Understanding Whole Life Insurance Policies

A statistic published by the Life Insurance Market Research Association (LIMRA) reported that whole life insurance has encompassed about 30% of overall annualized premium sales.  There are benefits to investing in whole life insurance, but buyers should be informed of all of their insurance options before making a decision.

Whole life insurance is different from term life insurance in that whole life insurance includes an investment component that can gain value over time.  Term life insurance only provides death benefit coverage, payable upon death of the insured to the named beneficiaries.  Whole life insurance allows a buyer to not only have death benefits, but also allows a variety of investment options that can be used to borrow money if needed.

Common Uses for Whole Life

The two basic reasons why someone purchases life insurance are to protect someone they love, or to pay someone they owe. While whole life insurance can be utilized in the same manner as term, universal or variable universal life insurance policies, the most common reasons for this type of policy include:

• To cover final expenses- Today’s burial costs range from $10,000- 15,000.
• Tax free investment diversification within their portfolio
• Charitable gifting funding (the death benefit portion)
• Alternative to term insurance programs; whole life offers a permanent life insurance solution

One of the biggest draws to whole life insurance policies are the guarantees offered by the insurance company, discussed in the next section.

Insurance Fundamentals

Whole life offers the insured party guarantees; the death benefit is guaranteed as long as the insured pays the required premiums, the premium is guaranteed not to increase, and the stated interest rate as the time of the policy’s issue is guaranteed. Some of the fundamentals to become familiar with include the manner in which the policy’s cash value is treated, premium payment options available, tax benefits and possible riders worth considering for your policy.

Cash Accumulation

Unlike variable universal life, the cash value accumulating within a whole life insurance policy isn’t directed by the insured, but by the insurance company. Whole life insurance investments can be in the form of bonds, money market accounts or stocks.  The interest rate credited to the buyer often varies, with a minimum amount stated in the original contract.

If the insurance company is mutual, or participating, the insured will receive annual dividends. These dividends can be added to the cash value, taken as a distribution, or used to purchase more paid up additions of life insurance face value. If the insurance company is publicly traded, the option exists to share in dividend payment annually, a decision that will be rendered by the board at their regularly scheduled meetings.

Whole life insurance policies generally fall into the ‘fixed’ investment category, as their returns are often lower than traditional market investments. This is however, by design.

Conservative investors or those seeking steady growth within their portfolios are drawn to this option. Aggressive investors or any investor looking to compare the returns offered by whole life policies to the traditional market will be disappointed; these policies aren’t designed to be ‘race horses’, out in front, but rather to be ‘work horses’, there when you need them.

Premium Payment Options

Whole life insurance premiums are level over the life of the policy. Unlike the variable universal life or universal life policies, these premiums cannot be adjusted without a policy change, involving a decrease or increase in the policy’s face value.

Policy premiums may be paid over the life of the policy, or in the form of a single premium. For persons who maintain a budget, level premiums can help with planning for finances over a long term. Single premium payment options exist for those individuals who do not wish to pay ongoing premium payments.

A single-premium whole life insurance policy allows a buyer to purchase the policy in one lump sum instead of a series of premium payments.  Because the cash value has some tax sheltered options, investors may choose to utilize a single-premium whole life insurance policy in order to take advantage of some deferred taxes on the cash value.

Tax Treatment

Like other forms of permanent life insurance, whole life insurance offers tax benefits to the insured party. The cash accumulated within the policy will grow on a tax deferred basis, saving the insured party from paying capital gains taxes on any growth seen in the account. Should the policy owner choose to withdrawal a portion of their cash value while the policy remains in force, these distributions are often treated on a tax-free basis. This tax benefit is not offered to full or partial surrenders from the cash value; only to withdrawals or distributions taken as a loan.

