Definition and Examples of Whole Life Insurance
What is Whole Life Insurance?
Whole life insurance is a type of “permanent” life insurance. It aims to cover your entire life and pay a specified amount of money upon your death. It also has a cash value that you can access as a loan during your lifetime.
Note: You do not have to be the policyholder who covers you. For example, you can be the owner and pay premiums on a policy that covers your partner. The insurance company won’t mind as long as the premiums are paid.
Whole life insurance differs from other types of permanent life insurance. The main difference is that it does not have fixed premiums. You can pay any amount you want within the minimum and maximum premium limits specified in the policy. These premiums are based on your age, gender, medical history, and the coverage amount you choose.
Alternative name: Modified Life Insurance
How Does Whole Life Insurance Work?
All permanent life insurance policies have three parts: the premium, the cash value, and the death benefits. You can choose from two schedules; there are also some fees and penalties you should be aware of.
Premium
The amount you pay on the policy covers the company’s costs to protect you and manage the plan. If you pay more than the minimum payment, any excess goes toward the cash value. If you do not pay more than the minimum, funds will be withdrawn from the cash value to make the payment.
Cash Value
The cash value (or account value) is a portion you can access. The insurance agency invests some of your money to grow the cash value. You can also choose the investments that make up the cash value if you prefer certain options (if you choose a variable whole life insurance policy). Interest and gains on the cash value are not taxable unless withdrawn or surrendered.
Death Benefits
Payments to beneficiaries upon your death are called death benefits (also known as the face value). Whole life insurance has two basic options for death benefits. Option A is a level death benefit, known as the specified value or face value. Option B is the face value plus the cash value. In Option A, more of your payment goes toward building the cash value; in Option B, more goes to increase the death benefit through investment. Many companies offer additional options for death benefits in the form of riders.
Note: If the beneficiary receives the benefit in one case, they do not have to pay taxes on it.
Schedules
Whole life insurance policies have two different “schedules” that are used to determine the amount you will pay. Your payment is based on policy charges and maintenance costs. These charges are what you pay. They can be found in your quarterly insurance statement.
The “current schedule” is based on the insurance company’s claim costs and investment performance and expenses. The “guaranteed schedule” shows the maximum amount that can be charged to you. The insurance company can raise or lower the current schedule, but not more than the guaranteed maximum stated in the policy.
With a whole life insurance policy, you can adjust your payments up or down. A higher payment will increase the cash value, while a lower or missed payment may decrease it. The overall value of the cash value depends on the amount of interest credited to it.
This works well if you need to lower your payments due to your current financial situation. You can also choose to increase your payments to take advantage of tax-deferred growth in the cash value. Other types of permanent life insurance, such as whole life insurance, have a fixed payment schedule that cannot be changed.
Note: Although you can reduce or stop premium payments, you should monitor the policy. If you do not pay enough, policy charges may deplete the cash value. If you significantly reduce payments, the charges may exhaust the cash value and result in the policy’s termination.
Period
Surrender and Fees
Most comprehensive life insurance policies charge fees if you cancel them. Fees will also be charged if you withdraw an amount greater than the cash value within a specified time frame.
The surrender period is the time during which you can cancel the policy and take the cash value. However, you will incur penalties if you do so. The duration can be set by the insurance company and may extend up to 15 years. The document outlines the fees and how they are calculated. Be sure to read the document if you are considering canceling it before the surrender period ends.
Once the surrender period is over, you can cancel the policy and take the cash value without incurring fees. You may need to pay taxes on the amount you receive. The amount of tax you pay depends on the payment period within the document. The amount also depends on the amount you receive and whether it is tax-exempt as income or capital. You may want to speak to a tax professional if you are considering canceling the policy because tax laws are complex.
Types of Comprehensive Life Insurance
Comprehensive life insurance policies are available in three styles: fixed payout, indexed, and variable.
Fixed Payout
Your money is placed in the cash value component as part of a general portfolio. Any interest for the account is calculated based on returns from investments in the portfolio. Although fixed payout comprehensive life insurance policies have a minimum interest guarantee, they do not generate much growth when interest rates are low.
Indexed
Most new comprehensive life insurance policies are indexed comprehensive life insurance. Indexed policies give you the opportunity to benefit from stock market gains without the risk of losing capital.
The cash value component is calculated based on the performance of a financial index. This means that investments in the cash value portion reflect a stock index such as the S&P 500. If the index rises, the cash value is calculated up to the maximum of the policy (or ceiling). If the index drops, there are no gains or losses on the cash value.
Variable
You choose the mutual funds in which the cash component is invested. The cash value will fluctuate based on the performance of the investments in the portfolio. If the investments perform poorly, the cash value might decrease even if you are making payments. If the losses are significant, the policy may end because the cash value can drop to zero.
Advantages and Disadvantages of Comprehensive Life Insurance
| Advantages | Disadvantages |
|---|---|
| Flexible premiums: You can choose to pay fully or make partial payments based on your financial situation at the time. | Higher premiums than term insurance. |
| Flexible savings component: You can choose how your money grows or let the company choose on your behalf. | Surrender penalties, often for 10 years or more. |
| Coverage can last a lifetime. | Expense fees and cost of insurance. |
| Favorable tax treatment. |
Explained Advantages:
- Flexible premiums: You can choose to pay fully or make partial payments based on your financial situation at the time.
- Flexible savings component: You can choose how your money grows or let the company choose on your behalf.
- Coverage can last a lifetime.
- Favorable tax treatment: You can use the cash value as a way to grow your money without paying taxes and pay deferred tax on the money you withdraw from the cash value. You may not have to pay taxes on certain withdrawals.
Explained Disadvantages:
- Higher premiums than term insurance: Monthly premiums are higher than other life insurance options.
- Surrender penalties: You cannot access the full cash value until a specified period passes without incurring a penalty.
- Expense fees and cost of insurance: The company may increase the amount you pay if costs rise.
Alternatives
For Comprehensive Life Insurance
There are two other types of life insurance policies available in the market that you can choose from today.
Term Insurance
Term insurance expires after several years. Policy terms range from 10 to 30 years. Term insurance is considered pure insurance protection, which means it has no cash value and can be a cheaper alternative. It’s a good option for young families who may need high amounts of coverage for a few years. You can purchase term insurance with the option to convert it to permanent insurance for an additional fee.
Whole Life Insurance
Whole life insurance is permanent and continues until the insured’s death. Whole life insurance has a guaranteed fixed monthly payment and cash value. You can also get a whole life insurance policy with term insurance that complements the coverage. Whole life insurance is sold by mutual insurance companies that pay you dividends based on the company’s profits.
Note: The terms adjustable insurance and comprehensive life insurance are used to describe flexible premium life insurance policies.
Is Comprehensive Life Insurance Right for You?
Source: https://www.thebalancemoney.com/what-you-need-to-know-about-universal-life-insurance-2645831
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