Whole life insurance

You probably already know you need some form of life insurance to protect your family financially. What you may not know is how all of these different life insurance policies compare. A lot of terms get thrown around and it’s hard to keep up.

We’re going to look specifically at whole life insurance and answer some of the biggest shopper questions: Is whole life insurance a good idea? Is whole life insurance better than term life insurance? Is whole life insurance a good investment? And, most importantly: Is whole life insurance worth it?

In this article:

• Whole life insurance quick facts
• What exactly is whole life insurance?
• How does the life insurance part work?
• How does the cash value part work?
• How much does whole life insurance cost?
• Pros and cons of whole life insurance
• What alternatives are there to whole life insurance?
• Who sells whole life insurance?
• Is whole life insurance worth it?

Whole life insurance quick facts

What exactly is whole life insurance?

Like all life insurance products, whole life insurance is designed to provide financial protection for people or organizations you care about in the event of your death.

Whole life insurance is a type of permanent life insurance (also called cash value life insurance), which is one of the two categories of life insurance. (The second major category is term life insurance.)

The biggest difference between these two categories is that term life insurance ends after a set number of years; it offers a death benefit and nothing more. Permanent policies like whole life, on the other hand, cost more because they include an extra savings component, which is referred to as the “cash value.”

How does the life insurance part work?

There are three major parts of a whole life policy:

1. The death benefit is a tax-free chunk of cash paid out by the life insurance company if you die. For example, let’s say you buy a whole life insurance policy with $500,000 in coverage. That $500,000 is the death benefit.
2. A beneficiary is the person or people that receive the death benefit. Beneficiaries can be your spouse, your kids, a trust, a business partner, a friend, a non-profit organization and other legal relationships and organizations.
3. Your premiums are how you pay for your life insurance policy. You usually pay monthly or annually.

Whole life insurance lasts for your whole life – as long as you keep paying the insurance premiums. That means if you buy it when you’re 30 and keep paying your premiums until you die at 85, your family will receive the death benefit.

How does the cash value part work?

When you pay your premium, a certain percentage goes into a tax-deferred savings component, known as the cash value of the policy.

The cash value of your policy earns interest and grows tax-deferred over time, at a rate determined by your individual policy. The growth rate is generally on the low end compared to other investments because life insurance companies have additional expenses (like policy administration expenses, underwriting costs, and death benefit payouts) that a pure asset manager does not.

However, life insurance companies often guarantee a certain amount of growth every year, which is one reason whole life insurance products attracted many people following the 2008 recession.

Here’s where whole life insurance (and permanent life insurance in general) gets confusing:

You can access the cash value of your policy in a few different ways, but each comes with certain risks.

• You can withdraw money tax-free from the cash value of your policy. However, if you completely surrender your policy or your policy lapses, any money you’ve withdrawn over your basis (that is, the portion of the cash value that’s drawn from your premiums) will be taxed as income.

• You can take out a low-interest loan. In this case, you’re borrowing against your policy. As with other loans, a cash value loan accrues interest until you pay it back. And if you die before you pay your cash value loan loan back, the amount you owe (including interest) will be deducted from your death benefit.

• You can collect the cash value by surrendering your policy. But keep in mind that most of the growth in your cash value happens when you’ve held the policy for two or three decades, so if you surrender within the first ten years, it’s unlikely that your cash value will be greater than the total premiums you have paid. Some life insurance companies also charge a surrender fee, so you should check with your carrier before terminating your policy.

Note that the cash value of your whole life policy is separate from the death benefit. While your beneficiaries are guaranteed to receive the death benefit when you die (provided you’ve paid your premiums), the cash value component can only be utilized while you are living.

This can be confusing to shoppers who believe that in the event of their death, their beneficiaries will receive both the death benefit and the accrued cash value. However, anything that remains of your policy’s cash value when you die will be retained by the insurance company.

How much does whole life insurance cost?

Since whole life insurance is guaranteed to pay out eventually, it is much more expensive and more complicated than term life insurance. Most permanent life insurance policies like whole life are at least six to 10 times more expensive than term life.

Methodology: Sample based on lowest cost average from top carriers for a 30-year-old male in highest health classification in the New Jersey area.

Pros and cons of whole life insurance

What’s good about whole life insurance?

• Whole life insurance lasts for your entire lifetime. As long as you keep making premium payments, your whole life insurance policy stays in force.

• Your premiums typically stay level for your entire lifetime. Most whole life insurance products feature level premiums, which means your insurance company cannot raise prices as you get older or if you get sick. Term life insurance also features this, but because whole life is meant to last much longer, this point is sometimes of concern to shoppers.

