Life insurance has been a part of American history dating back to 1735, with the birth of the first U.S. insurance company in Charleston, South Carolina. Insurance in general has evolved much since then, and life insurance especially has developed into a group of product s with a variety of coverage and payment options. Whole life insurance is one of those products, and understanding it can help consumers evaluate whether it is right for their needs.
Whole Life Insurance, Defined
Whole life insurance is a type of policy designed to provide insurance coverage for the entire life of the insured party. A whole life, or permanent life insurance policy generally offers fixed premiums, with a guaranteed death benefit and a cash value component designed to grow on a tax-deferred basis. A good way to describe whole life insurance is a policy that provides life insurance protection with an additional savings feature.
A whole life insurance policy fulfills a need for lifelong insurance coverage. The policy’s built-in savings feature allows the premiums paid over time to build up a cash value within the insurance policy. A whole life insurance policy also makes up a part of many people’s overall estate planning.
The premiums on a whole life insurance policy may be quite a bit higher than those on a term life policy in the earlier years. However, they are smaller than term life premiums that would be paid on a policy covering individuals in their later years, since risks are generally higher then.
How is Whole Life Different from Term Life?
Whole life insurance provides coverage on an insured person for his entire life, as long as payments for premiums stay up to date and he does not surrender the policy. Term insurance, on the other hand, provides the coverage only for the fixed number of years stated in the insurance policy.
Whole Life Insurance Premiums
With whole life insurance policies, scheduled premiums stay level over time. Each premium payment consists of part life insurance and part savings payment. The balance of the two elements may vary over the length of the policy, but the total premium will remain the same. Some whole life policies provide for a premium schedule that allows for lower payments in the earlier years, and then increases to a higher amount that remains level for the duration of the insurance policy.
As mentioned earlier, whole life policies have a cash value, which reflects the accumulation of premiums paid after paying expenses and any claims made on the policy. The cash value is different from the face value, and in the earlier years of a whole life policy, the cash value will be less than the face value. The face value is the amount of life insurance coverage paid to beneficiaries upon the demise of the policyholder. Insurance laws set the minimum cash value of a policy, and the cash value grows over time on a tax-deferred basis.
The cash value of a whole life policy can be compared to building equity in a house. If a policy owner chooses to surrender her life insurance policy, she will receive at least part of the cash value that has accumulated in the policy.
Borrowing the Cash Value
The cash value in the life insurance policy is also available as a loan to the policy owner. There may be a waiting period of up to three years before the cash value is accessible for loan purposes. A policy owner will pay the loan back with a specified interest rate over time; otherwise, the loan is deducted from the policy’s proceeds upon the insured person’s death or from any remaining cash value if the policyholder surrenders the insurance policy for its total cash value.
The dividends earned on the cash value of whole life insurance policies can pay a part of the premium payments or all of them, depending on the choice of the policyholder. Premium payments can also be paid annually or over a set numbers of years, such as 20 for example, although each payment would be much higher because of the shorter payment period. A policyholder can also surrender her policy, and the cash value can then purchase a smaller amount of paid-up whole life insurance or a term insurance policy for a specific number of years.
The portion of the cash value that makes up dividends is not subject to annual tax according to the Internal Revenue Code. Instead, dividends are generally considered a “return of premium”, and do not fall into the taxable income category as long as the amount of dividends received do not exceed the amount of premiums that have been paid. If the whole life policy is surrendered for a cash value, any excess of cash value over the total amount premiums paid, reduced by dividends, is taxable.
Types of Whole Life Policies
Participating and Non-participating Whole Life Insurance:
Non-participating insurance has low premiums, a fixed face value, fixed costs and relatively low premiums. Non-participating means, however, that the policy does not pay any dividends, while a participating policy does pay dividends. These represent a positive return based on investment earnings, expense savings and lower policy payouts on the part of the insurance company.
Dividends are not guaranteed, but if paid present many options for policyholders. Dividends can be used to reduce premium payments; they can be paid out in cash, left in the policy to accumulate with interest, or used to buy additional fully paid up insurance to increase the overall face value of coverage that would be paid out to beneficiaries in the case of the policyholders death.
Level Premium Whole Life Insurance:
Insurance with a level premium has payments that remain the same each period, and it will require payment as long as the policyholder lives. In earlier years, the insurance premium is much higher than the amount needed to pay the current insurance protection costs. This excess amount, including interest earned, covers the deficiency when premiums in later years are not sufficient to pay the true cost of insurance protection. The insurance company invests the extra premiums paid in the earlier years, which creates the “cash value” of the life insurance policy.
Whole Life Policies – Different Payment Schedules:
Life insurance premiums can also be paid on different payment schedules, chosen at the beginning of the policy. With limited payments, an insurance policy can be paid over a shorter time, such as 10 or 20 years. The payment schedule can also consider the policyholder’s age, such as a whole life policy paid up by the time the policyholder reaches 65 or 85 years of age. Since the policy premiums are paid over a shorter amount of time, the amount will be much higher. Single premium policies are available with one large premium payment due upon the policy issue. Indeterminate premium whole life provides for adjustable premiums. The insurance company adjusts the premium over time based on current projections of investment earnings, expense costs and mortality rates. As estimates change over the years, the insurer adjusts the premium accordingly, but never higher than the guaranteed maximum premium for the policy.