Whole Life Insurance, Explained.
If you look up the definition of whole life insurance, you’ll discover it is “a type of permanent life insurance that offers cash value.” People with a limited understanding may say it’s just “expensive life insurance.” Others may claim it’s an investment or even a replacement for any other type of retirement plan.
But what is whole life insurance, really? What are the “basics” you should know? How does it work, what does it do, and what are the benefits of starting (or keeping) a whole life policy?
Since it is not uncommon to need whole life insurance explained, we will cover the highlights in this article:
- What whole life insurance is… and what it’s not
- How it works and what it does
- Who uses it and why
- The unique benefits it offers
- And much more!
What is whole life insurance? The basics.
Whole life is a traditional financial product that has been around for more than 150 years. Chances are—your grandparents and great-grandparents may have used it! It is an ideal asset for emergencies, opportunities and legacy.
As mentioned above, whole life insurance is permanent life insurance that also grows cash value. By “permanent,“ we mean that you can never outlive your death benefit. (This is also the “face value” of the policy.) Unless you cancel the policy or stop making payments before a policy is “paid up,” whole life insurance will pay a death benefit—guaranteed.
It is more expensive than other kinds of insurance because of the significant guarantees of whole life. In addition to a guaranteed death benefit, whole life insurance guarantees a minimum level of cash value growth and guaranteed level premiums for life. And it guarantees that rising mortality costs within the policy will never invalidate the other guarantees!
Often (incorrectly) compared to mutual funds and other investments, whole life insurance is a savings vehicle or cash equivalent and a risk-management tool. Your cash value cannot be lost or decreased due to stock market or interest rate fluctuations. Gains are locked in. Depending on policy riders, a policy may include other protections in addition to a death benefit, such as potential long-term care benefits.
Whole life is not technically an “investment.” It’s an asset that protects all other investments. During the Great Recession, many people liquidated or made withdrawals from IRAs and 401(k)s. This meant liquidating depressed assets while paying penalties and taxes to boot! Using whole life insurance as an emergency fund during times of trouble can save a home, save a business, or prevent devastating losses in the rest of your portfolio.
Whole life provides an ideal financial foundation because it grows money safely and steadily while protecting from the storms of life. It is an ideal place to store cash where it can grow safely and more effectively than at a bank.
Whole life insurance vs. term insurance.
To understand whole life, let’s compare it to term life insurance, which most people understand. Term insurance is temporary insurance that lasts for a certain term, such as 10 or 20 years. Then, much like a product warranty, it expires before you are likely to use it! 99% of term insurance never pays out. That is why it is “cheap”—the risk for the insurance company is very low.
In contrast, whole life insurance is permanent life insurance. It is guaranteed to pay out as long as the policy stays in force. You could compare it to owning a home versus renting:
Term insurance is like renting a home. You sign a lease for a predetermined period of time. It’s temporary. And when the term of the contract is up… it’s over and done! Renting is less expensive than buying a property, though as years pass, you’re likely to pay more if you sign a new contract. Renting serves a purpose, but you don’t build any equity or value.
Whole life insurance is more like owning a home. It costs more because you are purchasing an asset you own and control! As time goes on, the asset builds equity you can borrow against or even withdraw. The longer you own it, the more cash value or equity the asset has. You can eventually pass it on to future generations, use the asset as collateral, or turn it into an income stream later in life. (With whole life, that can happen through dividends or by converting it into an annuity).
Another way to express some of these benefits is through the CLUE acronym, which stands for:
I explain more about the CLUE method in this podcast: “The CLUE Method” and also in my book, Live Your Life Insurance.
The mutual life insurance company.
Whole life insurance is purchased from mutual life insurance companies. A mutual company is actually owned by the policyholders! In this way, mutual companies function more like co-ops or credit unions. Rather than working to satisfy and enrich shareholders, they are beholden to the interests of policy owners. This also allows them to focus on long-term growth and stability rather than quarterly profits.
You may have heard whole life insurance referred to as “participating whole life.“ This means that the policyholders *participate in the profits of the company through dividends. (Dividends are historically reliable but not guaranteed.)
