Whole life insurance is an incredible asset for protection, liquidity, and certainty… yet it’s frequently misunderstood. It’s often considered a more “expensive” kind of life insurance, or people view it as complicated. That’s why we’ve created this ultimate guide to whole life insurance. In this guide, you’ll learn everything you could want to know about whole life insurance. That way, you can decide for yourself: is whole life insurance worth it?
What is Whole Life Insurance?
Life insurance is insurance that you buy in order to protect the value of your life. If you pass away while your life insurance is in place, the insurance company pays a death benefit to your family (your beneficiaries). People usually buy life insurance when they get married or have children so that if something were to happen, their loved ones would have money to cushion the blow. Whole life insurance is a type of life insurance.
Whole Life Insurance Definition
Whole life insurance is a type of permanent life insurance. This means that when you buy a policy, it stays “in force” for your entire life. While many people consider whole life insurance more expensive, it’s also guaranteed. In other words, so long as you keep your policy in force (by paying your premiums) that policy will pay out.
While the death benefit is generally paid to your beneficiaries upon your death, there’s a chance your policy may endow. This means that you live to the endowment age on your life insurance contract. For policies bought this year, the endowment is age 121. At that time, if you’re still alive, the death benefit will be paid to you. When we say it’s guaranteed, it’s guaranteed.
Whole life insurance is also called cash value life insurance because you get access to a cash value account. This is the “living” benefit of your insurance. As you pay premiums, the floor of your cash value account increases. It also earns interest and dividends. This makes it an efficient savings vehicle.
A Brief History of Whole Life Insurance
All insurance exists as a way to minimize risk. You buy car insurance to subsidize the cost of vehicle repairs in an emergency. Home insurance can help you rebuild your home for its full value if burned down. Liability and umbrella insurance can protect you from lawsuits. And life insurance protects you from death… or at least, it protects your loved ones from the loss of your income.
Although whole life insurance has had a rocky reputation thanks to the financial media, it’s actually one of the most traditional financial vehicles in the country. The wealthy have been using it for over 200 years as a savings vehicle, and a way to build generational wealth. After all, it’s an efficient and guaranteed way of recapturing family wealth after one’s passing.
One of the first examples of life insurance benefits being recorded is in 1759, known as the Presbyterian Minister’s Fund. The fund was to help women who had been widowed pay for funeral costs and care for their children. After some time, it became apparent that this kind of program would be beneficial to more than just widowed women and their children. Thus began some of the first life insurance companies and with it whole life insurance. The earliest companies were established in the 1820s and only grew from there.
A Short Glossary of Essential Whole Life Insurance Terms
Understanding whole life insurance can be complicated if you don’t know the terms. We’ve created a short yet comprehensive list of the essential whole life insurance terms you need to know to get started.
Premium: A premium is the cost of your insurance, and can be paid monthly, quarterly, or annually.
PUA: This stands for paid-up additions, which are essentially small, fully paid insurance policies that can be added to your existing policy. They increase your early cash value and death benefit. There is a limit to how much PUA you can add annually.
Cash Value: Your cash value account is the money you can access while alive. Think of it as your policy’s “equity.” As you pay premiums, your equity in your policy increases.
Policy loan: A policy loan is a great way to access your cash value. To do so, you borrow against your cash value account. The life insurance then loans you money. You can repay this loan on your own schedule, and there are no qualifications necessary to do a policy loan.
Death Benefit: This is also called the “face amount” of your whole life insurance policy. This is the amount the insurance company guarantees to pay to your beneficiaries upon your death, or endowment.
Beneficiary: This is the person or people, you designate to receive your death benefit upon your death. There are a few ways to designate your beneficiaries, which you can find in our Beneficiary Checklist.
Insured: This is the person whose life is being insured by the policy. While this is often the same person who owns the policy, you can also insure someone other than yourself. You simply need insurable interest.
Insurable Interest: This is how a life insurance company determines whether you can buy a policy on someone other than yourself. Generally, there has to be a provable financial loss if this person were to pass. For example, you can buy life insurance for your children or grandchildren or even a valuable employee.
Dividend: When you have a policy with a mutual company, you become a partial owner of the company. As such, you’re guaranteed to partake in any profits of the company, in the form of a dividend.
