What is whole life insurance?
Whole life insurance provides a guaranteed death benefit to the policyholder’s beneficiaries regardless of how long the policyholder lives. Term life insurance, by contrast, only offers coverage for a set period of time, like 10, 20, or 30 years. With term life insurance, if you outlive the set term, your beneficiaries won’t receive a payout upon your death.
Provided you make the agreed-upon payments to your life insurance company, whole life insurance guarantees you’ll be covered for your entire life. Whole life insurance offers a guaranteed payout, making it more expensive than term life insurance.
How does whole life insurance work?
When you purchase a whole life insurance policy, you’ll generally pay premium payments at regular intervals that don’t change. The premiums for whole life cost more than for a term life insurance policy for the same amount of coverage. For instance, a 40-year-old woman with a 30-year term life insurance policy for a $500,000 payout will pay a lower monthly premium than she would for a whole life insurance policy with the same payout.
A healthy 40-year-old policyholder has a relatively low risk of dying, but the risk increases as a person ages. The cost for a $500,000 term life insurance policy would also increase, making it harder for this policyholder to afford a new term life policy after the initial 30-year term expires for her at age 70.
Whole life insurance premiums start high to offset the higher cost of premiums later in life. But these higher premiums help build an accumulated cash value that you may access during your lifetime for long-term care, medical care, or even portions of premium payments.
The insurer will generally invest your cash value and may even guarantee a certain rate of interest over time. Some policies will allow you to take a loan against your cash value, although you’ll generally have to repay the loan with interest to ensure the death benefit remains the same.
Additionally, the accumulated cash value grows tax-deferred, meaning you’ll only owe taxes on the portion that represents investment gains or growth if you withdraw money from the cash value. Withdrawals from the portion of your cash value that came from your premium payments are tax-free.
When a whole life insurance policyholder dies, the insurance company pays the death benefit to the beneficiaries. If the policyholder previously took out a withdrawal or loan from the cash value prior to their death, the death benefit will generally not include the amount of the cash value withdrawal.
For instance, let’s say a policyholder with a $500,000 whole life insurance policy took $100,000 from the cash value to pay for a stay in a nursing home. If the policyholder passes away without repaying the $100,000 to the cash value, the beneficiaries may only receive $400,000 as a death benefit.
Learn More: How Much Life Insurance Do I Need?