What Life Insurance Is
Life Insurance Policies Explained
Hood Life & Financial offers a wide variety of A+ rated and fully customizable insurance policies and retirement income solutions for all of our clients’ needs. Schedule your consultation today to learn what we can do for you.
Whole Life Insurance
Lasts your whole life, Builds cash value, Premiums never increase, Death Benefit never decreases
According to investopedia, whole life insurance, also known as traditional life insurance, provides permanent death benefit coverage for the life of the insured. In addition to paying a death benefit, whole life insurance also contains a savings component in which cash value may accumulate. Interest accrues at a fixed rate and on a tax-deferred basis.
​
Whole life insurance policies are one type of permanent life insurance. Universal life, indexed universal life, and variable universal life are others. Whole life insurance is the original life insurance policy, but whole life does not equal permanent life insurance as there are many types of permanent life.
KEY POINTS
-
Whole life insurance lasts for an insured's lifetime, as opposed to term life insurance, which is for a specific amount of years.
-
Whole life insurance is paid out to a beneficiary or beneficiaries upon the insured's death, provided the policy was in force.
-
Whole life insurance has a cash savings component, which the policy owner can draw or borrow from.
-
The cash value of a whole life policy typically earns a fixed rate of interest.
-
Outstanding loan principal and interest reduce death benefits.
​
How Whole Life Insurance Works
Understanding Whole Life Insurance 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.
To build cash value, a policyholder can remit payments more than the scheduled premium (known as paid-up additions or PUA). Policy dividends can also be reinvested into the cash value and earn interest. The cash value offers a living benefit to the policyholder. Over time, the dividends and interest earned on the policy's cash value will often provide a positive return to investors, growing larger than the total amount of premiums paid into the policy. In essence, it serves as a source of equity.
​
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 tax-free up to the value of total premiums paid. Unpaid loans will reduce the death benefit by the outstanding amount.
​
Withdrawals and unpaid policy loans reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could moreover chip away at the death benefit or even wipe it out altogether. While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others (such as some traditional whole life policies) may reduce the death benefit by an amount greater than what is withdrawn.
Whole life insurance is different from term life insurance, which only provides coverage for a certain number of years, rather than a lifetime, and only pays out a death benefit. Term life does not have a cash savings component.
​
Special Considerations
The death benefit is typically a set amount of the policy contract. Some policies are eligible for dividend payments, and the policyholder may elect to have the dividends purchase additional death benefits, which will increase the amount paid at the time of death. Death proceeds are non-taxable to the beneficiary and are, therefore, not part of taxable gross income.
​
The death benefit can also be affected by certain policy provisions or events. For example, unpaid policy loans, including accrued interest, reduce the death benefit dollar for dollar. Alternatively, many insurers offer voluntary riders—for a fee—that secure or guarantee coverage, including the stated death benefit. For example, two of the most common are the accidental death benefit and waiver of premium riders, which protect the death benefit if the insured becomes disabled or critically or terminally ill and are unable to remit premiums due.
Many policies allow the policyholder to designate that the funds from the policy be held in an account and distributed in allotments rather than as a lump sum. 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 insured, there may be taxes assessed on the proceeds from that sale.
​
Example of Whole Life Insurance
For insurers, the accumulation of cash value reduces their net amount of risk. For example, ABC Insurance issues a $25,000 life insurance policy to S. Smith, the policy owner and insured. Over time, the cash value accumulates to $10,000. Upon Mr. Smith’s death, ABC Insurance 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, it was $15,000.
Most whole life insurance policies have a withdrawal clause, which allows the policyholder to withdraw a portion of the cash value or cancel coverage, receiving a cash surrender value.
​
What Is the Difference Between Whole Life and Term Life Insurance?
As its name suggests, term life insurance provides a death benefit for a specific term (number of years). This type of life insurance, unlike a whole life policy, does not have a saving component. At the end of the term, the policy terminates. Some insurers allow the policyholder to covert their term policy to whole life or renew for a longer term. Whole life insurance is a type of permanent life insurance that provides coverage for the life of the insured. A whole life insurance policyholder can also build cash value in the savings component of the policy.
What Is the Difference Between Universal and Whole Life Insurance?
Universal life insurance and whole life insurance are both permanent life insurance types that offer guaranteed death benefits for the life of the insured. However, a universal life policy allows the policyholder to adjust the death benefit as well as the premiums. As one might expect, higher death benefits require higher premiums. Universal life policyholders can also use their accumulated cash value to pay premiums, provided the balance is sufficient to cover the minimum due. Whole life insurance, alternatively, does not allow for changes to the death benefit or premiums, which are set upon issue.
​
How Much Does Whole Life Insurance Cost?
The cost of whole life insurance varies and is based on several factors, such as age, occupation, and health history. Older applicants typically have higher rates than younger applicants. Insureds with a stellar health history typically have better rates than those with a history of health challenges. The face amount of coverage also determines how much a policyholder will pay; the higher the face amount, the higher the premium. Interestingly, certain companies have higher rates than others, independent of the applicant and their risk profile. It's also worth noting that for the same amount of coverage, whole life insurance is more expensive than term life insurance.
