How does whole life insurance work?
In six steps, this is how whole life insurance works:
- You apply for coverage. The application may be made in person with an insurance agent or online, depending on the company and your preferred method.
- The insurer will take a deep dive into your history to determine whether you're insurable, and if so, how much your premiums will cost. Here's a list of some of what the insurance company will check:
- Age
- Gender
- Height and weight
- Credit history
- Criminal history
- Nicotine use, including nicotine patches and gum
- Your health history
- Health history of your immediate family
- Substance abuse
- Driving record
- Hobbies and activities that may be considered dangerous
3. When approved, you will be offered a rate quote. If you accept the quote, you'll sign insurance documents.
4. You make a premium payment and pay premiums at regular intervals to maintain coverage.
5. When the policy has accumulated enough cash value, you can begin to make withdrawals.
6. If you decide you don't need life insurance anymore (for example, if you've already saved and invested enough to provide for your family if you die), you can surrender the policy and receive a lump sum.
Whole life insurance features
As we'll cover here, you're likely to find that whole life insurance quotes are more expensive than term insurance quotes. The reason why has to do with the extra benefits associated with whole life coverage. For example, while borrowing against life insurance is not possible with a typical term policy, whole life allows policyholders to take out a policy loan and use the money as an emergency fund. It's important to note, though, that it typically takes around 10 years to build up enough cash to access the policy's cash value.
Here are a few of the other features associated with whole life insurance:
Cash value accumulates with whole life insurance
In addition to a death benefit, whole life insurance allows policyholders to build up cash value in their policy. The cash grows tax-deferred, much like a 401(k) plan. A policyholder is not expected to pay taxes on it during their high-income years. Instead, they pay taxes when they begin withdrawing funds.
Guaranteed rate of return
In the meantime, whole life insurance companies offer a guaranteed rate of return on the cash value of the policy. According to Consumer Reports, the average annual rate of return on a whole life policy is 1.5%. While that is low, it does beat the interest rate on many banking products, including interest-bearing savings accounts and money market accounts (MMAs).
Guaranteed death benefit
A whole life policy is an investment vehicle that pays death benefits. As long as the policy is still in effect when the policyholder dies, the death benefit chosen by that policyholder at the time of purchase will be paid to their estate.
Whole life insurance pros and cons
As with any financial product, whole life insurance has pros and cons. The trick is to figure out if the pros outweigh the cons in your situation.
Pros:
- Premiums are fixed for life.
- The policy builds tax-deferred cash value at a guaranteed rate.
- If the policyholder decides they no longer need life insurance, they can surrender the policy and receive any cash value it holds.
- If the policyholder cannot make the payments, they can ask to receive the cash value and use those funds to catch up on the premium.
Cons:
- It can cost six to 10 times more than a term policy with the same death benefit.
- If the policyholder allows coverage to lapse, the losses can be expensive.
Is whole life insurance worth it?
The answer is "maybe." Depending on your situation, whole life can make sense. Let's say you have no investment strategy in place, and making your monthly whole life premium is the only way you are likely to create an emergency fund or receive a guaranteed return. In that case, it may make sense to look into a whole life policy of your own.
Whole life coverage may be less complex than other types of permanent insurance -- like universal life insurance -- but it is still more complicated than term life insurance. If you're happy to do your own investing and savings, and your sole goal is to purchase life insurance to cover your loved ones, term life is less expensive and simpler to navigate.
Agents who sell whole life policies say that it's an "investment vehicle." But when you compare the average guaranteed rate of a whole life policy against the average annual return in the stock market, you'll quickly realize how much money you may be leaving on the table.
Let's say you're looking for coverage and can't decide between term life insurance and whole life. You're a 35-year-old male in good health. You're quoted a rate of $600 per year for a term life policy and $3,600 per year for a whole life policy with the same death benefit.
You have two choices. You can pay $300 a month for the whole life policy and earn an average return of 1.5% on the accumulated cash. Or, you can pay $50 a month for a term policy and invest the extra $250 in the stock market. As you know, the stock market rises and falls. Still, between 1971 and 2020, the annual average return on stock investments was 10.9%.
Even if we were to use a more conservative estimate of 7%, it's easy to see how investing in the stock market will ultimately earn more than settling for a low 1.5% rate of return.
Whole life insurance rates
To give you an idea of how history and lifestyle can impact rates, each of these quotes starts with a 35-year-old who has requested $300,000 in death benefit coverage.
