How Does Whole Life Insurance Work?

These policies are life insurance and investment products rolled into one, and they have the price tag to match.
Written by Katia Iervasi
Reviewed by Tony Steuer

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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.

Age

Average annual rate for men

Average annual rate for women

30

$4,690

$4,143

40

$6,997

$6,122

50

$10,800

$9,508

60

$17,735

$15,517

70

$30,462

$27,398

Source: Quotacy. Lowest three rates for each age and risk class averaged. Valid as of Sept. 14, 2022.

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.

🤓Nerdy Tip

Life insurance companies sometimes provide projections of how each policy’s cash value could perform. Always ask which parts of the projection are guaranteed.

Be aware of surrender charges

Whole life insurance policies typically have a surrender charge for the first 10-15 years. This means if you decide to cancel your coverage, you’ll need to pay a fee, which is a percentage of the cash value you’ve accumulated. In the early years, the surrender charge may be close to 100%. The surrender charge decreases each year until it no longer applies.

Understand the different approval processes

There are three main types of approval processes.

  1. Fully underwritten whole life insurance typically involves filling out a lengthy application and taking a life insurance medical exam.

  2. Simplified issue whole life insurance involves answering some health questions, but there’s no medical exam.

  3. Guaranteed issue whole life insurance means you’ll be accepted with no medical exam and no health questions.

Even if you have some health issues, you’ll generally find the most competitive price with a fully underwritten policy.

Simplified issue and guaranteed issue life insurance policies are worth considering if you’ve been turned down for standard whole life coverage due to health problems, but be aware of the downsides. Death benefits on these policies are relatively small, and premiums can be expensive when compared with fully underwritten products. In addition, these policies don’t pay the full death benefit if you die of natural causes or suicide within the first few years of coverage.

Compare whole life insurance quotes

When you’re shopping for life insurance, get life insurance quotes for the same amount of coverage from several insurers to compare prices. You might find that rates for whole life insurance vary widely.

Check the insurer’s financial strength

Look up the financial strength rating of each whole life insurer you’re considering. You can find financial information through a rating firm such as AM Best. Financial strength is important because a strong company has a better chance of being around decades from now to pay claims.

Any company with an AM Best rating of B+ or higher has a good ability to meet its obligations, in AM Best’s opinion. NerdWallet typically recommends considering insurers with ratings of A- or higher.

Research the insurer’s reputation for customer service

You can look up an insurer’s complaint index on the National Association of Insurance Commissioners website. The score is based on the number of complaints filed against the insurance company with state regulators, adjusted for the company’s market share (based on premiums written). The average is 1, so a score higher than 1 means the company received more complaints than expected for its size.

Alternatives to whole life insurance

Whole life insurance fits the bill for some people, but term life insurance is sufficient for most families. While these policies have no cash value and will expire after the term is over, they also typically have much lower premiums than whole life insurance.

Another option is universal life insurance. These policies usually last your entire life and give you the flexibility to adjust your premiums and death benefit amount.

More about whole life insurance

Learn more about how whole life works and where to find a policy.

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