WHOLE LIFE INSURANCE

This type of insurance policy covers the insured’s whole life, thus the name “whole life” insurance. Whole life not only offers a death benefit, but it also offers a cash value feature. This cash value is the result of the investment of paid-in insurance premiums. Therefore, the insured also earns a modest return on the premiums paid for the insurance policy. The rate at which the cash value grows is usually fixed, but is generally guaranteed to be more than a set minimum interest rate (i.e. four or five percent). The longer the policy owner pays the premiums and keeps the coverage, the more time the cash value has to appreciate, which results in a larger cash value over time. But what if you decide that you don’t need the insurance coverage? Does that mean that you no longer have access to your cash value? No. If you decide that you want to cancel your whole life policy, you are forfeiting the right to a death benefit when you die. However, because of that forfeiture, the insurance company is obliged to give you the cash value from your policy. Insurance companies put aside assets in anticipation of paying off life insurance claims. As time passes, the amount of money set aside for each insured (the cash value of each policy) increases to reflect the increase in paying off claims. After all, the chance of death increases with the age of the policyholder. As long as the policy is canceled prior to the death of the insured, the insurance company must return the cash value. Since the insurance company is holding and accumulating that money to pay off the insured’s future death claim, the company no longer requires that money once the policy is canceled.

There are a wide variety of types of whole life policies, but we only touch on three main types: continuous-premium, single-premium, and limited-payment.

Continuous-Premium Whole Life

This type of policy is the most common because the policyholder pays premiums throughout either the lifetime of the policy or his or her own lifetime. Continuous-premium whole life is also referred to as a “straight life” policy since you pay straight through your life. The premiums remain level as long as the policy is in force. Therefore, the younger you are when you purchase a straight life policy, the lower your premiums will be. However, the younger you are when you purchase a policy, the more you will usually wind up paying as a whole since you will be paying for coverage for a longer period of time. But your annual premium will be less than it would be if you were to wait until you were older to purchase a policy.

A person should buy life insurance because there is some type of need, not just because the premium would be lower if the policy was purchased at age 25, rather than at age 40. Generally, for younger people, permanent life insurance isn’t as important as other things may be. I generally recommend that younger people direct their money into retirement accounts rather than insurance, unless there is an actual need for it.

As compared with other types of whole life policies, straight life offers the greatest amount of permanent death protection, but the least amount of savings per dollar of premium paid. For most people, especially families, straight life is the best choice for permanent insurance coverage because the emphasis is on the death benefit, not the savings feature.

Many people may think that once you start paying the premiums for a straight life policy, then you are stuck unless you cancel the policy. That’s not necessarily true. Once a policy has accumulated some cash value, if you want, you can “trade in” the policy for another, paid-up policy that has a lower death benefit. As long as your policy has a change-of-premium provision, you can do this at no cost.

Single-Premium Whole Life

As the name implies, a single-premium life policy is paid for at its inception with one premium. The policy is then in force for the rest of the insured’s life, unless it is otherwise canceled by the insured. The single-premium policy (SPWL) is, as a rule, not well suited for younger people and young families. Because of its investment attributes, the SPWL is appealing to those people looking for a taxsheltered investment vehicle.

As with other types of cash-value policies, the earnings and interest of an SPWL accumulate on a tax-deferred basis. While the policy also provides life insurance coverage and will pay a death benefit upon the insured’s death, the amount of the coverage is usually the minimum allowed under the IRS’s rules. Generally, the death benefit is treated as an added bonus to those who purchase this type of coverage. As with other types of policies, the death benefits will pass through to the beneficiaries on a tax-free basis. Minimum premiums are usually $5000, but most people put in more, thus garnering a larger amount of tax-deferred earnings.

While this type of policy sounds great, it’s not without a catch. If you needed to take a loan from your policy, or just make a withdrawal, and you are younger than 591/2, you will be penalized by the IRS. First of all, the money withdrawn will be treated as a gain, not a return of your original premium. Therefore, it will be taxed as income. Secondly, you will face a 10-percent early withdrawal penalty because you aren’t 591/2 years old yet. These are the main reasons the SPWL isn’t suited for younger people and young families. Instead, the SPWL is more appropriate for middle-aged people with higher incomes who may want to supplement their retirement income or cover future, potential estate costs.

Limited-Payment Whole Life

Limited-payment policies also cover the insured throughout his or her entire life. But, they are a split between the single-premium and continuous-payment whole life policies. Limited-payment policies are designed to have the insured stop paying the premium after a certain period of time. Common types of policies are 20-pay life, 30-pay life, paid-up at age 55, and paid-up at age 65. This is the way it works: Under the 20-pay and 30-pay life policies, the policyholder pays the same level premium for the 20 or 30 years, depending on the policy type. After that time period elapses, the policy is paid up and the insured owes no more money in the way of premiums. For the paid-up at age 55 and paid-up at age 65 policies, the policyholder pays the premiums until that person is either 55 or 65. Again, the policy is then fully paid for. Naturally, the older the insured is when he or she takes out the policy, the larger the premiums will be, especially when choosing the paid-up at a specific age policies. Once the policies are paid for, they remain in force for the rest of the insured’s life.

Beware of salespeople who try and sell you a limited-payment policy using the following two arguments: a large savings element, and limited payment time. The aim of life insurance is to provide financially for the beneficiaries of a deceased person. They take care of the financial loss that occurs when someone dies. They aren’t specifically designed for an accumulation of savings. Plus, as we discussed earlier, those people who elect to purchase a straight life policy only need to pay the premiums for as long as they want to. As long as there is a cash value, those straight life policies may be converted into paid-up policies with a smaller death benefit, thus negating the limited payment argument.

Limited-payment insurance policies are a good deal for certain people. But, when faced with a choice between a limited-payment policy and a straight life policy, chances are the straight life policy will be a better fit. Again, it’s always important that you are purchasing insurance because you need it, not just for a tax-deferred investment. There are other types of tax-deferred investments that offer better rates of return that will suit your needs better than an insurance policy.