What it means
Whole life sits at the opposite end of the spectrum from term insurance, which covers a set number of years and pays nothing if you outlive it. Because a whole life policy pays out whenever death occurs, the insurer prices it so that the premiums, plus investment returns, will fund the benefit.
The premium is usually level, meaning it stays the same for life. The cash value is the feature that sets it apart.
In the early years most of the premium goes to cover costs and insurance, but over time the cash value grows at a rate set by the insurer. The policyholder can borrow against it or surrender the policy and receive the cash value, though surrender charges may apply in the first years.
Some policies are described as participating, which means the policyholder may receive dividends when the insurer performs better than expected. Dividends are not guaranteed, and they can be taken in cash, used to reduce premiums or used to buy extra cover.
Non-participating policies have no dividends but may have lower premiums. In a business context, whole life is used for key person cover, funding buy-sell agreements between partners, and executive benefit plans.
The company usually owns the policy, pays the premiums and shows the cash value as an asset on its balance sheet. Finance teams should record the premium net of any increase in cash value.
Whole life is not always the best fit. Because the premiums are much higher than term cover for the same death benefit, many advisers suggest it for people with a lifelong need, such as providing for a dependant with special needs or covering an estate tax bill.
Anyone considering it should compare the guaranteed returns, the fees and the alternatives before signing. Finally, the policy is a long contract with a financial institution, so the strength of the insurer matters.
Check its financial strength rating and understand how the cash value is credited. Ask for an illustration of guaranteed values and not just projected values.
In practice
Real-world examples.
Example
A 35-year-old founder buys a whole life policy to make sure her family is protected whenever she dies. She pays the same premium for 30 years and later borrows from the cash value to help fund a business expansion.
Example
Two partners in a design studio each take out a whole life policy on the other. If one partner dies, the proceeds fund the purchase of the deceased partner's share without selling the firm to an outsider.
Example
A mid-sized company buys whole life policies on its senior executives as part of a deferred compensation plan. The cash value builds up on the balance sheet and can be used to help pay benefits when the executives retire.
Formula
Calculation
Net cost of the policy = total premiums paid - cash value at the end of the period (ignoring dividends and the time value of money)
Suppose a policy with a $500,000 death benefit has an annual premium of $6,000. After 10 years the total premiums paid are 6,000 x 10 = $60,000. If the cash value is then $48,000, the net cost = 60,000 - 48,000 = $12,000, which is 12,000 / 10 = $1,200 per year for $500,000 of cover.Case study
Seen in the real world.
Marlowe Engineering is an illustrative, fictional company with two founders. They agreed that if either died, the survivor would buy the other's 50% stake from the estate at an agreed value of $2,000,000.
To fund this, the company bought a $2,000,000 whole life policy on each founder at an annual premium of $22,000 each. After 12 years the company had paid 22,000 x 12 = $264,000 per policy, and each policy had a cash value of about $230,000.
When one founder died unexpectedly, the insurer paid $2,000,000 and the survivor bought the stake without borrowing. The illustrative lesson is that the permanent cover and the cash value gave certainty, but the premiums were a long-term commitment that had to be budgeted for every year.
Watch out
Common mistakes.
- Treating whole life as a pure investment, when a large part of the early premiums pays for insurance and costs.
- Assuming projected dividends are guaranteed, when only the contractual values in the policy are guaranteed.
- Surrendering the policy early without checking charges, which can leave the policyholder with less cash than the premiums paid.
Questions
People also ask.
How is whole life different from term life?
Term life covers a fixed period at a lower cost and builds no cash value, while whole life covers you for life and builds cash value.
Can I borrow against a whole life policy?
Yes, most policies allow loans against the cash value, but unpaid loans and interest reduce the death benefit and may cause the policy to lapse.
Are whole life premiums fixed?
In most policies the premium is level for life, although the actual cost to the policyholder depends on dividends and charges.
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