There are few things more important than making sure that your family is taken care of financially. Life insurance is designed to protect your family after your death. Whole life insurance is one option to do so, though it is much more expensive than term life insurance. So, is it worth the cost?
Understanding the ins-and-outs of whole life insurance can help you decide if it makes sense for you, your finances, and the long-term welfare of your family.
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What is Whole Life Insurance?
Whole life insurance is a type of permanent insurance, one without an expiration date. Holding this policy will provide your designated beneficiaries with a death benefit payment when you eventually pass away.
Similar to other insurance policies (including term life insurance), the policy holders will make regular premium payments in order to remain covered by the plan. With a whole life insurance policy, these premiums never change throughout the life of your plan (and in fact the real cost goes down as inflation rises).
There are single-premium plans that allow you to make a lump-sum payment upfront. However, because these plans require holders of these policies to have large sums of money available, they tend not to be feasible for most.
What are Premium Payments Used For?
Premium payments will never change during the lifetime of the policy, and will be used for three different purposes: paying for the death payment, accumulating cash value, and fees to the policy issuer.
(1) Death benefit: Holders of whole life plans guarantee their dependents a death benefit payment when they die, assuming that they have remained current with their premiums. The death benefit is determined beforehand and does not change throughout the life of the policy, ensuring that your dependents will receive a pre-determined payout.
Depending on the type of plan, beneficiaries will have the option to receive the death benefit either as a lump-sum payment or through regular installments until the monies in the account have been depleted. These payments are usually exempt from being taxed, though if you choose the installment plan any interest earned while the monies remain with the issuer will be taxable. Some plans may give the beneficiaries the option to take the payment as an annuity, meaning that they will receive a monthly sum for the rest of their lives.
(2) Cash value: Whole life insurance policies also have what is called a cash value portion, which grows throughout the years as you make your regular premium payments. The cash value enjoys a guaranteed interest rate that the issuer provides, and can be accessed during the life of the policy holder for a variety of different purposes (see below for more details).
(3) Fees to the policy issuer: As with any investment vehicle, whole life insurance policies have management fees that you are on the hook for paying.
Understanding the Cash Value Component
The cash value of a whole life insurance policy acts in many ways like a savings or investment account. It grows over the years, through both regular contributions through your premiums as well as due to the interest it gains. These interest payments are accrued on a tax-deferred basis.
As a policy holder, you have the ability to access the cash value in your whole life insurance plan as either a loan or as a withdrawal. The amount you remove will be taxed only if it includes interest you have earned after you have placed it into the account. It is important to note that withdrawals and loans that are not repaid will likely reduce the death benefit, depending on the details of your particular plan.
You can also elect to end your insurance coverage, also known as surrendering your policy. If you decide to do so, you will receive the amount of money that has accumulated over time, minus any cancellation fees that the company charges. Your beneficiaries will also no longer receive a death payment.
The cash value is considered a so-called living benefit. For most plans, when you die the cash value in your whole life policy will revert back to the insurance company.
Who Should Purchase Whole Life Insurance?
Whole life insurance has some pronounced advantages over term life insurance.
Not only does it never expire, but its cash value component allows policy owners to access some of the funds they have paid into the plan while they are still alive.
A whole life insurance plan therefore contains measurable value, and if you decide to cease your coverage you will be able to receive a portion of the monies you have paid into the account. When term life insurance ends, the (now former) policy holder is simply not covered any more.
For these reasons, whole life insurance plans are more expensive than term life insurance. These tend to make the most sense for wealthier individuals, especially those who have maxed out their contributions to their 401(k) and IRA accounts and who can afford the higher monthly premiums. While the return on investment is guaranteed and grows tax-free, it is also a very low amount that even conservative investment strategies would likely surpass.
Still, for those with a dependent with lifelong needs, owners of major assets whose beneficiaries will need help paying estate taxes, or those who want to ensure that their dependents will receive a death benefit no matter when they die, a whole life insurance plan can serve as a good option. It is only worth the cost, however, if the significant monthly premiums do not harm your ability to meet your current budgetary needs.
Conclusion: Thinking About the Future
Every insurance plan is meant to provide both peace of mind and coverage if an accident, illness, or other unintended event occurs. Whole life insurance functions the same way, save for the fact that your dependents will be the ones receiving the money instead of you.
As you plan for the future, the importance of looking out for your dependents is an important consideration. Whole life insurance can serve as a source of comfort that never expires, helping those you care most about navigate life after you are gone.
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