Rider: This is an additional provision you pay for in addition to your life insurance policy, which can give your policy extra protection and features.
HLV: Stands for Human Life Value, and represents the maximum amount of life insurance you’re entitled to buy. This number is based on a multiple of your income.
How Whole Life Insurance Works
Life insurance is a contract between you and the insurance company. When you buy a policy, you agree to pay a premium over a specific time frame. In exchange for the premium, the life insurance company guarantees that they will do certain things for you.
These whole life insurance guarantees include:
- A death benefit when you pass on. Though this is the “point” of life insurance, it’s not a guarantee when you have term life insurance coverage. Since death is a guaranteed event, it makes sense to have guaranteed coverage.
- Level premiums. In other words, your premium can never increase. Once your contract is in effect, the base premium does not change. You can, however, use PUAs to pay more when you want to.
- Cash value access and “floor.” This is the living benefit of your whole life insurance. As you pay premiums, your cash value increases net of all insurance costs (mortality costs, company expenses, and agent commission). These costs decrease over time. You cannot lose cash value, unless through withdrawal.
- Cash value increase. In addition to having a cash value account, there is also a guarantee that the “floor” of your cash value will increase each year–even without dividends.
- Guaranteed participation in company profits. This is technically true only of mutual life insurance companies, which position policyholders as partial owners of the company. While you aren’t guaranteed to receive a dividend each year, you are guaranteed to participate in any profits of the company in the form of a dividend. (Though historically, mutual insurance companies have paid dividends without fail for over 100 years, even through wars and recessions.)
The Actuarial Science Behind Whole Life Insurance
The actual cost of your insurance is determined by actuaries, who use complicated mathematical and statistical data to determine insurance risks. These calculations allow insurance companies to determine how much a policy will cost, based on the likelihood of when they’ll pay a death claim.
These costs are factored into your premium so that they are front-loaded. This is why in the early years of a whole life insurance policy, cash value growth is limited. The reason the insurance cost is front-loaded is because the risk to the insurance company is greatest at this time. Because of the contractual agreement, if the insured dies in year one of the policy, they have to pay the full death benefit.
Over time, the risk decreases, so the cost decreases, and more and more of the premium gets applied to the cash value floor. This is why it takes around years 7-10 for people hit the “break-even” point. After that, their cash value is always greater than the premiums paid.
Using Your Whole Life Insurance
Thanks to these guarantees, whole life insurance is an incredibly efficient savings vehicle. You can count on your money being safe and certain, while still being liquid. In fact, this is one of the reasons that banks use whole life insurance for a good portion of their tier-one capital.
When you wish to access your cash, we recommend using a policy loan to do so. One of the primary benefits to a policy loan is that you can access your capital without interrupting the compounding growth. In other words, because you’re using the life insurance company’s money (backed by your policy as collateral), your account continues to earn interest and dividends at the full amount. With this leverage, you can do whatever you want. You can buy real estate, fund a family retreat, buy the vintage car of your dreams, and so much more.
You can pay the policy loan on your own schedule, providing much-needed flexibility. And as you repay your policy loan, the collateral on your cash value lifts and becomes available to use again. To learn more about how leverage can benefit you, check out this article on the power of leverage.
Types of Whole Life Insurance Explained
When you’re exploring whole life insurance options, you may face some of the choices below. These are key features to note before you apply for a life insurance policy. We’ll go through what they mean, and how to choose the policy and/or company that will best suit your desires.
Direct Recognition vs. Non-Direct Recognition Policies
Direct and non-direct recognition refers to how companies apply dividends to policies that have outstanding policy loans. A direct recognition company “directly recognizes” policies that have outstanding loans, and will pay dividends accordingly. This does not mean that policies with loans do not receive dividends. However, it does mean that the dividend may apply differently to cash value that has a lien against it, versus cash value that does not. This is all dependent on factors including the annual declared dividend, federal interest rates, the interest rates on policy loans, etc. While the exact process is proprietary, direct recognition companies do this to maintain an equal playing field for all policy owners.
Non-direct recognition means that the companies do not apply their dividend differently to policies based on policy loans. The trade-off is that the published dividend is usually a bit lower across the board.
