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What Is Whole Life Insurance? Benjamin Franklin famously said that nothing in life is certain except death and taxes. True, there’s not much you can do to get around or avoid either one. However, you do have some control over how you prepare for these events. When it comes to end-of-life planning, you’ll want to have the right kind of life insurance in place. That way you can your loved ones can have the protection you need.

Find out now: How much life insurance do I need?

Term vs. Whole Life Insurance

Before you dive into the many insurance options, you should assess what you want from a life insurance policy. That way you can better choose one that fits your situation. One option is a whole life policy, which allows you to build cash value. Compared to term life insurance, whole life coverage tends to cost more. However, the extra cost may be worth it in certain situations.

Unlike term life policies, which cover you for a set period of time, whole life insurance remains permanent. Both types of life insurance provide death benefits. But if you outlive the length of your term life policy, your beneficiaries will not receive any money at all.

How Whole Life Insurance Works

What Is Whole Life Insurance?

As you pay your premiums, your whole life policy accumulates a cash value that you can take out or borrow against later on. The money is allowed to grow with interest on a tax-deferred basis. Compared to other types of permanent life insurance, such as universal or variable life, the rate of return with a whole life policy is typically much lower.

Whole life policies stay in place for the duration of your life. This means you won’t have to worry about renewing it like you would with term life insurance. Plus, changes in the status of your health won’t affect your coverage, so your premiums won’t go up if you get sick later on.

Benefits of Choosing Whole Life

One of the biggest advantages of whole life insurance is its predictability. Since the coverage is permanent, you know that your beneficiaries are protected for as long as you live.

Whole life insurance premiums also typically remain level for the entire time you’re covered. You would have to pay a much higher rate to renew a term life policy once it expires (because you are not qualifying at an older age). However, modified life insurance is an exception. Under this type of plan, premiums are often low for the first five years of coverage and then increase after. This makes them more expensive than other whole life insurance policies.

When you have a whole life policy, you’re guaranteed to build cash value for as long as the policy is in place, although dividends are not guaranteed. Plus, your returns aren’t tied to market performance. This means you probably won’t see any major fluctuations in your investment.

Borrowing Against Your Policy

Taking out a whole life policy loan is relatively easy once you’ve built up sufficient cash value. There aren’t any credit check or income requirements and interest rates are generally lower than what you would pay to a traditional lender.

You can either pay your interest out-of-pocket or have it added on to the loan value. If your policy has earned dividends or gains, you can apply these to the interest.

Typically, you won’t actually have to make payments against the loan. When you die, any amount still outstanding is simply deducted from your death benefit.

If you do decide to make payments on the loan, it’ll help to rebuild your value in the policy over time. Keep in mind that if you take multiple loans totaling more than your cash value, it could cause your policy to lapse.

Tax Implications of Having a Whole Life Policy 

What Is Whole Life Insurance?

Like other forms of life insurance, death benefits paid from a whole life policy are tax-free for your beneficiaries. You pay no taxes on earnings while your cash value is accumulating and loan proceeds are also tax-free. This is certainly an advantage over borrowing from an IRA or 401(k), which may subject you to federal income taxes and penalties. Whole life insurance coverage may allow you to avoid certain estate taxes if you transfer the policy into a trust.

While there are some tax advantages to whole life coverage, there are some potential disadvantages associated with these types of policies as well. If, for example, you decide to withdraw your cash value rather than borrow against it, you will have to pay taxes on any gains or dividends you receive.

You also need to be aware of the potential tax implications of not repaying the interest on a loan. The IRS considers this phantom income, which could add up to a major tax bill later on.

Is Whole Life or Term Life Insurance Best for Me?

There are plenty of reasons why you might want to choose whole life coverage over term life or another type of permanent insurance. Having the ability to borrow money when you need it is certainly a convenience and it may give your family members peace of mind to know that they’re financially equipped to face the inevitable.

On the other hand, there are the added costs and potential tax pitfalls to consider. By shopping around and comparing quotes and rates, you’ll be able to find the best insurance company and policy to meet your needs. Ultimately, it comes down to what level of risk you’re comfortable with and how well a whole life policy fits into your bigger financial picture.

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Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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