Editor’s Note: Good morning, peeps. Our flight from Montego Bay to Charlotte, North Carolina got cancelled due to weather so we’re stranded at our hotel for another day. Please enjoy this post from Gary Dek. Gary is a former investment banker and private equity analyst. He blogs at Gajizmo.com and also contributes to MyLifeInsuranceQuotes123.com, providing comprehensive life insurance guides for consumers looking for the best coverage at affordable prices.
Whole life insurance is the original type of life insurance, despite the fact that term life has become much more popular, and for a while, it was once the only kind available. Unfortunately, it was very expensive and companies decided to tweak the characteristics of the policy to make it affordable and thus less costly to the carrier.
How Can Life Insurance Provide Benefits For The Living?
To understand how whole life insurance provides financial benefits, here are the basics you have to know:
- Fixed premiums and death benefits
- Offers an investment component called a cash value
- The cash value earns a fixed interest rate
- Coverage for a lifetime
- Significantly more expensive than term life insurance
As mentioned, whole life insurance diverts part of your premiums into a savings feature called the cash value. The insurance company guarantees the interest rate paid on the cash value, which is usually around 4%. Over the years, the cash value grows and it can be used as collateral for low interest loans without canceling the policy. If the loans are not repaid before you die, the owed balance is simply deducted from the death benefit. The money can be used to build a nest egg for retirement, finance college tuition, a down payment on a home, or to cover unexpected emergencies.
For example, if your whole life cash value amounts to $50,000 and you have a death benefit of $250,000. Later, you decide to pull that money out and use it as a down payment for an investment property, without repaying it because the interest is lower than your mortgage rate. If you were to die thereafter and the insurance company paid out your death benefit, your family would only receive $200,000.
The primary purpose for life insurance is the potential death benefit payout if anything happens to you. The death benefit of a policy helps support your financial dependents by covering living expenses so your family doesn’t have to struggle. It can also be used to cover final expense, such as funeral and medical bills, as well as outstanding debts, including your mortgage or auto loan. This is why smaller burial insurance plans are frequently just small whole life policies.
Whole Life Insurance Basics
Fixed Premiums For Life. Traditional whole life insurance policies have fixed premiums over your lifetime. This means you will pay the same amount at age 50 as you did at 25. Term life insurance has lower initial premiums than whole life, but the insurance is temporary and must be renewed at expiration at a higher rate.
Fixed Death Benefit. Most people aren’t sure how much life insurance coverage they need to buy. Each family has a different financial situation and must opt for a balance between complete protection and affordability. While some advisors like to recommend a range of 5 to 15 times a policyholder’s income, the truth is that the calculation is more complex. Would a husband and wife combining for $100,000 per year and renting an apartment need as much protection as a family of 4 earning $100,000, with a mortgage and one child in college? The basic idea is to buy enough coverage to allow your family to continue their current lifestyle with the necessities.
Permanent Protection. Whole life insurance cannot be canceled by the insurance company and the death benefit never changes. Universal life insurance, another type of permanent life policy, has a death benefit that can fluctuate since it is tied to the cash value and invested in financial markets. Whole coverage guarantees payment of the face value of the policy if the insured person dies.
Calculating Life Insurance Rates
Life insurance premiums are based on many factors, but among the most important are your age, gender, general health, and whether you are a smoker or not. Companies base premiums on your statistically-calculated expected life span, while term insurance uses the length of the policy period in relation to your risk/life span. The longer the period of time, generally, the higher the term life insurance rates.
Pros and Cons of Whole Life Policies
Pros. Whole life insurance provides an automatic savings plan for those who do not have the discipline to make regular deposits in a savings account or retirement plan. The measly interest paid (usually less than 1%) on savings accounts is taxed when it is paid, but the interest paid (usually around 4%) on whole life policies is tax-deferred until it is withdrawn. You can use up to 90% of the cash value as collateral for a loan and have no income tax due on the money.
Cons. The primary disadvantages are the initial costs and lack of flexibility. While term life offers cheap premiums and greater flexibility due to its temporary nature, it does not accrue cash value and offers no benefits to policyholders who do not die during the policy term. Obviously you don’t want to feel like you have to die in order to “win”. While the death benefit of whole insurance cannot be changed to meet changing financial circumstances, term life policies can be used to supplement whole life when financial obligations increase and more protection is needed.
Why You Shouldn’t Buy Whole Life Insurance
Generally speaking, the verdict on whole life insurance is that you should only buy it if you absolutely need a forced savings account or you are an affluent family seeking effective tax advantages. Whole life premiums are a high price to pay for a lack of discipline, especially when coverage ranges from 5 to 10 more than term life insurance.
Any wise financial advisor will tell you to buy a 30 year term life insurance policy, take the difference you would have spent on whole coverage, and invest long-term in the stock market. With the stock market averaging just over 9% annual returns over the course of the last 100 years, you will build a large nest egg by the time retirement comes around.
Modified Whole Life Insurance
Modified whole life insurance was developed to make permanent coverage more affordable for young families who expect their incomes to rise over time. Instead of a fixed premium, modified whole life insurance has a low initial premium that increases incrementally over time. The lifetime payments total the same as for standard policies, but they are structured so young families can afford the security and cash value of permanent whole life insurance.
Other Payment Options
While the death benefit of whole life insurance is fixed, payment options other than fixed premiums are available. In addition to modified plans, other payment plans include limited and single payment options. The premiums for limited payment protection are high, but after a specified period of time, usually 20 years, the policy is paid up and remains permanent with no further payments. The single payment is paid in a lump sum when the policy is issued and remains in force unless you cancel it.
If you think whole life insurance may be right for your financial situation and family, compare life insurance quotes online to find company worth working with. Although not our first choice when recommending a type of policy, whole life insurance does protect loved ones in the event that a policyholder dies prematurely and offers benefits while you are alive.