rider, this allows you to have access to a portion of the death benefit while still living, if they become terminally ill – usually with a documented life expectancy of 2 years or less. The amount you can receive is generally limited to a percentage of the death benefit, and helps to defray the additional costs resulting from the illness.
• Term life rider: This adds a term insurance policy to the whole life policy, increasing the death benefit for a specific period. Adding a term rider to a whole life policy is less expensive than purchasing a whole life policy and a term life policy separately.
• Guaranteed purchase option rider: This allows you to buy additional life insurance without having to take a medical exam and go through the underwriting process again. The additional insurance would be based on the rating you received when your policy was issued, and your age when you buy the additional insurance.

Frequently Asked Questions

With pension plans, there are a lot of questions asked by business owners and employees alike. We’ve covered some of the more common questions below – if you have other questions, feel free to email us and we’ll get you an answer!

There are a lot of myths about insurance, and questions that people have – we’ve tackled some of the more common ones below. If you have any other questions, feel free to contact us and we’ll help you out!

• Do I have to be in perfect health to get life insurance? No! You can purchase life insurance regardless of your health – there are insurance companies that have no-medical exam policies, or guaranteed acceptance. You may have to pay a higher premium for this, but you would certainly have access to a life insurance policy.
• I’m a senior citizen, isn’t life insurance really expensive for me? It’s true that premium costs increase with age, and if you’re looking for a large death benefit, that would be pretty expensive. However, you could purchase a final expense policy, which would cover your funeral costs and other final expenses, for a reasonable cost.
• Why would I pay more for whole life insurance, when I can get term insurance so much cheaper? “Buy term, invest the difference” is a common chant among financial advisors that would rather put money into the market instead of an insurance contract. Price is just one factor to consider for life insurance. Term insurance is certainly cheaper, but coverage is only for a limited period – if you survive through the term period, your policy lapses, and you’d need to purchase another policy at that point – for higher premiums. In addition, term insurance doesn’t have a cash value account – there’s no value to the policy. Make sure you talk to your financial advisor to determine what type of policy is best for you.
• What if, down the road, I don’t want to pay premiums anymore? At that point, you have a few choices – you can surrender the policy, and the insurance company will pay you the cash value. Or, you could “RPU” your policy, which stands for “reduced paid up”. The insurance company will consider your policy “paid up”, which means there’s no more premium payments, and the death benefit will be reduced. At that point, you have a paid up policy, where the cash value continues to grow, you can still take loans, and when you pass away, your beneficiaries will receive the reduced death benefit (minus whatever loans are
  outstanding)
• What if I live to 100 (or whenever the policy finishes)? If a policyholder outlives the policy, the insurance company may pay the cash value to the policyholder, which (by this point) is equal to the death benefit. At that point, the policy is closed out. Other insurers stop collecting the premiums, but keep the policy active until you pass away.

Monarch Financial Advisors

Whole life insurance is a great product if you’re looking for fixed premium payments, coverage for your whole life, and/or a cash value build up that can be accessed with no tax penalties. Is it right for you? Let’s find out! Contact us!

Our team is ready to answer your questions, and start planning for your future!