There are many good mutual life insurance companies. Some of the better known ones include MassMutual, New York Life, Northwestern Mutual and Guardian Life.
How cash value grows.
One of the most important ways a policy grows is through consistent contributions in the form of premiums! It is said that “life insurance is a savings account that shows up like a bill.” While other types of insurance represent costs, whole life insurance represents long-term savings and an important asset.represents long-term savings and an important asset.
We say that whole life insurance is the best place for your long-term savings. That’s because in the first few years, policies have extra costs (the mortality costs of insurance, commissions, the cost of running the company). After the first few years, whole life policies tend to easily outperform banking products, even when factoring in the first few years of slow or negative growth.
The cash value grows by a minimum dollar amount each year. Guarantees are stated in dollar amounts, not interest rates. This is important because other types of policies can produce little if any cash value. And if a policy has very little cash value… the rate becomes irrelevant!
Additionally, the profits of the company are distributed through dividends that can increase the growth of cash value. Historically, cash value tends to grow at a rate of about 2 percent more than what the best bank savings accounts are paying. Dividend rates tend to float up and down over time, reflective of economic conditions.
How dividends work.
Whole life dividends are not guaranteed. However, the mutual companies that we are aware of have paid dividends steadily for well over 100 years—through every world war, stock market crash, recession and even the Great Depression.
Policy dividends are declared prior to the beginning of each year. In 2020, most mutual companies are paying dividends from the low 5 percent to the low 6 percent range. This is before costs and inclusive of policy guarantees.
For example, let’s say the net guaranteed growth of the cash value equals 2 percent, the gross dividend rate is 5.7 percent, and the policy costs equal 2 percent. In this case, the policy cash value would grow at a rate of 3.7 percent. That’s the gross dividend rate (5.7) subtract costs (2.0).
We get questions about which companies pay the highest dividends. While you can compare this year’s dividend, over time, dividends rise and fall. The company that pays the best dividend this year is not likely to pay the highest dividend five years from now. Therefore, it is most important to choose an advisor or agent you feel comfortable rather than choosing a company according to the current dividend rate.
Dividends can be paid in many different ways. Popular options include: taking dividends in cash, using them to offset premiums, or purchasing paid-up additions (the most effective way to reinvest dividends). The policyholder chooses how they would like dividends distributed and this can be changed over time as the policy owner’s needs change.
For more on whole life insurance dividends, read “Understanding Life Insurance Dividends.”
Utilizing your cash value.
The cash value in a policy can be left alone and saved, borrowed against, or withdrawn. Since whole life is the best place to store cash, if you don’t need it, just let it grow! Growing your cash value to six figures or more can be very beneficial and strategic. If you have access to lump sums of cash you will find tremendous opportunities down the road.
When an emergency or an opportunity arises, you can withdraw cash value or borrow against it. In most cases, we recommend borrowing against your policy. That is because once you withdraw the cash, you can’t just “put it back” as if it was a savings account. (This is just how life insurance works.) If you are confident you can pay back a policy loan, borrow against it and keep your cash value growing uninterrupted.
The interest rate you’ll pay on a policy loan is determined by your policy contract. It can be fixed or adjustable, depending on the company. Currently rates are in the mid-single digits. You can also use your policy as collateral for a bank loan, which could potentially be offered at a better rate.
For more, see these articles: “7 Things to Know about Life Insurance Loans” and “Should You Borrow Against Your Cash Value or Withdraw It?”
The living benefits of whole life.
Whole life insurance is not just “death insurance.” It is designed for, well, your whole life! Life insurance riders offer important living benefits which protect the insured during their lifetimes.
There are many different kinds of life-insurance riders. Some important ones include:
- Waiver of premium, which ensures that if you become disabled prior to age 65, the life insurance company will continue to pay your premiums.
- Accelerated death benefit riders offer financial protection in a health crisis. In the case of a designated terminal or critical illness diagnosis, the policyowner can receive a portion of the death benefit. This money can be used for whatever they wish.
- Long-term care benefit riders can be used to pay for Long term care if the insured needs assistance with activities of daily living.
- Paid-up additions is our favorite rider: it allows policyholders to build cash value faster while also increasing future death benefit through purchasing “paid up” additional insurance.