While there are many opinions about direct vs. non-direct recognition companies, the truth is that there is very little difference. Everyone has their preferences, yet don’t let this decision keep you from making any choice at all. If you compare two policies, one direct and one non-direct, over 30 years, you’ll see that the difference is going to be pennies.
Mutual vs. Stock Companies
When you’re researching life insurance companies, you’ll notice that there are two different types of insurance companies. There will be stock companies and mutual insurance companies. If you’re interested in using whole life insurance like a savings vehicle, we recommend choosing a mutual company.
When you choose a mutual company, you participate in the company’s profits in the form of a dividend. This makes your cash value growth much more efficient in the long term.
A stock company, on the other hand, pays profits to stockholders. This also means that the company will make decisions in the best interest of the stockholders, not you, the policyholder.
Policy Riders
When you buy whole life insurance, you may want additional protection. And like most insurance policies, things are more cost-effective when you bundle. Policy riders are sort of like bundling your coverage. These are additional provisions that you pay for that “ride” on your life insurance policy. There are lots of riders, and your life insurance agent can help you determine which ones you might want, based on your lifestyle and desires.
One of the most common riders is the PUA rider. This rider allows you to add PUAs to your base premium each year. If you think you’ll want to contribute above your base premium, this is a good idea. You can also add riders for things like disability insurance, long-term care, and more. Another one we often recommend is a waiver of premium rider. This allows you to “waive” your premium in the event of a disability.
Payment Structure
When you buy a whole life insurance policy, you have some say in how you’ll fund your policy. For example, if you want early cash value growth, you may choose to have a low base premium (your fixed payment) with max PUAs (your optional additional payment). On the other hand, if you’re more interested in having a high death benefit right away, you may choose to have a significantly larger portion of your payment be the “base” premium.
You also have some options on how long you wish to fund your policy. For example, you can choose a 10-pay policy and have a fully paid policy in just 10 years. You can also choose a 99-pay policy and essentially fund it your whole life. There are also options in between. People who want to use their policy as a savings vehicle usually opt for a 99-pay in order to guarantee that they can fund it for their whole life.
MEC Policies
MEC stands for modified-endowment contract. When someone over-funds a whole life insurance policy, the policy becomes a MEC and loses its tax benefits. This provision was written into the tax law in order to prevent people from using whole life insurance as a tax shelter or to launder money.
The parameters for what constitutes a MEC have changed in the last few years, and insurance agents are still learning what those changes mean for new policies. However, insurance companies are extremely diligent in tracking what policies have been over-funded. You can rest assured that if you accidentally MEC a policy, the company will inform you and provide you with options to reverse this.
Is Universal Life Insurance the Same as Whole Life Insurance?
There’s a common misunderstanding that universal life insurance is also a permanent form of life insurance. And because the dividends are correlated to the stock market, people falsely believe they’ll make more money. Unfortunately, no one can get rich on life insurance alone. Everything is a trade-off between cost and risk.
One of the more alluring claims of universal life insurance is that you have flexible premiums. So people believe that they can pay whatever they want. Unfortunately, if you read the contract carefully, you risk under-funding the policy. That’s because as the stock market changes, so does the cost of keeping the policy in force. If you continue to under-fund the policy, even unknowingly, the cash value can implode and you can lose it. And because the cash value is not contractually guaranteed in the same way, this is legal.
Instead, it would be more prudent to choose a fixed premium. That way it’s guaranteed not to increase. You still have the option of paying more via PUAs, yet you’ll always have a fixed payment that won’t change. The policy costs are all baked into your fixed premiums ahead of time, so you won’t ever be blindsided by increased prices/costs.
Whole Life Insurance Benefits and Uses
In addition to being used for income replacement and as a savings vehicle, whole life insurance has many benefits and uses. We’ll go more in-depth into some of the benefits of whole life insurance below.
Emergency AND Opportunity Fund
One of the great things about whole life insurance is that it’s an asset that “does it all.” For example, you don’t have to choose between an emergency fund OR an opportunity fund. You can have both in one account!
You can use a policy loan at any time for any reason, as long as you’ve got the cash. This means that it’s there for you whether you have an emergency expense or an opportunity you want to capitalize on. So rather than splitting your money into different pools—education, retirement, savings—you can do it all in one and have a much larger pool. And as you pay the loans back, the pool replenishes. All the while, that cash value just keeps growing, untouched, because you leveraged the life insurance company’s money.
