Whole Life vs Variable Life
Standard whole life insurance is permanent insurance that remains in effect for the entire life of the policyholder. It has a cash value component that builds over time. Part of the premium, whether paid in installments or as one lump sum, is invested. Earnings will grow and compound tax-deferred as long as the insured owns the policy. Whole life insurance is often used as a way to provide insurance coverage, to build retirement savings and to help with estate planning.
Because it is both an insurance and investment product, whole life policyholders must be financially disciplined. Except for a single premium policy, the premium must be paid according to schedule or the policy will be considered lapsed. The policyholder will have access to a limited portion of the cash account if the policy lapses. More importantly, he or she loses the death benefit that would be paid to the beneficiary upon his or her death.
A “variable” policy gets its name from the way the cash portion of the policy is invested. It can be invested in a combination of investment accounts that function like stock and bond mutual funds per the direction of the policyholder. Unlike traditional whole life policies, for which the insurance company determines how the underlying investments are applied, the owner of a variable insurance policy is responsible for the investment decisions and asset allocation. He or she is also responsible for the gains or the losses.
The Investments of a Variable Life Insurance Policy
A variable whole life policy is one for which a policyholder can choose investments in which the premiums will be invested. He or she can usually select from several different investment objectives. Some insurance companies offer up to 50 different categories of investments.
Depending on who offers the policy, the options can range from conservative to aggressive. Options usually also exist for selection of domestic, international and emerging market asset allocation. The policyholder is completely responsible for deciding upon the investments. The insurance company simply manages the account.
Policyholder investments are not co-mingled in any account that has insurance company or other investor assets. Insurance agents who sell variable whole life policies must be licensed to sell insurance and securities.
Some insurance companies also allow policyholders to choose a death benefit that is fixed or one that is variable. A fixed death benefit pays a level amount to the beneficiary, regardless of increases or decreases to cash account. A variable death benefit, however, pays an amount determined by the cash value retained in the policy.
While a variable death benefit may seem like a wise choice in a rising market, policyholders are cautioned to choose the death benefit carefully. A market downturn can result in losses that may reduce the amount of the death benefit, leaving a beneficiary vulnerable financially.
Variable life insurance policies are not suited for those who prefer not to take financial risks or for those whose beneficiaries would not be able to do with a reduction in the death benefit. Also, while insurance policies can sometimes be a good vehicle to save for college tuition, a variable whole life insurance policy is usually not. Even though the cash account has the potential to increase, the policyholder risks incurring losses that might not be made back in time.
Variable life insurance policies are considered to be securities and are not insured by the FDIC. While the insurance company selling the variable life policy must be a member of the Securities Investor Protection Corporation (SIPC), this organization may not be able to intervene. It is the job of the SIPC to “make whole” investors who have lost assets due to a bankruptcy or other financial calamity encountered by the company.
Due to higher premiums than other kinds of insurance and a possible decrease in the value of the policy, the lapse rate of variable life policies is much higher. Therefore, suitability of this type of policy is most often financially stable families or individuals who can withstand the shock of market losses and who have other significant cash and liquid assets.
Choosing a Whole Life Policy
There are six main types of whole life insurance from which to choose:
Participating Whole Life
The participating whole life policy “participates” in the financial success of the insurance company. The policyholder can take the dividend as cash payment, add it to the cash account of the policy or use it to offset the cost of the premium.
Earnings on a whole life policy grow and compound tax-deferred for as long as the insured pays the premiums. This policy provides one more way to save money for retirement. Compounded growth can accrue much more quickly as money is left in the account to grow over several years if not decades.
Non-Participating Whole Life
No dividend paid on a non-participating whole life policy. Costs, however, remain fixed for the life of the policy and are less than those for a participating policy.
Level Premium Whole Life
Premiums are paid in installments throughout the life of the insured and remain level.
Limited Payment Whole Life
A limited payment whole life policy lets the policyholder pay the premiums for a set number of years rather than over his or her lifetime.
Single Premium Whole Life
One single lump sum premium is used to buy a single premium whole life policy. This policy is frequently used more as an investment strategy or as part of estate planning than it is for the death benefit. A single premium whole life policy can also be purchased in place of a single premium immediate annuity. One of the most significant features of a single premium whole life policy is that equity is available immediately. The policyholder does not have to wait years or even months to use the policy as collateral or to borrow against it.
Intermediate Whole Life
Premium payments are flexible. The policyholder can change the amount of the premium and the payment schedule based on current needs.
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