​
Term Life Insurance
Covers you when you need it most
According to Investopedia, when you buy a term life insurance policy, the insurance company determines the premiums based on the policy's value (the payout amount) and your age, gender, and health. In some cases, a medical exam may be required. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, and family history.
​
If you die during the policy term, the insurer will pay the policy's face value to your beneficiaries. This cash benefit—which is, in most cases, not taxable—may be used by beneficiaries to settle your healthcare and funeral costs, consumer debt, or mortgage debt, among other things. However, if the policy expires before your death, there is no payout. You may be able to renew a term policy at its expiration, but the premiums will be recalculated for your age at the time of renewal.
​
Term life policies have no value other than the guaranteed death benefit. There is no savings component as found in a whole life insurance product.
​
Term life is usually the least costly life insurance available because it offers a benefit for a restricted time and provides only a death benefit. For example, a healthy 35-year-old non-smoker can typically obtain a 20-year level-premium policy with a $250,000 face value for $20 to $30 per month.
​
Depending on the issuer, purchasing a whole life equivalent would have significantly higher premiums, possibly $200 to $300 per month, or more. Because most term life insurance policies expire before paying a death benefit, the overall risk to the insurer is lower than that of a permanent life policy. The reduced risk allows insurers to pass cost savings to the customers in the form of lowering premiums.
Interest rates, the financials of the insurance company, and state regulations can also affect premiums. In general, companies often offer better rates at "breakpoint" coverage levels of $100,000, $250,000, $500,000, and $1,000,000.
When you consider the amount of coverage you can get for your premium dollars, term life insurance tends to be the least expensive option for life insurance.
​
Example of Term Life Insurance
Thirty-year-old George wants to protect his family in the unlikely event of his early death. He buys a $500,000 10-year term life insurance policy with a premium of $50 per month. If George dies within the 10-year term, the policy will pay George’s beneficiary $500,000. If he dies after he turns 40, when the policy has expired, his beneficiary will receive no benefit. If he renews the policy, the premiums will be higher than his initial policy because they will be based on his age of 40 instead of age 30.
​
If George is diagnosed with a terminal illness during the first policy term, he likely will not be eligible to renew once that policy expires. Some policies do offer guaranteed re-insurability (without proof of insurability), but such features, when available, tend to make the policy cost more.
​
Types of Term Life Insurance
There are several different types of term life insurance; the best option will depend on your individual circumstances.
​
Level Term, or Level-Premium, Policies
These provide coverage for a specified period ranging from 10 to 30 years. Both the death benefit and premium are fixed. Because actuaries must account for the increasing costs of insurance over the life of the policy's effectiveness, the premium is comparatively higher than yearly renewable term life insurance.
​
Decreasing Term Policies
These policies have a death benefit that declines each year, according to a predetermined schedule. The policyholder pays a fixed, level premium for the duration of the policy. Decreasing term policies are often used in concert with a mortgage to match the coverage with the declining principal of the home loan.
​
Benefits of Term Life Insurance
Term life insurance is attractive to young people with children. Parents may obtain large amounts of coverage for reasonably low costs. Upon the death of a parent, the significant benefit can replace lost income.
These policies are also well-suited for people who temporarily need specific amounts of life insurance. For example, the policyholder may calculate that by the time the policy expires, their survivors will no longer need extra financial protection or will have accumulated enough liquid assets to self-insure.
​
Term Life Insurance vs. Permanent Life Insurance
The main differences between a term life insurance policy and a permanent insurance policy, such as universal life insurance, are the duration of the policy, the accumulation of a cash value, and the cost. The right choice for you will depend on your needs; here are some things to consider.
​
Cost of Premiums
Term life policies are ideal for people who want substantial coverage at low costs. Customers who own whole life insurance pay more in premiums for less coverage but have the security of knowing they are protected for life.
While many buyers favor the affordability of term life, they are paying premiums for an extended period, and having no benefit after the term's expiration is an unattractive feature. Upon renewal, term life insurance premiums increase with age and may become cost-prohibitive over time. Renewal term life premiums may be more expensive than permanent life insurance premiums would have been at the issue of the original term life policy.
​
What Is the Difference Between Term Life and Whole Life Insurance?
Term life insurance occurs over a predetermined period of time, typically between 10 and 30 years. Term policies may be renewed after they end, with premiums recalculated according to the holder’s age, life expectancy, and health. By contrast, whole life insurance covers the entire life of the holder. Unlike a term life policy, whole life insurance includes a savings component, where the cash value of the contract accumulates for the holder. Here, the holder can withdraw or borrow against the savings portion of their policy, where it can serve as a source of equity.
​
Do You Get Your Money Back at the End of a Term Life Insurance Policy?
There are policies that guarantee a Return Of Premium at the end of the term, however these are actually Universal Life policies (see Universal Life). A term life insurance policy holder will not have their money returned once a term life insurance policy expires, if they outlive the policy. Meanwhile, whole life insurance premiums may cost as much as 10 times more by comparison. This is because the risk to the insurer is much lower with term life policies.