Tax Advantages
Whole life insurance boasts tax advantages that make owning a policy more efficient. For starters, the death benefit passes to your heirs tax-free. Since there are no income taxes on the death benefit, it’s an excellent tool for generational wealth building. You can learn more about that in Kim’s book, Perpetual Wealth.
On top of that, your cash value grows tax-deferred. However, with a policy loan, you can actually access that money as if it were tax-free. That makes the impact of uninterrupted compound growth even more efficient. Just be aware that if you withdraw funds or default on a loan, you’ll be obligated to pay tax on the gains.
Privacy
Another advantage to whole life insurance is that it’s an incredibly private asset. Your cash value account is protected from the prying eyes of the IRS, creditors, and other institutions that might have an interest in that sum. So on top of the contractual guarantees, you can be sure that money is secure.
And because of this privacy, you don’t have to report it on FASFA forms, either. This can be advantageous since other accounts can count as marks against you when your kids apply for financial aid. When you store your wealth in whole life insurance policies, there’s a chance your kids can qualify for more financial aid, and you can even use the policy to help fund school. You can learn more about this and other education strategies in the book, Busting the College Planning Lies.
Wealth Building
Whole life insurance makes it easy to build a system of family wealth, or what we call a family banking system. It starts by funding a whole life insurance policy, or a system of whole life insurance policies. This becomes a pool of money for the family to access, based on the family’s values. You may decide on these values over time, or host a family retreat to draft a family mission statement.
The family can then use family bank loans to support their endeavors, guided by family principles. It can even be used to build more wealth for the family, by leveraging it for investments, such as real estate. This can even be a segue to involve family members in wealth creation in a hands-on way. You can learn more about family banking in the Perpetual Wealth book.
Is Whole Life Insurance Worth It?
At the end of the day, we believe in whole life insurance. And while it makes an incredible generational wealth builder, it’s also insurance. Simply having a death benefit in place can help you sleep better at night knowing that if you leave this earth, the people you love will still be okay. And that is priceless.
If you’re unsure about whole life insurance, yet you’re interested in having something, try convertible term insurance. You’ll get the protection you want at an affordable rate, with the option to convert to whole life insurance at a later date if you wish. This can help you lock in your insurability while you’re young and healthy, and keep your options open. Then you’ve got some time to learn and ask questions.
Ultimately, insurance can be a fantastic asset to anyone. Yet you’ve got to see and understand how it fits into your personal economy. If we can help you get those questions answered, go ahead and set up a meeting, or shoot us an email at welcome@prosperitythinkers.com.
How to Buy Whole Life Insurance
If you’re ready to buy whole life insurance, we can help! The most important piece is that you find an agent you trust to support you on your journey. Once you do that, you’re ready to start the process.
Generally, you’ll meet with your insurance agent and discuss things like your financial goals, as well as your income and assets. This helps determine how much life insurance you’re entitled to. In the insurance industry, this is called Human Life Value and refers to the maximum amount of insurance a company will allow you to buy. The number is generally a multiple of your income, based on how many years until 65.
While you don’t have to buy enough insurance to cover your HLV, it’s a good number to know. (And you can always supplement a whole life insurance policy with much cheaper term insurance to get as close to your HLV as possible). Once you’ve determined this, you can work with your agent to determine what you actually want to pursue.
The Whole Life Insurance Application
Once you know your number, your agent will give you an illustration. This gives you a rough idea of what you can expect from your insurance policy, including cash value projections. Don’t dwell on this too much, since this is just an illustration.
If you’re ready to move forward, it’s time for the application process. You’ll answer some questions about your health and lifestyle, and provide other personal information. You must also get a physical exam (at no cost to you). This helps the insurance company decide whether to approve your application. It also determines your premiums, if approved. For example, someone with a terminal illness will not get approval, since the risk is too high for the company. On the other hand, someone who smokes but is otherwise in good health can get approved but may pay slightly more.
Once you’re approved, you get to fill out and sign the final paperwork. After you’ve applied, you may still have some questions, be sure to reach out to your agent. This is also the time when you’ll decide whether you want to pay monthly, quarterly, or annually. An annual payment will be the cheapest, however, monthly payments are often easier for people to digest.
