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Ryan Frailich

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Whole life insurance is one type of permanent life insurance that can provide lifelong coverage. It provides a variety of guarantees, which can be appealing to someone who doesn’t want any guesswork after buying life insurance.

Whole life insurance combines an investment account called “cash value” and an insurance product. As long as you pay the premiums, your beneficiaries can claim the policy’s death benefit when you pass away.

Whole life insurance offers three kinds of guarantees:

A guaranteed minimum rate of return on the cash value.
The promise that your premium payments won’t go up.
A guaranteed death benefit that won’t go down.

While it can sound like a good choice, there are often better options for individuals who want insurance that will last as long as they live.

Some people use the phrase “whole life insurance” very broadly to refer to any type of life insurance that can provide lifelong coverage. But there are other types of permanent life policies that can provide lifelong insurance. These policies work very differently from traditional whole life insurance and include:

Universal life insurance.
Variable life insurance.
Survivorship life insurance.
Cash Value Accumulation in Whole Life Insurance

Part of the premium payments for whole life insurance will accumulate in a cash value account, which grows over time and can be accessed.

Similar to a 401(k) or IRA, the money in the cash value account grows tax-free. However, if you take out cash value that includes investment gains, through a policy withdrawal or loan, that portion will be taxable.

The accumulation of cash value is the major differentiator between whole life and term life insurance. While actual growth varies from policy to policy, some take decades before the accumulated cash value exceeds the amount of premiums paid. This is because the entire premium does not go to the cash value; only a small portion. The rest goes to paying for the insurance itself and expense charges.

Most whole life policies have a guaranteed return rate at a low percentage, but it’s impossible to know how much your cash value will actually grow. That’s because most insurance companies that sell whole life also offer a “non-guaranteed” return rate of return based on dividends. You can choose to apply your dividends to cash value every year, but you can’t know how much that will amount to over time.

In my experience, having reviewed several dozen policies, guaranteed rates of return are often 1% to 2%, with non-guaranteed rates at about 4% to 6% annually.

In one policy I recently evaluated, it would take 35 years, according to the guaranteed rate projections, for the policyholder’s cash value to exceed what she had paid in premiums. Even at the higher estimates from the “non-guaranteed” projections, it would take the client 15 years for the cash value to exceed the amount she had paid in.

It’s unclear what percentage of policyholders get returns closer to the “non-guaranteed” rates.

Using the Cash Value

You can tap into cash value with a withdrawal or a loan. If you take a loan, it’s tax-free, and you can pay it back, with interest. If you make a withdrawal, there are no taxes as long as your withdrawal is less than the portion of your cash value that’s attributable to premiums you’ve paid. If your withdrawal is greater, you’ll owe taxes on the difference because those are investment gains.

Outstanding loans and withdrawals will both reduce the amount of death benefit paid out if you pass away. That’s not necessarily a bad thing. After all, one of the reasons to buy a whole life insurance policy is to get cash value, so why let the money sit there without ever using it?

While the cash value is there, you want to be sure that you know all the ramifications of accessing it prior to making any decisions.

Picking Life Insurance Beneficiaries

When you buy a policy you’ll designate one or more beneficiaries to receive the death benefit. You don’t have to split the payout equally among beneficiaries. You can designate the percentage for each, such as 75% to Mary and 25% to John.

It’s also a good idea to also designate one or more contingent beneficiaries. These folks are like your backup plan in case all the primary beneficiaries are deceased when you pass away.

Designating beneficiaries is an important task, as is keeping your designation up to date with your wishes. The life insurance company is contractually obligated to pay the beneficiaries named on the policy, regardless of what your will says. It’s wise to check once a year to verify your beneficiaries still reflect your wishes.

What Happens When You Die

A major selling point of whole life insurance is that it will be in force until your death, unlike term life insurance. You can’t outlive the whole life policy as long as you’ve paid the premiums.

But here’s a kicker: For most policies, the policy pays out only the death benefit, no matter how much cash value you’ve accumulated. At your death, the cash value reverts to the insurance company. And remember that outstanding loans and past withdrawals from cash value will reduce the payout to your beneficiaries.

Some policies allow you to purchase a rider that gives your beneficiaries both the death benefit and the accumulated cash value. This provision also means you’ll pay higher annual premiums, as the insurance company is on the hook for a larger payout.

Whole Life Insurance Costs

While some of the cash value features and the permanent nature of whole life insurance sound appealing, for many people, whole life insurance is simply unaffordable.

Many life insurance shoppers look at term life vs. whole insurance costs. It’s never an apples-to-apples comparison because the policies are so different. That said, we found that a $500,000 40-year term life policy from Legal & General (the longest term life policy currently available) would cost about $700 a year for a healthy 30-year-old male. A $500,000 whole life policy from American National would cost about $4,060 — or 5.8 times more. Price differentials will vary according to age and coverage amount.

This cost differential makes whole life far less attractive to the majority of individuals with an insurance need.

Factors in Whole Life Insurance Pricing

The coverage amount you choose will help determine your rate, along with:

Age and gender
Height and weight
Past and current health conditions
The health history of your parents and siblings
Nicotine and marijuana use, including nicotine patches and gum
Substance abuse
Credit
Criminal history

Driving record (especially DUI convictions and moving violations such as speeding tickets)
Dangerous hobbies and activities (such as piloting planes or rock climbing
For whole life, there are a variety of other features and provisions that can affect costs as well, such as:

Payment period: You can choose to pay for the entire policy in a short time frame, such as 10 or 20 years. The premium would rise substantially given the front loading of payments.
Guaranteed return rate: Some companies offer a higher guaranteed return, which can result in higher annual premiums.
Dividend crediting: Many whole life policies pay out a dividend, and policyholders can choose how to receive it. Receiving your dividend payments as a credit toward premiums reduces your annual out of pocket cost.

