Whole life insurance, also called traditional life insurance, gives the insured a death benefit that lasts as long as they live. Whole life insurance not only pays out a death benefit but also has a savings part where cash value can build up. Interest builds up at a fixed rate and is not taxed right away.
Permanent life insurance includes whole life insurance policies. There are also universal life, indexed universal life, and variable universal life. Whole life insurance was the first type of life insurance, but it is not the same as permanent life insurance because there are different kinds of permanent life.
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How to Make Sense of Whole Life Insurance
Whole life insurance guarantees the beneficiaries will get a death benefit if the policyholder dies. In exchange, the policyholder pays a level, regularly due premium. Along with the death benefit, the policy has a savings part called the “cash value.” In the savings part, interest can build up without being taxed. A crucial part of life insurance is that the cash value grows over time.
A policyholder can pay more than the scheduled premium to build cash value (known as paid-up additions or PUA). Dividends from a policy can also be put back into the cash value, where they earn interest. The cash value gives the policyholder a benefit that keeps on giving. Over time, dividends and interest earned on the policy’s cash value usually give investors a return more significant than the total premiums paid into the policy. In the end, it is a source of fairness.
Policyholders can ask for a withdrawal or a loan to get to their cash reserves. Loans come with interest, and the rates vary from insurer to insurer. Also, the owner can take out money without paying taxes up to the premiums’ value. The unpaid loan amount will be taken out of the death benefit.
Withdrawals and unpaid policy loans lower the cash value of the policy. Depending on the type of policy and how much cash value is still in it. A withdrawal could cut into the death benefit or even wipe it out completely. Some policies reduce the death benefit by the same amount as what is taken out. Other policies, like traditional whole-life policies, may reduce the death benefit by more than what is taken out.
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Things to think about Whole Life Insurance
Most of the time, the death benefit is a set amount in the policy contract. Some policies can pay dividends, and the policyholder can use the dividends to buy more death benefits, increasing the amount that will be paid out when the policyholder dies. The beneficiary does not have to pay taxes on the death proceeds, so they are not counted as taxable gross income.
Some policy rules or events can also change the death benefit amount. For instance, unpaid policy loans, including interest, lower the death benefit by the same amount. On the other hand, many insurers offer optional riders that, for a fee, guarantee or secure coverage, including the stated death benefit. For example, the accidental death benefit and the waiver of premium riders are two of the most common. These riders protect the death benefit if the insured becomes disabled or seriously or terminally ill and can’t pay the premiums.
In many policies, the policyholder can choose to have the money from the policy held in an account and given out over time instead of all at once. Any interest on the holding account will be taxed, and the beneficiary must report it. Also, if the insurance policy was sold before the insured person died, the money from the sale may have to be taxed.
As with any permanent policy, it’s essential to do a lot of research on the insurance companies you’re thinking about to ensure they’re among the best whole life insurance companies currently in business.
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Whole life insurance: a case
For insurers, the more cash value they have, the less net risk they have. For example, ABC Insurance gives S. Smith, the owner of the policy and the insured person, a $25,000 life insurance policy. The cash value adds up to $10,000 over time.
ABC Insurance will pay Mr. Smith’s total $25,000 death benefit when he dies. However, the company will only realize a loss of $15,000 due to the $10,000 accumulated cash value. The net amount at risk was $25,000, but it was only $15,000 when the insured person died.
How Whole Life Insurance Works
Two primary varieties of whole life insurance exist, each with its premium structure and method for allocating policy risk.
- Single Premium: This type of whole life insurance is the most basic. The insured pays a fixed premium, which continues to grow as cash value and protects them as long as premiums are paid.
- Limited Payment: This kind of policy has higher premiums in the beginning and lower or no premiums in the end.
This type of whole life insurance is the opposite of a limited payment policy because the premiums are lower at the beginning of the policy’s life.
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