Universal Life Insurance
Flexible premiums, Pays tax-deferred interest, Supplements retirement
Acoording to investopedia, UL insurance option provides more flexibility than whole life insurance. Policyholders can adjust their premiums and death benefits. UL insurance premiums consist of two components: a cost of insurance (COI) amount and a saving component, known as the cash value.
​
As the name implies, the COI is the minimum amount of a premium payment required to keep the policy active. It consists of several items rolled together into one payment. COI includes the charges for mortality, policy administration, and other directly associated expenses to keeping the policy in force. COI will vary by policy based on the policyholder’s age, insurability, and the insured risk amount.
​
Collected premiums in excess of the cost of UL insurance accumulate within the cash value portion of the policy. Over time the cost of insurance will increase as the insured ages. However, if sufficient, the accumulated cash value will cover the increases in the COI.
​
Advantages and Disadvantages of Universal Life (UL) Insurance
Much like a savings account, a UL insurance policy can accumulate cash value. In a UL insurance policy, the cash value earns interest based on the current market or minimum interest rate, whichever is greater. As cash value accumulates, policyholders may access a portion of the cash value without affecting the guaranteed death benefit. However, the withdrawals will be taxed.
​
Also, depending on when the policy and premium payments are made, earnings will be available as either last in, first out (LIFO) or first in, first out (FIFO) funds. Upon the death of the insured, the insurance company will retain any remaining cash value, with beneficiaries only receiving the policy’s death benefit.
​
Universal life policyholders may borrow against the accumulated cash value without tax implications. However, if they do, interest will be calculated on the loan amount, and there will be a cash surrender fee. Unpaid loans will reduce the death benefit by the outstanding amount, with unpaid interest on the loan deducted from the remaining cash value.
​
Unlike whole life insurance policies, which have fixed premiums over the life of the policy, a UL insurance policy can have flexible premiums. Policyholders can make payments that are more than the COI. The excess premium is added to the cash value and accumulates interest. If there is enough cash value, policyholders may skip payments without the threat of a policy lapse.
​
That said, policyholders must be attentive to the rising cost of insurance as they age. Depending on the credited interest, there may not be enough cash value to keep the policy in force, thus requiring them to pay higher premiums. Missed payments must be paid within a specific time frame for the policy to remain in force.
​
Pros
-
You may borrow from your cash value.
-
Lasts your lifetime
-
Provides both a death benefit and a cash value account
Cons
-
Withdrawals of cash value component are taxed.
-
When a policy holder dies, the company keeps the account's cash value.
-
You must pay back a policy loan with interest.
Universal Life Insurance vs. Term Life Insurance vs. Whole Life insurance
Universal life, a form of permanent life insurance provides policyholders with flexibility on paying premiums, a cash savings component, and a death benefit. Premium costs may change with interest rates and as the policyholder grows older.
​
Universal life insurance allows you to borrow against or cash in their savings portion, which grows, tax-deferred over your lifetime. Term life provides coverage, often through an employer, for a set number of years, generally, 20 or 30, and expires once the term is up. Term life is usually affordable, with low premiums, but there is not a cash component to borrow from or cash in, and the death benefit is null and void if you die after the term is up.
​
Whole life insurance is also a form of permanent life insurance, with a cash value savings component. Another important difference between universal and whole life insurance is that universal life insurance has more flexibility in where you can invest your policy's cash value account. Whole life insurance premiums are locked in for the life of the policy, whereas universal premiums are flexible.
​
What Is Universal Life Insurance and How Does It Work?
UL insurance policies are a form of permanent life insurance with flexible premiums. Unlike term life, can accumulate interest-bearing funds like a savings account. Also, policyholders can adjust their premiums and death benefits, and holders paying extra toward their premium receive interest on that excess.
​
What Is the Disadvantage of Universal Life Insurance?
A big disadvantage is that holders must keep their eyes on fees. They will be taxed on cash withdrawals, and interest is charged on loans. Holders should also pay attention to rising premiums as they age because there's a chance enough cash may not be available to keep the policy active, and the holder will be forced to pay higher premiums.
​
Which Is Better Whole Life or Universal?
Both whole life and universal life are forms of permanent life insurance and provide a cash value savings component that policyholders may borrow from or cash out. Whole life offers fixed premiums, universal premiums, may start out lower, but they are flexible and may increase as you age. Depending on the amount of coverage and flexibility you want in a permanent policy, either form may be a good choice, depending on your situation.
​
What Is the Difference Between Universal Life Insurance and Whole Life Insurance?
Whole life insurance is more stable because the death benefit will never go down if you pay your premiums, which are fixed monthly amounts. Universal life insurance offers more flexibility, but your death benefit is not guaranteed. If you borrow too much against the policy, the benefit will decrease, but you can design your coverage for many years or your lifetime. You can increase or decrease your death benefit and the amount you spend on premiums.
​
Can I Cash Out My Universal Life Insurance Policy?
You can sell your universal life insurance policy, or you can liquidate the cash value component and cancel the policy, but you will have to pay a surrender fee.