Considering a whole life insurance policy? If so, you might have questions about how these whole life policies work. If you’re looking to augment your existing life insurance coverage or to purchase your first life insurance policy, it pays to know the types of products that are available. For the uninitiated, life insurance policies are legal contracts. The policyholder pays a premium to the insurer. In return, the insurer promises to pay a designated beneficiary the death benefit specified in the policy.

In case the policyholder dies because of an insured event, the insurer pays the death benefit to the beneficiary named in the policy. Whole life insurance shouldn’t be confused with funeral or final expense insurance as that is a completely different product.

The most common types of life insurance policies available include:

  • Term life policies: These do not accumulate any cash value. Rather, they provide insurance coverage for a specified term. Therefore, the premium paid only obtains protection from the insured risks for a specified period of time. Depending on your age, a term policy might fit your needs but you will want to do your research.
  • Whole life policies: These policies provide a lifetime of coverage for a fixed premium. In addition, they accumulate a tax-deferred cash value based on a minimum guaranteed rate of interest.
  • Universal life policies: Compared to whole life policies, these policies offer greater levels of flexibility. These policies enable the policyholder to amend the coverage, the cash value or the premium over the lifetime of the policy. These policies usually treat the death benefit and the investment portions separately.
  • Variable life policies: These policies have a cash value account, which insurers invest in several sub-accounts available in the policy. Sub-accounts are similar to mutual funds. The cash value account has the potential to increase or decrease, depending on the underlying investments. This investment element remains the most popular feature of these policies.

An Overview of Whole Life Insurance Policies

As mentioned earlier, whole life insurance policies remain in force for the lifetime of the policyholder. They do not lapse or expire unless the policyholder stops paying the premiums. These policies feature a level premium, which cover both the death benefit and the cash value of the policy.

In whole life policies, the insurer typically utilizes a portion of the premium paid for providing life coverage toward management of the policy. Thereafter, the insurer sets aside the remainder and allows it to accumulate a cash value. This portion of the premium continues to increase based on a guaranteed minimum rate of interest.

Once the cash value reaches a certain level, the insurer could consider the policy as being “paid up.” This means that you could use the cash value of the policy to pay your subsequent premiums. Your whole life policy also becomes “paid up” when the cash value becomes equivalent to the face value of the policy. A policy in a “paid up” state highlights that:

  • The policyholder does not need to pay subsequent premiums and,
  • The policyholder continues to enjoy lifetime insurance coverage under the policy

On occasion, policyholders could also take loans against the cash value of their whole life policies. However, they will need to repay this at some later date. If the policyholder dies with an outstanding loan against the cash value of the policy, the insurer would deduct the outstanding loan amount from the death benefit that is payable to the beneficiary.

Similarly, some insurers pay dividends to their policyholders. Policyholders could utilize these dividends to:

  • Purchasing additional coverage
  • For paying their insurance premiums or,
  • For meeting various expenses (as cash)

It is worth noting that in whole life policies, the insurer guarantees the cash value of the policy. The policies state the minimum interest rate payable each year. They also specify the increase in cash value over time. In addition, whole life policies provide guaranteed death benefits equivalent to the face value of the policy. Therefore, many people consider these policies to be insurance policies, backed by a savings account.

Reasons You Might Consider Purchasing A Whole Life Insurance Policy

In the past, many people purchased term life policies because these were relatively cheap. They also invested the difference in premiums in other lucrative investments such as stocks or other investments. However, whole life policies are becoming increasingly popular because of their numerous benefits.

Here is a list of the possible benefits of a whole life insurance policy:

  • Whole life policies protect your cash value portion, unlike when you invest in mutual funds and other similar investments
  • Whole life policies guarantee compound tax-free growth each year – even if the current rate of interest might not seem very attractive
  • Many whole life policies provide dividends to their policyholders, which the policyholders could use in various ways
  • Well-structured whole life policies offer high initial cash value amounts, which help you grow your wealth
  • Whole life policies enable policyholders to access their cash value at any time (usually after the minimum lock-in period of approximately six months)

In addition to the above, with a whole life insurance policy, you also get to enjoy life coverage and guaranteed death benefits. There are some compelling reasons to consider securing your life with a whole life policy. At the same time, you could reap the benefits of letting the policy accumulate a cash value too.

Jason

Founder of FinancialSumo.com, his writing has appeared on many financial, entrepreneurial and small biz sites across the internet. When not writing, Jason enjoys spending time with his family in San Diego.
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