Optional Whole Life Insurance Riders

In addition to the base amount of death benefit selected, most life insurance companies offer a number of optional riders for consideration. Building a life insurance policy is like a customized puzzle; each piece you decide to put together to form the entire picture is personalized to your specific needs and financial situation. Riders are designed to enhance your policy’s performance as well as living and death benefits. While each insurance company will offer their own set of riders, there are some basics to become familiar with, including:

• Disability Waiver of Premium– During a person’s younger years, they are more likely to become disabled than to die prematurely. In the event of a disability, most people start to cancel things that they deem as unnecessary from their budgets, including items such as life insurance. If this rider is added to a policy, once the waiting period has been reached as a result of a disability, the insurance company will make the insured’s premium payments, often until the age of 65.
• Paid Up Addition Option– Some insurance companies call this rider an ‘Enricher’. When added to a policy, it enables the insured to increase the cash value through the purchase of paid up additions. Ultimately, this rider allows the insured to contribute more to their policy, boosting their cash account’s balance and boosting the internal rate of return.
• Guaranteed Issue Rider– As we age, it becomes more and more common for health issues to develop. In the event that a serious health issue were to arise, it is possible that the individual could be deemed uninsurable by an insurance company. This rider helps provide some protection against this possibility. This rider guarantees the insured the right to purchase additional death benefit without proving insurability.
• Accelerated Death Benefit– This rider enables the insured to access a portion of their death benefit while they are still living. The conditions in which someone would be eligible to access this benefit include diagnosis of a terminal illness, admission to a nursing home or skilled nursing facility, or the medical need to receive long term care benefits.
• Accidental Death and Dismemberment– Many people confuse this benefit with true life insurance death benefit. Accidental death and dismemberment pays an additional amount out to named beneficiaries in the event the insured dies in what the insurance company deems to be an accident. Alternatively, some insurance companies will also pay an additional death benefit in the event the insured has been dismembered; loss of limbs, eyesight, etc. Due to the low probability of either of these things occurring, the premium to add this rider to a policy is relatively low.

These are just a few of the most common whole life insurance riders. When comparing policy quotes from various insurance companies, be sure to consider what is offered, the associated cost of each, and whether there is an associated benefit to your personal financial situation before adding them to your base policy.

How Much Insurance do you Need?

The amount of whole life insurance is at the discretion of the buyer. Many consumer reports recommend that an average person should consider having ten times the annual income as the policy amount.  However, there is no hard, fast rule about how much to purchase.

The biggest determining factor for how much life insurance you need it what your wishes are for the insurance proceeds. For example, if your only goal is to cover burial expenses, then $10,000-15,000 in coverage may be sufficient.

If your goal is to provide for a surviving spouse’s ongoing income needs, then you need to determine what that annual figure actually is. Review your household’s budget, including fixed and variable costs, to arrive at a cost per month, or an annual expense figure.  Using 5% as a conservative rate of return on investments, you can work backward to determine how much life insurance death benefit you actually need. For example, if your annual household expenses add up to $100,000, assuming a 5% rate of return, you would need $2,000,000 in insurance coverage to generate the income needed over your spouse’s lifetime.

Ultimately, spend time considering what the insurance will be used for, what assets you currently have accumulated and determine a figure that works for your specific needs and wishes. Remember; there is no magic amount of life insurance each and every person needs. The amount is purely what works best for you and your household.

What to Expect Once You Apply For A Life Policy

With a whole life insurance policy, the buyer will need to answer a great deal of questions in order to determine whether they will be issued a policy. These answers are generally provided in the form of an insurance application. Once submitted, the insurance company will review the answers then provide several policy choices for the buyer to make a decision regarding.  The questions can include inquiries about age, weight, height, male or female, smoker or non-smoker, drinker or non-drinker, types of traffic tickets including DUI’s, occupation, and participation in hazardous activities such as scuba diving or sky diving.  Along with the battery of questions, the buyer will then provide the results from a medical examination to the insurance provider. This medical exam is provided for at no-cost by the insurance company.  After the exam and answers have been reviewed, the insurance provider can present policy options to the buyers in order to make a decision on the whole life plan that would be best for them.

Buyers should evaluate all of their insurance options before deciding on a plan.  Whole life insurance is an option to consider for the tax benefits, investment options, and the steady consistent premiums.  But, other life insurance types exist. Take time to consider your entire financial picture when selecting not only the type, but the amount of insurance you require. And, revisit this plan regularly, as things change dramatically over the course of our lifetimes.