Advantages of Whole Life Insurance
Although it can be expensive, the advantages of whole life insurance are often very appealing. With various uses of its cash value mechanism, whole life insurance can do more than just provide a death benefit.
What is Whole Life Insurance
Whole life insurance is the most basic of permanent insurance products. After undergoing the usual application and underwriting process, upon policy issuance it guarantees a level premium on a permanent basis. This is accomplished by both higher premiums than a comparable term life insurance product as well as a cash value mechanism, which acts like a savings account of sorts and helps to offset the increasing cost of insurance as one ages.
In time the cash value of whole life insurance may grow to the point where it is equal to the face value of the policy. This phenomenon is known as when the policy matures. While older policies were set to mature at age 95 or 100, whole life insurance issued today won’t mature until age 115 or even age 120. So, while it is possible to outlive a whole life policy, by design it is highly unlikely.
Comparison to Term and Universal
The main advantage that whole life has over term life is that whole life is permanent by design. As long as premiums are paid, the policy will remain in force long enough to pay a death benefit. By contrast, well over 90 percent of term life insurance policies issued in the United States lapse before a death benefit can be paid. In addition term life has no cash value mechanism, therefore there is no way to borrow against it.
The main drawback of whole life insurance against term life is that it is significantly more expensive, often 10 times more expensive than a comparable term life product. Because of this many people recommend purchasing a mix of term and whole life to maximize protection and minimize cost.
Universal life (UL) is an offshoot of whole life. Both whole life and UL have cash value mechanisms, but universal life offers flexible payments. However because of that it is possible to lose a UL policy if enough in premium isn’t paid. Since whole life has a fixed payment schedule, it largely avoids this problem.
Apart from its death benefit, perhaps the main advantage of whole life insurance is its cash value mechanism. In addition to providing a hedge against the cost of insurance and keeping premiums level, in many cases it is possible to borrow against the cash value. This allows the insured a means to access cash for emergency situations and for other needs, and do so tax free in most cases. Of course, one needs to be mindful not to take out too much, and to make sure the cash value is eventually replaced in order to prevent the policy from lapsing.
When a variable option is selected on whole life insurance policy, this cash value becomes tied to mechanisms like separate accounts, which operate in much the same way as mutual funds. One can select conservative or aggressive accounts, or a mixture of both, based on suitability and preference. Variable cash value mechanisms can generate a better return on investment than their fixed counterparts, however it is possible to lose money on them as well.
It is important to keep in mind that variable life insurance products should be thought of as life insurance rather than investments. Indeed it is illegal for an insurance professional to present these products as investments in the United States. Along those lines, a product such as an annuity or even a mutual fund may be a better choice if the death benefit is not the primary reason for purchasing a particular product.
Single Premium and Reduced Paid Up
Another advantage of whole life insurance is that it can be purchased with a single premium. While this premium is invariably quite substantial, it provides the obvious benefit of placing an insurance policy in force for life with a single payment. Single premium policies work particularly well when the insured is a minor and costs are relatively reasonable.
A related option is the “reduced paid up” option. This allows an insured to declare a policy paid in full based on premiums already paid in, although at a reduced face value. This can often be a smart budget-saving move while at the same time keeping the policy in force. In most cases it is a clearly superior alternative to outright policy surrender.
Of course, once a policy is declared reduced paid up, that’s usually a final decision. Any future insurance coverage would require a new application and underwriting process.
Use in Business Settings
Whole life can be used advantageously in business settings as well. A common business application is when partners take out policies on each other, or perhaps a single joint life policy. This can provide a death benefit should one of the partners die unexpectedly.
Another common application is what’s known as “key person” insurance. This occurs when a company takes out a policy on a particularly important employee, naming itself as the beneficiary. Should the employee die, the company can take a death benefit based on the lost revenue represented by that employee. Key person insurance is usually only done with longtime employees in senior positions who are unlikely to leave.
Both of these options can be purchased using the single premium option or with regular installment payments.
In many states a whole life policy can be used as a vehicle for charitable giving. This works by an insured taking out a policy with a non-profit organization as the beneficiary. Of course the standard underwriting rules still apply. In most states the beneficiary must be made irrevocable (i.e. once it’s set, it can’t be changed). Once that is all done, however, the insured can claim a tax deduction on the premiums.
This can be a fairly complex process, especially in comparison to other life insurance transactions. Consult with a licensed insurance professional before proceeding.
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