What Is Whole Life Insurance?

Whole life insurance, also known as traditional life insurance, provides permanent death benefit coverage for the life of the insured. In addition to paying a death benefit, whole life insurance also contains a savings component in which cash value may grow. Interest accrues at a fixed rate and on a tax-deferred basis.

Whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level, regularly-due premium payments. The policy includes a savings portion, called the “cash value,” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis. Growing cash value is an essential part of whole life insurance.

To build cash value, a policyholder can remit payments more than the scheduled premium (known as paid-up additions or PUA). Policy dividends can also be reinvested into the cash value and earn interest. The cash value offers a living benefit to the policyholder.

Over time, the dividends and interest earned on the policy’s cash value will often provide a positive return to investors, growing larger than the total amount of premiums paid into the policy. In essence, it serves as a source of equity.

To access cash reserves, the policyholder requests a withdrawal of funds or a loan. Interest is charged on loans with rates varying per insurer. Also, the owner may withdraw funds tax-free up to the value of total premiums paid. Unpaid loans will reduce the death benefit by the un amount.

Withdrawals and unpaid policy loans reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could moreover chip away at the death benefit or even wipe it out completely.

While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others (such as some traditional whole life policies) may reduce the death benefit by an amount greater than what is taken out.

The death benefit is typically a set amount of the policy contract. Some policies are eligible for dividend payments, and the policyholder may elect to have the dividends purchase additional death benefits, which will increase the amount paid at the time of death. Death proceeds are non-taxable to the beneficiary and are, therefore, not part of taxable gross income.

The death benefit can also be affected by certain policy provisions or events. For example, unpaid policy loans, including accrued interest, reduce the death benefit dollar for dollar. Alternatively, many insurers offer voluntary riders—for a fee—that secure or guarantee coverage, including the stated death benefit.

For example, two of the most common are the accidental death benefit and waiver of premium riders.  These protect the death benefit if the insured becomes disabled or critically or terminally ill and are unable to remit premiums due.

Many life insurance policies allow the policyholder to designate that the funds from the policy be held in an account and handed out in parts rather than as a lump sum. Interest earned on the holding account will be taxable and should be reported by the beneficiary. Also, if the insurance policy was sold before the death of the insured, there may be taxes assessed on the proceeds from that sale.

As is the case with any kind of permanent policy, it’s important to thoroughly research all insurers being considered.  It must be ensured that they’re among the best whole life insurance companies currently operating.