Surrendering Whole Life Insurance

With term life insurance, if you no longer have a need for insurance, you can simply stop paying. Once you stop, the policy lapses, and the insurance company will no longer pay any benefit if you pass away.

With whole life, it’s not that simple. If you stop paying, the cash value will be used to pay any premiums until the cash value runs out and the policy lapses. But there are alternatives to simply stopping payments. Options vary depending on your plan but may include:

Cash surrender value: You can simply ask for the cash surrender value to be paid to you. This is the cash value minus the surrender charge. This action ends the insurance policy, so you should only do this if you no longer have a need for insurance, or have new insurance in place.

By taking the surrender value, you’ll have to pay income taxes on any investment gains that were part of the cash value.

Reduced paid-up life insurance: The company takes what you’ve already paid in, calculates how large of a death benefit that would permanently provide, and gives you a policy with the lower death benefit amount. This avoids any taxes and leaves you with some life insurance, but it may not be the full amount of coverage you need.

Extended term life insurance: The company takes wahat you’ve already paid and converts your policy into a term life policy for the same death benefit. How long the policy lasts depends on how much you’ve paid, how old you are, and the company’s current rates for a policy of that size and duration. This is helpful for someone who wants to preserve some life insurance for a short period of time, but no longer has a need for whole life insurance.

1035 exchange: You can exchange your policy for a different life insurance policy, or for an annuity. This can make sense to avoid taxes on the surrender value, or if you realize another whole life policy has substantially better features and you’d prefer to have that policy instead.

When Does Whole Life Make Sense?

Given the expense of whole life insurance and that many people do not need insurance for their entire lives, it is often not the ideal product to purchase. However, there are some specific situations where a form of permanent life insurance makes sense.

Funding a trust:
Permanent life insurance can be used to fund a trust that will support children after you die.

Paying estate taxes:
For those with estates larger than the current estate tax exemption, which is $11,580,000 in 2020, permanent life insurance may make sense to help heirs pay any estate taxes due when you pass away. Some states have lower estate tax limits, so it may make sense for folks living in those states as well.

Funding a buy-sell agreement: If you’re an owner of a business with a partner, you might consider whole life insurance to fund the purchase of each other’s shares in the business at death.

Top Sellers of Whole Life Insurance

Below are the biggest sellers of whole life insurance, in alphabetical order. The list is based on annualized premium in the first three quarters of 2019, according to LIMRA, a research group for the financial services industry.

Gerber Life Insurance Co.
Guardian Life Insurance Co. of America
MassMutual Life Insurance Co.
Mutual of Omaha Cos.
New York Life
Northwestern Mutual
OneAmerica Financial
Penn Mutual
State Farm Life
Transamerica
Life Insurance Market Share

Whole life makes up over one-third of the individual life insurance market as measured by premiums paid. This is largely driven by its high cost.

Is Whole Life Insurance the Right Choice for You?

Here are questions and alternatives to help you decide if whole life insurance is right for you.

Do you need life insurance for more than 30 years?
Do you need cash value life?
Do you want flexibility with payments or the payout amount?
Do you need a payout when you pass away, or only after both you and a spouse pass away?
Do you need life insurance for more than 30 years?

If the situation you want to cover with life insurance has a finite end, it might not make sense to pay for whole life insurance.

Alternative: Term life is good for covering specific debts and time periods. For example, if you want life insurance to cover 20 years while you pay a mortgage, term life is a good choice. Life insurers commonly offer 30-year term life policies, and you can generally buy one into your 50s.

Do you even need cash value?

One of the features that adds to the cost of whole life insurance is the cash value feature and the guaranteed investment gain on it. Cash value policies are good for people who intend to withdraw the money later, or take a loan against it.

Alternative: Guaranteed universal life insurance offers lifelong coverage for a lower cost than whole life because it usually doesn’t build any cash value.

Do you want flexibility with payments or the payout amount?

With whole life insurance, you generally pay a fixed amount for the rest of your life. Whole life insurance also guarantees to pay a specific death benefit to your beneficiaries. But it may turn out that you’d prefer to pay less, or that your beneficiaries don’t need the full payout.

Alternative: Some forms of universal life insurance let you vary both the premium payment and the death benefit. This can provide some flexibility down the road, as your finances change, or your beneficiaries’ own finances grow.

Do heirs need a payout when you pass away, or only after both you and a spouse pass away?
If your beneficiaries need a life insurance payout only after both you and spouse are deceased, you may not need whole life insurance.

Alternative: Survivorship life insurance, also called second-to-die life insurance, might be a better choice. These policies insure two lives at once and pay out only when both people pass away. Survivorship life insurance is generally cheaper than buying two separate life insurance policies.

Know What You’re Getting Into

Whole life insurance is a product that has some uses, but it’s not for everybody. The additional benefits offered by whole life can often be found by using your retirement and investment accounts for gains, in combination with a term life insurance policy. Before purchasing any insurance policy, be sure to fully understand the options available, and the various provisions each policy comes with.

Author: Ryan Frailich

Source: Forbes: Forbes Guide to Whole Life Insurance

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