What Is Whole Life Insurance? | A Complete Guide

Because of its low cost, term life is perhaps the most dominant type of life insurance. But term insurance doesn’t work for everyone. Though it’s inexpensive, it’s only temporary coverage.

If you need permanent coverage, whole life insurance is a better choice.

The more you know about whole life insurance, the easier it will be to determine if it’s the right insurance choice for you.

In this article:

What Is Whole Life Insurance?

Whole life insurance is often referred to as permanent life insurance. This is perhaps the most distinguishing characteristic of a whole life insurance policy.

Once a whole life insurance policy has been issued, it can only be canceled for either fraud or non-payment of premium.

It is also characterized by the fact that both the death benefit and the premium payments are fixed for life.

These policies also have a cash value, which adds an investment component to your policy.

Part of the premium you pay goes toward the cash value, which accumulates and earns interest over the life of the policy.

Either you can borrow against the cash value during your life (at very favorable interest rates), or it will be added to your death benefit payout.

What’s the Difference Between Term and Whole Life Insurance?

Most importantly, term life policies are only in force for the stated term length, while whole life insurance remains in force for the rest of your life.

With term life insurance, policy features only apply during the original term of the policy. Once the original term expires, a new premium will be based on your age and health at the time of renewal.

Whole life insurance also provides an investment provision in addition to the death benefit.

Still, term life insurance is much less costly. With enough discipline and knowledge, it may be possible to accumulate a bigger nest egg by investing the difference on your own.

How Does Whole Life Insurance Work?

When you apply for whole life insurance, you’ll be applying for a specific death benefit that will remain constant for the rest of your life.

It’s important to choose an amount that is sufficient for current needs in addition to any anticipated obligations.

Most whole life insurance policies require medical qualification. You’ll need to answer a series of health-related questions on the application. And you may be required to pass an insurance company medical exam.

Basic information will be taken, including your height, weight, and blood pressure.

Because of the medical aspect of the policy, the application process generally takes several weeks.

If there are any findings regarding your health, the premium you’ll pay may be adjusted—typically higher.

Whole Life Insurance Cash Value

A whole life policy includes guaranteed death benefit and a cash value. However, that cash value accumulation is minimal in the early years of the policy.

For example, with most whole life insurance policies, cash value accumulation doesn’t start until about the fifth year the policy is in force. But from then on, the majority of your premium is dedicated to your cash value.

As the policy builds cash value, it will also accumulate interest. The interest rate is set in the policy. Some companies may provide you with projections of the cash value at different points in the future.

The good news on cash value interest is that it’s guaranteed, even if prevailing interest rates fall below that level. The bad news is the insurance company may not increase the interest rate if prevailing rates rise.

Once your cash value accumulation reaches a certain level, you can allocate some of that money to pay your premiums in the future. This is referred to as “paid-up life insurance.” You’ll keep your coverage but lose the premium payments.

Is Whole Life Insurance a Good Investment?

Generally speaking, whole life insurance policy cash values are not considered superior investments. You can generally outperform them over the long term simply by investing in common stock index funds.

That said, whole life insurance cash value provisions are an excellent option for consumers who have no desire to invest their money. You can think of whole life insurance as a forced savings program.

Average Cost of Whole Life Insurance

Premiums for whole life insurance policies are based on a combination of your age, your health at the time of application, and the amount of the death benefit in the policy.

The premium will also be affected by any policy riders you add to it. In most cases, each rider will carry its own premium addition, which will increase the total premium.

Age and health are critical factors in determining all life insurance premiums. So it’s always best to apply for whole life insurance when you are young and in good health.

For younger applicants—those in their 20s and 30s—whole life insurance premiums can easily be 10 times higher than the cost of an equivalent amount of term coverage.

However, the difference in premium cost between whole life and term life narrows with age, particularly past 50.

It’s even possible that a whole life policy taken in your 20s will cost less than an equivalent amount of coverage from a term policy taken 30 years later.

A 30-year-old applicant in good health can generally expect to pay about 1% of the death benefit for a whole life insurance policy.

For example, the premium on a $250,000 policy may be around $2,500 per year. But once again, this will increase based on your age at the time of application and any health conditions you may have.

Pros and Cons of Whole Life Insurance

Pros:

  • Whole life insurance is permanent coverage.
  • The premium will remain the same.
  • Whole life insurance policies build cash value.
  • Riders can be added to a whole life insurance policy.
  • Investment provision with a guaranteed return.
  • Cash value may reach a level that eliminates the need for payment of future premiums.

Cons:

  • Whole life insurance is significantly more expensive than term life.
  • You may find the death benefit amount taken at age 30 to be insufficient 10, 20, or 30 years later.
  • Could get better returns through alternative investments, such as equities.
  • Very little goes toward cash accumulation in the first few years.

Alternatives to Whole Life Insurance

Term life is the most obvious alternative to whole life insurance. It’s sometimes referred to as pure life insurance because life insurance coverage is the only benefit it provides.

There is no cash accumulation provision and no interest rate earned.

Term life costs only about 10% of whole life insurance.

In other words, you could purchase a term policy and invest the remaining 90% in higher-yielding investments. For example, an S&P 500 index fund can be expected to pay 10% per year based on the average returns on the index, going all the way back to the 1920s.

A single premium life insurance policy is another option. This is a whole life insurance policy in which you make a one-time premium payment rather than incurring a monthly or annual expense.

The portion of the single premium dedicated to the cash value will begin accumulating interest immediately. This will enable the cash value to increase from the beginning.

Is Whole Life Insurance Best for You?

For the majority of consumers, term life insurance will be the better choice. Because it’s much less expensive, you can purchase a larger death benefit and still save money on the premium.

But there are certain situations where whole life insurance is a better choice than term:

  • You can afford to pay the premiums for the desired level of whole life insurance coverage and prefer to lock-in the cost now.
  • Your family’s medical history indicates you may not qualify for a new term insurance policy in the future. A whole life insurance policy will guarantee coverage regardless of the state of your health.
  • Even though term life insurance is much cheaper, the whole life cash value accumulation provision is a better choice because you don’t believe you have the discipline to save and invest for the future.
  • You want to maintain a certain minimum level of life insurance, even if that won’t be adequate at some point in the future. As such, you choose a whole life insurance policy now, intending to supplement that coverage with a term policy or two in the future.
  • You like the idea of having the option to eventually use the cash value to pay the policy premiums, essentially providing you with free life insurance coverage for the rest of your life.

Should You Consider a Whole Life Policy?

You may fully intend to purchase a term life insurance policy. But you owe it to yourself and your loved ones to take a long, hard look at whole life insurance.

Whole life has been much maligned in the financial media in recent years. This is due to the lower cost of term coverage.

But as discussed above, there are certain situations where whole life insurance can make more sense than term.

At a minimum, you may choose a whole life insurance policy to provide you with a permanent life insurance base.

That will guarantee you’ll have at least that much coverage for the rest of your life. And at times in your life, when your need for life insurance is greater, you can supplement your whole life base with term life insurance.