What if You Don’t Get Approved for Whole Life Insurance?
If you don’t get approved for a whole life insurance policy, it’s generally because the insurance company has deemed you too “high risk.” This could be for health reasons, or it could be for lifestyle reasons like you work a dangerous career.
If you can’t get the insurance you want, what can you do? There may be some options for you, still. For example, if you’re looking to save money in a whole life insurance policy, insure someone else. You may not be able to get a policy for yourself, yet maybe your spouse, your parents, or even your kids are viable options.
Sometimes, you can’t get whole life insurance for age-related reasons. If you think you’re too old for life insurance, you may want to look into buying an annuity. Annuities are also offered by life insurance companies and are a sort of inverse. You pay a lump sum to the insurance company, and they pay you an income for the rest of your life. This can help you solve for cash flow.
If you’re ready to get started with a whole life insurance policy, we’d be happy to help. Connect with us, or email your questions to welcome@prosperitythinkers.com.
Whole Life Insurance FAQ
How Does a Life Insurance Plan Offer Liquidity?
Life Insurance policies that are Whole Life (and not term life insurance) turn an expense into an asset by building “cash value” inside the policy. This cash is liquid within 7-10 days via a withdrawal or a loan. Many people learn to borrow against this cash, rather than withdrawing it, so that it can keep growing inside the policy as collateral while the owner of the policy is using that cash to solve emergencies or take advantage of opportunities.
What is a Paid-Up Addition (PUA)?
A paid-up addition is extra cash that you can put into your policy that goes to increase cash value and death benefit. The insurance company sends you a letter annually stating the minimum ($250) and the maximum PUA. It’s your choice every year how much you contribute.
On most policies, the minimum PUA is $250, the maximum is whatever is specified by the terms of the policy, usually about equal to the base premium. If your base premium is $10k/year, your maximum PUA will be about $10k a year, or a total of approximately $20k per year for “mid-age” folks. This is dependent on age. (But do pay attention—the allowable paid-up additions will fluctuate as the death benefit rises.)
Since it is the Paid-Up Additions that really super-charge the accounts, remember to aim to fund the maximum contribution rather than the minimum base premiums. Every dollar above the premium becomes a PUA dollar, and it is very advantageous to over-fund your policy up to the MEC limit.
What is the Internal Rate of Return on the Cash Value?
From birth to age 40 to 45, the internal rate of return on your cash value would be approximately 4.0%, according to the 2020 dividend. If you are older, the return decreases since insurance costs are higher, so your cash value is approximately 3.5 to 4% depending on the current year’s dividend. There is not a specific year or cut-off, just a gradual change. Think of this calculation: $100,000 cash at 1% for 20 years = $122,019, but at 4% it will = $219,112 because 1 to 4 is a 300% difference.
Are Dividends Guaranteed?
They aren’t guaranteed to be paid, but once a dividend gets paid, it becomes a part of the guaranteed cash value. That means there is a new floor set every year for your cash value.
What is the Interest Rate on the Loan?
Some companies charge variable rates (currently 5-7%) and some are fixed (6-8%). This interest rate is paid back to the insurance companies annually. You pay back the principal in your own time frame.
If you want to pay a loan back with extra interest, then that “extra” interest goes to your cash value in the form of a PUA (paid-up additions) contribution. Your gross cash value continues to earn the dividend, unaffected by the loan, offsetting the impact of the policy loan interest, but not “netting” it. These are 2 separate accounts, cash value, and loan.
How Safe are Whole Life Insurance Companies?
Mutual insurance companies (owned by their policyholders) have been around since the mid-1800s. Remember, the insurance industry is a 100% legal reserve environment, unlike the banks that operate on fractional reserves. It is also state-regulated.
What is the qualifying exam like?
They will take a blood sample and a urine sample, ask medical questions, and measure your blood pressure, height, and weight. They may want a resting EKG (especially for older clients or higher amounts.) For each new policy, you get a new physical.
Note: They DO contact people’s doctors. Doctors receive a form the client has signed, giving permission for their doctor to send their medical records to the insurance company. This is called the APS, or Attending Physician Statement, and the Doctor’s office is paid for it by the insurance company. This is a non-negotiable requirement.
