Whole Life Insurance

What is 'Whole Life Insurance'

Whole life insurance provides coverage for the life of the insured. In addition to providing a death benefit, whole life also contains a savings component where cash value may accumulate. These policies are also known as permanent or traditional life insurance. 

BREAKING DOWN 'Whole Life Insurance'

The most common of life insurance products, 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 component of whole life insurance.

Whole Life Cash Value

To build cash value, a policyholder can remit payments more than the scheduled premium.  Additionally, dividends can be reinvested into the cash value and earn interest. The cash value offers a living benefit to the policyholder. In essence, the cash value serves as a source of equity for the policyholder. 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 up to the value of total premiums paid tax-free. Loans which are unpaid, the loan will reduce the death benefit by the outstanding amount.  Withdrawals reduce the cash value but not the death benefit. 

For the insurer, the accumulation of cash value reduces their net amount of risk. For example, ABC Insurance Company issues a $25,000 life insurance policy to S. Smith, the policy owner and the insured. Over time, the cash value accumulates to $10,000. Upon Mr. Smith's death, the insurance company will pay the full death benefit of $25,000. However, the company will only realize a loss of $15,000, due to the $10,000 accumulated cash value. The net amount of risk at issue was $25,000 but at the death of the insured was $15,000. 

Death Benefit of Whole Life Insurance

The death benefit of a whole life insurance policy is typically a set amount of the policy contract. Some policies are eligible for dividend payments. In this case, the policyholder may elect to have the dividends purchase additional death benefits, which will increase the death benefit at the time of death. Alternatively, unpaid outstanding loans taken against the cash value will reduce the death benefit. Many insurers offer riders that protect the death benefit in the event the insured becomes disabled or becomes critically or terminally ill. Typical riders include an accidental death benefit and waiver of premium riders.

The named beneficiaries do not have to add money received from a death benefit to their gross income. However, sometimes the owner may designate the funds from the policy be held in an account and distributed in allotments. 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 owner, there may be taxes assessed on the proceeds from that sell.

History of Whole Life Insurance

From 1940 to 1970, whole life insurance was the most popular insurance product. Policies secured income for families in the event of the untimely death of the insured and helped subsidize retirement planning. After the passing of the Tax Equity and Fiscal Responsibility Act (TEFRA) in 1981, many banks and insurance companies became more interest sensitive. Individuals weighed the benefits of purchasing whole life insurance against investing in the stock market where return rates were, at the time, between 10 and 12%. The majority of individuals, at that time, began investing in the stock market and term life insurance.