How Whole Life Insurance Works

In this article we will be talking about how Whole Life Insurance Works according to Nerd wallet.

If you want life insurance that won’t expire within a few years or decades, consider a whole life insurance policy. It’s the most common form of permanent life insurance, but it’s expensive so it isn’t right for everyone.

To find out if you’re a good candidate for this type of coverage, learn how whole life insurance works and the policy features to look for.

What is whole life insurance?
Whole life insurance is a type of permanent life insurance that typically offers lifelong coverage and level premiums, which means you’ll pay the same amount each month.

Along with offering life insurance coverage, these policies become a cash asset over time. When you pay your premium, a portion is allocated to your policy’s cash value, which grows at a fixed rate set by your insurer — typically 1% to 3.5%, according to Quotacy, a brokerage firm. This sets whole life insurance apart from other permanent policies, which don’t guarantee returns.

Once you’ve accumulated enough cash value, you can start taking out loans against your policy. And when you die, your beneficiaries will typically receive a payout that isn’t subject to income tax.

If you have a whole life policy with a mutual life insurer, you might be eligible for dividends each year based on the company’s financial performance. You can choose to receive the dividend in cash, or use the funds to reduce your premium, repay cash value loans or buy additional coverage. Some insurers also allow you to leave the dividend amount with them to accumulate interest, though you’ll be taxed when you eventually withdraw the money.

How much does whole life insurance cost?

In general, whole life insurance is more expensive than term life insurance. This is because it usually lasts your entire life and offers cash value growth, plus commission fees might be rolled into your total cost if you purchased the policy through a life insurance agent.

For a healthy applicant buying a $500,000 policy at 40 years old, the annual cost of whole life insurance is $6,997, compared with $335 for a 20-year term life policy. But whole life can be a good fit if you need lifelong coverage and want a guaranteed return on the policy’s cash value.

Is whole life insurance worth it?
Whole life insurance might be a good fit for you if:

  • You can comfortably afford the higher premiums.
  • You’re a high-income earner who’s maxed out your investment accounts, like 401(k)s.
  • You want to treat your life insurance policy as a cash asset.
  • You have a lifelong dependent, such as a child with special needs.
  • You’re looking for a policy that offers guaranteed returns on cash value.
  • You’re a wealthy individual who wants your life insurance policy to help your heirs pay estate taxes.

How to find the right whole life insurance policy

A whole life insurance policy is a pricey commitment, so make sure you research and compare policies before buying.

Choose the amount of coverage you need
To find out how much life insurance you need, first decide what you want the policy to accomplish. A relatively small policy — $10,000, for example — may pay for a funeral. But you’ll need more if you have additional priorities, such as funding a trust for a child.

Examine riders
Life insurance riders are coverage features you can add to a life insurance policy. Depending on the policy, they’re either included in the coverage or can be purchased at an extra cost. Examples include an accelerated death benefit or chronic illness rider, which lets you access some of the death benefit if you develop a chronic health condition or become terminally ill. Another add-on to consider is a waiver of premium rider, which lets you skip payments if you become disabled.

Available types and costs of riders vary by insurance company, so make sure your policy has the riders you want before you buy.

Look at the rate of return on cash value
With whole life insurance, a portion of your premium is added to your cash value, which typically grows slowly on a tax-deferred basis. You can borrow against the cash value or surrender the policy for the cash. The death benefit may be reduced if you don’t repay a loan, and it doesn’t pay out if you surrender the policy.

Whole life policies guarantee a minimum growth rate on the cash value. If you bought a policy with a mutual life insurance company, it has the potential to earn dividends, which are portions of the insurer’s financial surplus. Dividends generally aren’t guaranteed, but they’re worth taking into account when you compare policies.

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