Whole life insurance policies not only provide financial protection for families if a wage earner should die, but also offer investment opportunities for the future.
The cash value or equity accrued by whole life can be withdrawn for retirement purposes, a down payment on a house for your children, or even used as collateral for loans. Furthermore, whole life coverage can be an important tool in financial and estate planning.
Defining Whole Life Insurance
Whole life insurance is a type of permanent policy that never expires and cannot be canceled except for non-payment of premiums. Your policy will have a fixed death benefit and cost over your lifetime. Fortunately for you, a portion of the premiums paid to the company are diverted into a savings feature called the cash value. A guaranteed interest rate, much higher than the interest rate on savings accounts, is paid on the cash value. Some whole life policies, called participating policies, also pay dividends. Whole life policies can serve as “forced savings accounts”.
Term vs. Whole Life insurance
Term life insurance, also known as pure insurance, is temporary coverage which expires after a specific period of time, usually between 5 and 30 years, although shorter terms are available. If you do not die during the term period, no benefits are paid and the company keeps the premiums. Term life policies have to be renewed or replaced usually at substantially higher rates, but whole policies remain fixed for your lifetime. However, initial whole policy rates are between 5 and 10 times higher than those of term.
Frankly, there is a saying: “term life insurance is bought, while whole life insurance is sold.” This is because whole life coverage produces huge commissions for agents, brokers, and carriers. Most insurance experts recommend that, instead of buying whole life insurance as an investment for retirement, you purchase a 30 year term life insurance policy. You then take the huge difference in savings/premiums and continually invest in index funds or low cost mutual funds, which will produce much greater returns than the likely 4% interest rate you will get on a whole policy.
The only times you should buy whole life insurance is when you are a high net worth individual seeking tax-advantages, a policy to cover estate taxes, or need a forced savings plan because you don’t trust yourself to save for retirement.
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Different Whole Life Policy Options
If whole life still seems like the right type of coverage for you and your family, companies offer a selection of policies to meet the needs of different people. The standard provisions are the same for all kinds of coverage, but there are a range of additional options and riders. Among them are limited payment, endowment, single payment, modified and guaranteed issue life insurance. The different payment options make whole life insurance a little more affordable for certain consumers.
Modified Payment Whole Life. Modified payment life insurance does not have fixed payments like most other policies. Instead, modified payment begins with a low premium that increases at regular intervals. Designed to make it more affordable for young families with incomes that will increase over time, modified protection provides a fixed death benefit and a cash value, but the payments are altered so young people can more easily fit the cost into their budgets.
Limited Payment Life Insurance. Limited payment contracts have higher premiums than standard ones because the payments are condensed into a limited period of time, such as 20 or 30 years. Once all the payments have been made, the policy is permanent and cannot be canceled by your company. The policy continues to build cash value because the carrier continues to pay interest, and it can be used as security for low interest, tax free loans. Limited payment whole life insurance is often used to save for retirement.
Endowment Life Insurance. Endowment policies are a form of limited payment that are popular for insuring infants and young children. This coverage pays a lump sum at maturity (18 years old) to provide money for college tuition, a car or even the down payment on a house. Rates are based on the age of the insured person, the death benefit amount and the number of payments chosen. Unlike other whole life insurance policies, endowments are not really permanent and are instead designed to provide a lump sum of money when they expire.
Single Payment Life Insurance. Most often used in estate planning, single payment insurance is paid in full at the time it is issued. Part of the payment becomes the cash value of the policy and does earn interest. You still have access to the money and can use up to 90% of the equity for a low interest loan. Most of the time, the death benefit is not subject to income or estate taxes and affluent individuals often use single payment life insurance as a tax shelter.
Guaranteed Issuance Life Insurance. Guaranteed issuance is also called no exam life insurance and is best for older individuals with health issues that might make them ineligible for traditional coverage. These policies have higher rates because of the increased risk to the insurance company, but there are restrictions on payouts for the first 2 years after purchase.
Interest Sensitive Life Insurance. Relatively new to the market, interest sensitive life insurance is a hybrid of universal and whole life insurance. It has a guaranteed minimum rate of return on investment, but allows for higher returns based on the performance of financial markets. Interest sensitive policies will not lapse like a universal option can, and the death benefit is fixed and will not fluctuate based on the performance of the cash value investments.
Comparison Shopping Is Crucial
Like any other product or service, consumers always need to comparison shop. There is no standard type of coverage every life insurance company offers. Each provider has their own terms and conditions, ways of calculating premiums, and underwriting guidelines. Many websites, offer free instant quotes so consumers can compare coverage options and rates from different companies. Take the time to fill out the quick questionnaire with basic information like age, gender and the policy desired to learn about the best carriers. In the process, you will also determine whether you can afford all the coverage you need.
Author Bio: Gary Dek, formerly an investment banker and private equity analyst, is a personal finance blogger at Gajizmo.