• Some of your premium goes into a tax-deferred savings account with interest. Like all insurance products, your premium goes to the insurance company to help spread out financial risk among a large group of people. However, what makes cash value life insurance products like whole life insurance unique is that some of your premium is being set aside into a savings account, which your life insurance company will deposit dividends into as an interest payment.

• You can potentially recapture some of the money you’ve spent on premiums. Because some of your premium is being put aside into a savings account, you have the potential to recapture that money. Note that this comes with many caveats. Often, if you attempt to make a withdrawal from your savings account in any way (such as a loan to yourself), the insurance company will charge you administrative fees, penalties, and other charges, and you’ll pay a tax penalty. These fees and penalties will eat into any earnings you’ve made on your savings.

• Your returns are usually guaranteed. Typically, your life insurance company will set a guaranteed minimum growth rate. Remember, however, that this “interest” is actually a dividend from your life insurance company’s profits, and the growth can vary wildly from year to year.

• Your money is protected from the stock market. If the stock market tanks, you don’t lose any of your cash value. And because your returns are guaranteed, your cash value will grow even if other investments stay stagnant or lose value.

What’s bad about whole life insurance?

• Whole life insurance is significantly more expensive. Premiums are often much higher than a term life insurance policy with the same amount of coverage because you’re paying for an insurance policy and putting money into the cash value portion of the policy. They can often cost six to 10 times as much as a comparable term policy. For a chart of rates broken down by age, see this full explainer on whole life insurance rates.

• Most policies are abandoned because they’re too expensive. Many people overestimate their ability to pay the large premiums year after year. Approximately 30% of whole life insurance policies are surrendered within the first three years and 45% are surrendered within the first ten years, according to a study by LIMRA and the Society of Actuaries (SOA).

• If you surrender your policy too early, your cash value will be very low. While your premium may be level, the percentage of it that goes into your savings account is not. In the first few years of your policy, a very small percentage of your premium goes into the savings account while the rest is used to pay for upfront costs like administrative fees and the agent’s commission.

• A whole life policy isn’t a very good investment. While the forced investment aspect of whole life insurance can help some people save, most dedicated investment options (like a mutual fund or IRA) will provide a better return over the long run.

What alternatives are there to whole life insurance?

• Term life insurance. Term life insurance is a lot like the life insurance part of whole life insurance, except that it ends after a specified number of years. Because term is so much cheaper than whole life insurance, you can buy a lot more coverage (meaning a larger death benefit) for the same amount of money. Term is popular among financial experts because it’s relatively cheap and easy to understand. It is pure protection, with no cash accumulation component. Learn more about whether you should buy term or whole life insurance .

• Other permanent (cash value) life insurance. There are other types of permanent life insurance policies besides whole. They are called variable life insurance, universal life insurance, and variable universal life insurance. These all differ in how the cash value portion of the policy works. Whole life is the simplest and least risky version because its cash value portion is a simple savings account, whereas the other three all incorporate an investment product with variable returns. Learn more about different types of life insurance .

Who sells whole life insurance?

Many major insurance companies, like AIG, Mutual of Omaha, and Transamerica offer whole life insurance.

While insurance companies are the ones who offer whole life products, you shouldn’t try to buy them directly from the companies.

Instead, you should go through an independent agent or broker like Policygenius, who can help you compare whole life insurance policies from a variety of companies. This advice is the same if you’re looking for term life insurance as well.

Is whole life insurance worth it?

While many agents, brokers, and insurers argue in favor of permanent life insurance policies like whole life insurance, these products do have their critics, including popular financial personalities like Dave Ramsey, Suze Orman, and Clark Howard.

Whole life insurance products, however, are useful for some people. For those with high incomes who have already maxed out their other tax-deferred accounts, whole life insurance can be a useful part of managing your estate. And if you have a special needs dependent who will need care after you are gone, whole life is a good option.

But for the vast majority of people – and especially the 45% who surrender whole life insurance policies – a term life insurance policy is the better option. You’ll get more coverage at a cheaper rate than you would with whole life insurance, making it more affordable for the decades that you’ll be paying premiums.

It’s also a good idea to avoid combining insurance and investment or savings. Insurance is not an investment, and shouldn’t be treated as an investment vehicle. If you’re trying to put together a long-term financial strategy, get expert help from a financial adviser or tax expert. They can help you structure your finances in such a way that you pay the least amount of tax and have a high growth rate.