What is Whole Life Insurance?

A whole life policy, sometimes called straight life or permanent life, is protection that can be kept as long as you live. It enables you to pay the same premium over the years—averaging the cost of the policy over your lifetime. Some characteristics of a whole life policy include the following:

• Whole life insurance builds a cash value—a sum that grows over the years, tax-deferred.
• If you cancel the policy, you receive a lump sum equal to this amount (and you pay taxes on it if the cash value plus any dividends exceeds the sum of the premiums you paid).
• If you need to stop paying premiums due to a temporary financial crisis, you can use the cash value in the policy to pay those premiums for a period of time.
• You also can withdraw part of the cash value in the form of a policy loan. (If you die before repaying it, the loan and any interest due is repaid from the death benefit amount.)
• The face amount in a whole life policy is constant, and this amount is paid if you die at any time while the policy is in effect.
• The policy is designed to mature when you reach 100. If you live to be 100, you won’t have to pay any more premiums, and the policy’s cash value will be equal to the face amount. So, the insurance company usually will pay you the face amount—even though you’re still alive.

Most people do not plan on paying premiums until age 100. More commonly, whole life insurance is used as a form of level protection during the income-producing years. At retirement, many people then start to use the accumulated cash value to supplement their retirement income.

Whole life plays an important role in financial planning for many families. In addition to the death benefit or eventual return of cash value, a whole life policy has some other significant features. For example, it may pay dividends. Whether or not it does is the primary difference between:

• a participating (par) policy, issued by a mutual life insurance company, is one in which the policyholders receive dividends (if a dividend is declared); and
• a nonparticipating (non-par) policy, issued by a stock life insurance company.

Many people use the dividends in a participating policy to buy additional amounts of insurance, instead of taking the cash. This is really no different than taking a few extra dollars out of your pocket and making a separate purchase. Still, dividends are often a successful sales tool because some people like the idea of getting something extra back—even though they’ve paid more initially.

Another significant feature of the whole life policy is that it guarantees the interest rate on any loans you take out against the cash value of the policy. (You also can get a bank loan using the cash value of the policy as collateral, but the guaranteed interest rate in the policy may be much lower than that available from a bank.)

Why We Need Life Insurance?

Life insurance plays an important role in securing the finances of many families. In the purest sense, life insurance is something that protects against the risk of you dying too soon. It pays a death benefit to someone when you die. Your premature death would expose your family or business to certain financial risks, such as:

• burial expenses;
• paying off debts;
• loss of family income;
• loss of business profits;
• paying estate taxes; and
• a lack of or a limited college fund for your children.

If you don’t have dependents, you probably don’t need life insurance. But if you have a spouse, children or elderly parents who rely on your income, you’ll want life insurance to pay expenses for them in the event of your premature death. You also may even want to consider insuring the life of your spouse if he or she is not earning money—particularly if he or she cares for your children. (If your spouse were to die unexpectedly, not only would you have funeral expenses, but you’d have to start paying for child care).

Life insurance guarantees a specific sum of money will be available at exactly the time it is needed. Savings accounts, mutual funds, stocks, bonds and other investments do not offer such protection—and, in fact, they can be tied up in probate at the time of your death. Life insurance, however, will be available immediately—and it creates, in essence, an estate that did not previously exist.

With life insurance, you get what you pay for. You pay the policy’s face amount—the amount the life insurance company will pay when you die.

Since this amount is payable upon the death of the insured, the element of risk to the insurance company is much different than it is for an automobile or homeowners policy.

When an insurance company issues an auto policy, for example, it hopes you will be a safe driver, never have an accident and never file a claim. When an insurance company issues a life policy, it knows it will be called upon to pay a claim someday—because everyone dies. The only unknown is whether the claim will be made in one year or in 50.

This is why, not surprisingly, life insurance costs vary based on your age, health and the amount of insurance you buy.