What is Whole Life Insurance?
Published: 09/08/2011 by Kevin Mulligan
Life insurance is one of the most controversial financial products available. There are two main types: term life insurance and whole life insurance. Whole life insurance can be confusing. There is a lot of paperwork riddled with fine print. How exactly does whole life insurance work, and should your family use it?
What is Whole Life Insurance?
A whole life insurance policy is an insurance that provides a financial payout if you die during the policy's guidelines. Most whole life plays are for your entire life, but can change based on the product you choose. It is often called permanent insurance because the term never runs out. Unlike term insurance that just pays out a benefit when you die, whole life insurance throws in an investment piece to your monthly premium that builds up what is called cash value. The product allows you to tap into this cash value during the policy should you need it for an emergency or other uses.
Three Types of Whole Life Insurance
Whole life insurance is a major category of insurance, but there are really three types of policies:
Traditional Whole Life Insurance: the traditional model that covers you until your death with flat, unchanging monthly premiums.
Universal Whole Life Insurance: your premiums are variable, but you can change how much of your payment goes to savings or to the premium. Your interest in the cash value side of the insurance can be used to pay part of the monthly premium.
Variable Whole Life Insurance: variable whole life covers you like a regular whole life policy, but you get options to invest in things like mutual funds, bonds, and stocks. Your “portfolio's performance” can lessen the payout of the insurance, but usually not below a certain amount dictated by the insurance contract.
The Upside to Whole Life Insurance
There are a few upsides to whole life insurance. The first is that you won't outlive the policy. No one lives forever, so as long as you continue to make your monthly premium payments on time, your family will receive the death benefit when you die. The second upside is that there is some benefit to using the cash value side of the insurance to help protect assets from estate taxes, but it is a complicated tax strategy.
The Downside to Whole Life Insurance
There are several downsides to whole life insurance. First, the monthly or annual premium payments you make will be significantly higher than a term life insurance policy for the same death benefit. The difference is usually equal to several times the cost of the term policy. You might pay $20 per month for a term policy and $150 per month for a whole life policy. The difference in cost is the cash value or investment portion of the policy, which is why the commissioned salesperson will tell you whole life is better. Not only are your covering your family, you are investing for your future.
What the salesperson doesn't tell you that if you try to cash out your cash value anytime during the first decade of your policy, you will be lucky to get anything out. The amount of commission and penalties you pay wipe out any of the investment gains or cash value that has accrued.