What is life insurance? Life insurance is a way to financially protect families if a wage earner, business owner, or caretaker dies prematurely. Upon the death of the insured person, the insurance company pays a death benefit to help families cover the mortgage, monthly credit card and daily expenses, college tuition, funeral or medical bills, and other living costs. More specifically, whole life insurance is a type of permanent coverage that cannot be cancelled by your carrier, regardless of the insured person’s health or age, and does not require the insured person to ever renew the policy or reapply for life insurance. This means that applying for whole life insurance early guarantees the insured will lock in the cheapest and best rates for a lifetime, meanwhile allowing them to utilize whole life insurance as an investment to build cash value/equity in the policy and protect their family.
All whole life policies are permanent and have a savings feature that builds cash value over time. A portion of the premiums paid into the policy are diverted to an account which pays interest, usually at a rate that is specified in your documentation. This rate can vary between providers and should be considered when comparing different plans, since a small percentage point difference can result in increased funds for retirement. Policyholders can also cancel the policy and draw out the cash value, or take out low interest loans against their equity in the policy. Since whole life insurance is considered a financial instrument, policies can be used in long term financial or retirement planning, especially when accruing a nest egg for retirement purposes. Overall, whole life insurance as an investment is a very good one, combining stable, moderate returns as well as life insurance coverage. However, we suggest that you supplement whole policies with term life insurance, since buying the full coverage you need with permanent life insurance will prove very expensive and costly.
How Rates Are Calculated
Premiums for all life insurance policies are based on the age, health, habits, and lifestyle of the insured person at the time the life insurance is purchased, and averaged over the time the policy is in effect. In the case of whole life insurance, this means spreading out the cost over the expected life span of the insured person. Standard whole life policies have fixed premiums that do not increase as the insured person ages. Whole life insurance rates paid by a 20-year-old man will be the same amount when he is 50 or 60, and the policy cannot be cancelled except for non-payment. Because whole life insurance does not have to be renewed or applied for again and rates are fixed are an important component when evaluating the pros and cons of life insurance.
Fixed Death Benefit
Not all permanent life insurance policies have fixed death benefits, but death benefits are based on the face value of the policy and never decrease. The face value of whole life insurance is the amount of money you decide to be insured for. Many potential policyholders opt for about 5 to 10 times their annual salary, depending on their mortgage, credit card bills, debts, business loans, children’s college tuition costs, number of dependents, final and medical expenses, and take into account other assets, such as investments, 401K, pensions, and IRA accounts.
A basic example is that a family lives off of $50,000 per year. If you want to provide your family with at least 10 years of security, then you may consider a $500,000 policy; however, what about your mortgage or children’s education funds? You may owe $250,000 on your home, and tuition for your 2 children could amount to $100,000, so you choose a policy worth $850,000. But wait, you already have $150,000 in savings, 401K, and IRA accounts, so the total face value of your life insurance policy may be $700,000. Instead of choosing whole life coverage for that amount, we recommend you divide up the protection between multiple policies, and get a $100,000 or $200,000 whole life policy, while opting for a $500,000 or $600,000 term life policy. The amount of protection you choose for your beneficiaries really depends on your budget and financial needs.
If a policyholder uses the cash value as collateral for a loan, the amount of the loan is deducted from the death benefit if the insured person dies before the loan is repaid. If there are no loans, the full face value is paid when the insured person dies. The company retains the cash value of the policy if the death benefit is paid.
Applying For Life Insurance
The application for all life insurance policies is basically the same, and focused on personal questions such as name, address, age, smoker vs. nonsmoker, alcohol consumption, exercise, lifestyle choices and medical history or pre-existing conditions. All questions on the application must be answered truthfully and completely. Although whole life insurance is permanent, the insurance company can void the policy if the applicant fails to report information of a nature that would have caused the company to deny issuance in the beginning. This is called a material misrepresentation or insurance fraud, and it allows the carrier to nullify the policy and refund any premiums that were paid, effectively ending your coverage.
Most life insurance companies require a physical examination by a doctor that works for the insurer. Individuals who choose to buy whole life insurance will have one medical exam when they apply for the policy. No further exams are required since the policy cannot be cancelled for health reasons once it is in effect. With temporary life insurance policies or term life insurance, the insured person must submit to a physical exam every time the policy is renewed.
Limited payment life insurance is a type of whole life policy that allows the insured person to pay all the premiums in a specified period, perhaps 20 years. After all the premiums have been paid, the policy remains in effect for the rest of the insured person’s life. Because the premiums are paid over a shorter period, a policyholder’s rates are usually higher than those for standard whole life policies. There are advantages to limited payment life policies, especially for individuals whose income will decrease after retirement.
Another form of permanent coverage, single premium life insurance policies are paid in full at the inception of the policy. All of the premiums that would be due on the policy over time are condensed into a single lump sum. Part of the sum is invested in the whole life policy’s savings feature and the rest is used for the costs of administering the policy. A single premium life insurance policy is usually used as an estate-planning instrument for affluent individuals since it has tax advantages over other types of investments.
Although there are no income taxes on death benefits, whole life insurance has tax advantages as an investment vehicle. Dividends and interest payments on the cash value are tax-deferred until they are removed or withdrawn from the life insurance policy. Loans against the cash value do not count as income for tax purposes since they must be repaid. There are no timetables for the repayment of loans on the cash value so the money can be used, tax free, during the insured person’s lifetime.
The tax advantages of whole life insurance make it an ideal financial instrument for saving for college expenses, an inheritance, gift or retirement. A whole life policy for an infant has very affordable life insurance rates and will increase in value as the child grows. The cash value of the policy can be used to pay for college expenses, or the child can choose to take out a loan against the policy and pay guaranteed low cost premiums for the rest of his or her life. Loans against whole insurance can also be used to finance retirement.
While price is always a consideration, cheap term life insurance policies cost more than people realize. Since premiums are fixed and increase upon renewal, over a lifetime, the costs of whole and term life insurance are about the same. Whole life insurance has a cash value that returns some of the premium dollars to the policyholder. When the tax advantages are considered, whole life may represent a better value for some families over cheaper life insurance policies that offer no return on payments. Readers can learn more about term vs. whole life insurance by comparing the pros and cons of each type of coverage.
Life insurance not only provides protection for an insured person’s family should the person die prematurely, but whole life insurance also offers an excellent opportunity for investing in the future. Whole life protection is more than insurance; it is a tax-free savings plan that can help families build financial stability for the future.