This type of permanent life insurance covers the entire insured’s entire lifetime on the condition that all premiums are paid. Unlike term life insurance, whole life insurance offers a death benefit to beneficiaries upon the policyholder’s death. Furthermore, it also includes a cash value consideration that accumulates during the policyholder’s lifetime. If you wonder how does whole life insurance work, we dive deep into this guide:
How Does Whole Life Insurance Work?
1. Coverage and Premiums
When purchasing a whole life insurance policy, you largely control its coverage and the premiums you will pay. The amount you would wish to be covered is referred to as the death benefit. The death benefit will be paid to your beneficiaries upon your demise.
When you consider taking whole life insurance, expect your premiums to be higher than those for term life insurance. The simple reason is; these premiums are designed to cover your entire lifetime as the policyholder. These premiums are payable for a specified period or in your life.
Whole life insurance whose premiums are payable for a specific period, is a limited payment whole life. Whole life insurance, whose premiums are payable throughout your lifetime, is an ordinary whole life.
The death benefit payable to your beneficiaries is typically tax-free. Your loved ones who will receive this lump sum from an insurer can use it to cover your funeral costs, pay off your outstanding debts, and finish paying off your mortgage payments, among others.
You should note that the amount recognized as a death benefit is constant throughout your life. If you wish to increase the death benefit payable to your beneficiaries, you can increase it before your demise.
Whole life insurance also allows you to enjoy a cash value accumulation. This feature of whole life insurance forces your insurer to allocate a part of the premiums into a cash value account. Your insurer can invest these amounts as you have authorized them. From the return on their investment, you can share based on a guaranteed minimum interest rate and potential dividends.
Dividends emanate from participating policies. These dividends are not guaranteed, as they are just a portion of the insurance company’s profits. If you receive these dividends, you can get them as cash, continue accumulating them in your cash value account or even use them for premiums payments. Some policyholders may opt to buy extra coverage to increase the death benefit.
The death benefit is guaranteed, provided you pay all your premiums.
2. Using the Cash Value
As a policyholder, you can access your life insurance policy’s cash value in several ways. One, you can withdraw the amount. Such withdrawals are taxable and could reduce the death benefit. You can also choose to take out loans against this cash value.
You can repay or deduct this loan from the repayable death benefit. Cash-value loans have lower interest rates compared to regular types of loans.
When you take a loan against your cash value, the cash value automatically becomes the collateral. Such loans are limited to a certain percentage of the accumulated cash value dictated by your insurer. These loans are quite flexible because you can repay on your terms. However, outstanding balances to such loans are deducted from the death benefit upon your death before full loan repayment.
What Happens When You Cancel Whole Life Insurance Policy?
Non-forfeiture options are effected if you wish to cancel or surrender whole life insurance. The most common non-forfeiture option is the cash surrender value. This will allow you to receive the accumulated cash value less any applicable fees and surrender charges.
Before buying a whole life insurance policy, carefully evaluate your financial goals. Consider factors such as the coverage amount, how comfortable you can afford the premium, the potential of your cash value to grow, and other policy-related factors. If needed, consult a certified financial advisor or insurance professional to help you make an informed decision based on your circumstances.