There is an additional cost for most life insurance riders, although it is often minimal. Contact us for a quote in the form of a life insurance illustration, and we can show you what these costs would be.
Investing using your whole life policy.
Those who say “the returns of whole life are lousy” don’t understand how to use whole life. You can generate impressive profits by leveraging your cash value to pursue opportunities, make investments, and expand assets. That’s where the real gains are: using the liquidity in your policy strategically!
Many businesses have been started or assisted with money from whole life insurance, including Disneyland, J.C. Penney’s, McDonalds, Foster Farms, and Pampered Chef. (Learn more in “The Surprising Business Financing Secret of Top Entrepreneurs.”)
Cash value life insurance is also very powerful when paired with real estate investing. My husband, Todd Langford, shares a case study that shows how using a policy loan can make a good real estate deal even better! By using the leverage of a mortgage plus a policy loan, you can actually increase your rate of return. You can read it here: “How do I tell if my real estate deal is a good one?” or watch a presentation on the Truth Concepts YouTube channel. (It’s titled, “Truth Concepts: Real Estate—7 of 8.”)
Privacy and protection.
One valuable benefit of whole life insurance is that it is much more private than traditional banking and many types of investments. This means protection against creditors, predators, and Uncle Sam!
With whole life insurance, the IRS is not informed of your cash value growth—nor do you pay taxes on that growth! As long as the policy remains in force, policy owners pay neither capital gains nor income tax on the growth of their policy.
When you borrow against life insurance, those loans are not reported to credit bureaus. (Nor do you need “good credit” or proof of income to qualify for policy loans.)
In many states, whole life cash value is protected (or protected to certain limits) against creditors. The Asset Protection Society offers some guidance on whole life protections. We also highly recommend consulting with an estate planning attorney.
Except in rare circumstances when the estate tax exemption is exceeded, death benefit proceeds are not taxed. Contrast this to what happens when an heir is left a traditional 401(k) or IRA: when withdrawn, they must pay income tax on the inheritance!
And while it’s important to protect your money and your privacy… whole life accomplishes something even more important: It protects your loved ones. It provides immediate financial relief when a father, husband, wife or mother is lost. It can pay for financial expenses and so much more. Beneficiaries use it to replace incomes, pay off debts, and be able to have financial certainty in challenging times.
The most flexible financial vehicle we know of!
Many financial vehicles only serve one or perhaps two purposes, such as growth or cash flow, liquidity or protection. Whole life insurance has been compared to a financial smart phone or a Swiss Army knife because it can do so many things:
- Grow money safely
- Offer a structure for saving consistently
- Protect against taxation
- Provide cash for emergencies
- Provide funding for opportunities
- Offer privacy and protection
- Create future income
- Provide death benefits as well as living benefits
What benefits do you value most? In what ways can whole life insurance provide needed balance to your investments?
Resources to learn more about whole life insurance:
The best little book on whole life is my first book, Live Your Life Insurance. It explains why whole life insurance is NOT just “death insurance”! It has been a category best seller on Amazon for years because it has brought so much CLARITY to investors, consumers, and advisors alike.
Want a deeper dive into understanding whole life insurance? Our Whole Life 101 Course was created for policy owners and anyone who truly wants to understand whole life insurance.
This (primarily) video course will help the policyowner learn:
- Learn to read an illustration from a life insurance company
- Break down the costs associated with your policy
- Understand how cash value grows
- Learn the language of life insurance
- See the big picture of how whole life works within the industry
- Know the best practices for borrowing against your policy
- Know with dividend options work best for you
- Make strategic use of your own death benefit
- And much more!
Go to WholeLifeCourse.com to find out more and get started! The course is currently 25% off and there’s no better time to learn about whole life insurance than these volatile times.
Would you like a whole life insurance quote? Do you have other questions? Contact Partners for Prosperity for assistance. There’s no sales pitch… just helpful information!
—By Kim Butler and Kate Phillips
Disclosure: Our content is meant for educational purposes only. While it’s our goal to help you learn about building a life of prosperity, we do not intend to provide financial advice. Please consult your financial, tax or legal advisor before making any investment or financial decisions.