- Top questions about whole life insurance
- June 4, 2015
Feeling overwhelmed about understanding whole life insurance? You are not alone. To better understand, below are the answers to the top questions about whole life insurance.
The purchase of any kind of life insurance can be an intimidating process.
According to a 2010 study by the National Association of Insurance Commissioners, less than half of American consumers feel confident about making insurance decisions. Perhaps more frightening is only 2 out of 5 U.S. consumers could answer basic questions about insurance coverage.
Among all the major types of life insurance policies, whole life insurance is often the most complicated policy for consumers to understand, perhaps because whole life insurance has three key components: a death benefit, a lifetime rate guarantee and a mandatory “cash value” or saving component. Whole life insurance, while expensive, does provide certainty in terms of future payouts and should only be purchased with the intention of keeping it for your entire life.
Here are the top questions and answers about whole life insurance:
What is whole life insurance?
Whole life insurance policy offers death protection to the beneficiary for the term of the policy, which is most often for the insured’s entire life. The policy is designed to provide a level death benefit and level premiums for the duration of your life. Some policies can become “paid up” faster if you choose to accelerate payments or make additional premium payments. The level death benefit and premium schedule for life are what make whole life appear to be much more expensive than term life, which is coverage designed for a specific number of years such as 10, 15, 20, 25 or 30 years.
Another difference between whole life and term life insurance is that whole life insurance builds “cash value” which means that the policy comes with a kind of forced savings account. This side account builds up over time and can be borrowed from in future years, but is never added to the death benefit. In other words, a $100,000 whole life policy that has a $25,000 cash value built up over time would pay $100,000 upon the death of the insured and the cash value fund is retained by the insurance company. If, at the time of death, you had, say, a loan of $25,000 outstanding against the cash value, then $75,000 would get paid to the beneficiary. So while the forced cash value side fund builds up over time, it never really belongs to the policy owner.
When should I consider buying whole life?
The best time to buy whole life insurance is when you are young and financially prepared to pay such premiums for the rest of your life. Generally speaking, whole life insurance is purchased when the need for life insurance is lifelong or permanent. It can also be used as a part of your estate planning. Whole life is controversial because many financial planners say that it is impossible to build a lifetime plan due to the many income and net worth changes a person can undergo during their lifetime. Critics of whole life say that it is impossible to plan 30, 40, 50 or more years into the future and that people who attempt to do so might be better off with buying term life insurance and investing the additional dollars into a separate investment that will grow over time outside of an insurance policy.
Whole life insurance is a good choice for you if you want to ensure that you have a life insurance policy in place for your entire lifetime and can comfortably afford the premiums, or if it fits within the framework of your estate or retirement plan.
Why do people choose whole life insurance versus term life insurance?
There are two key reasons why people choose the protection of a whole life insurance plan over term life insurance. One is the ability to hold the policy for life (as long as premiums are paid) and the other is the “cash value” that the policy builds over time. Historically, the interest rate charged on a whole life cash value loan was very low, around 3 percent. But in today’s market environment of zero percent interest rates, the rate charged by life insurers on cash value loans is often not competitive.
What is “cash value”?
Cash value is “excess” of premiums collected over and above the pure insurance or mortality charge. Because whole life insurance offers level premiums for life, younger applicants pay much more than an equivalent term life policy in the early years and much less than a term life policy in the later years. Cash value is a side fund of money that can be borrowed against in future years, but is not money that ever belongs to the policyholder. And if there is a cash value loan outstanding at time of death, it gets repaid or deducted from the overall death proceeds.
Can I borrow from the cash value of my whole life insurance policy?
Yes. You can borrow money from the cash value that has built up in the policy, as long as all premiums are paid. Interest will accumulate on all policy loans. In some cases, there may be a waiting period of up to three years before a loan is available.
If the policy owner borrows from the policy, the cash value is used as collateral and interest is charged at the rate specified or described in the policy. Any money owed on an outstanding policy loan is deducted from the benefits upon the insured’s death or from the cash value if the policy owner surrenders the policy for cash.
Do I have to pay back money that I borrow from the policy?
Yes and if the insured dies before a cash value loan is paid off, that sum due is then deducted from the death benefit. That is completely your choice. You can pay back the money plus accumulated interest or, if you choose to not pay back the money borrowed, it will simply be deducted when the policy’s death benefit is paid or deducted from the cash value when the policy is cashed in.
Can I surrender my policy for its cash value?
Yes, if you surrender your whole life policy before you die, you will then receive the cash value. But, all death protection then ceases.
Will my whole life insurance payments increase every year?
No. Whole life insurance is designed and priced to offer level premiums for life. The amount you pay when your coverage starts is the same amount that you will pay throughout the life of your policy (unless you decided to increase your coverage or the frequency of your payments). The sooner you apply for coverage, the lower your starting premium rate, as premiums are based off your age and current health.
How do term life premiums differ from whole life premiums?
Comparisons of term life and whole life are complex because each policy has a different rate guarantee period that has a profound effect on cost. Premiums for whole life insurance appear to be higher than those of term life because the whole life policy offers a lifetime rate guarantee whereas the term life policy offers a shorter guarantee, typically from 10 to 30 years. Because of the shorter rate guarantee period, term life is priced far below whole life when comparing death benefit amounts and premiums.
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