About Life Insurance. Understand Whole Life Insurance. Whole life insurance was the first kind of permanent life insurance that was made available. But just because it’s been around a long time, that hasn’t made it any easier to understand.
To help you get a better understanding, here’s a list of 10 things you should know about whole life insurance:
1. It’s permanent.
Whole life is a type of permanent life insurance which means that it doesn't expire unless you cancel the policy, or you don't pay your premiums. This is one reason that whole life insurance is very expensive compared to term life insurance. Because this policy never expires, the insurance company knows that it’s not a matter of ‘if’ they will have to pay out money, but ‘when’ they will have to pay out money.
2. It has a built in savings account called the ‘cash value’.
This is another reason that whole life insurance is usually relatively expensive. A portion of your premiums are being put into a ‘savings account’ that is part of the policy. This ‘savings account’ is called the policy reserve or the cash value of the policy.
3. Poor returns on your savings.
Usually the interest on the savings is quite low and any growth is often lost due to inflation. A 3% interest rate on your savings during a year that has 3% inflation means you didn’t really get ahead with your savings.
(Inflation basically means an overall increase in the cost of goods and services. If the inflation rate in one year is 3%, then each dollar you have will be able to purchase 3% less than it did 1 year ago.)
4. If you want to access the cash value savings in your policy, you usually have to take it as a loan.
Even though it’s your money that is accumulating in the policy, if you want to access any of it you usually have to borrow it in the form of a loan. This is called a policy loan and you will be charged interest on that loan until it is paid back in full. Many whole life policies that I've seen said in writing that the insurance company would decide what the interest on the loan would be and they could change it 'from time to time' without any agreement from you required.
Imagine having a bank account that you regularly deposit money in. Then when you want to make a withdrawal, the bank tells you that the only way you can have any of your own money is to borrow it with interest. While you're repaying your own money, they could adjust the interest rate they're charing you whenever they feel like it to whatever rate they want. How would you feel if you had a bank that treated you and your money like this? Many whole life policies work just like this.
Often, the only way to get your money without having to pay interest is to cancel the policy.
5. If you take a loan from the cash value of your policy, it usually reduces the death benefit payable to the beneficiary of the policy.
This is best illustrated by example. Say your spouse has a whole life policy with a $100,000 death benefit payable to you when they pass away. Recently they took out a $25,000 loan from the policy to do some renovations on the house. If your spouse passes away while a $25,000 loan is still outstanding on the policy, you will likely only receive a $75,000 payout ($100,000 - $25,000 = $75,000).
(The death benefit is the money which must be paid to the beneficiary of your life insurance policy when you pass away. The beneficiary is the person that is supposed to receive the proceeds of a life insurance policy)
6. Any cash value in the policy is usually kept by the insurance company when you pass away.
An example of this would be if you had a whole life insurance policy for $100,000. You’ve had the policy for a long time and have accumulated $40,000 in cash value savings in the policy. If you were to pass away today, the beneficiary of your policy usually would only receive $100,000. The cash value in the policy is almost always kept by the insurance company, never to be seen again.
Going back to the bank account example we used earlier. Imagine if you passed away and your family went to the bank to make a withdrawal from your account only to be told that the account was closed and the bank was keeping all of the money. Whole life insurance policies often do this very thing.
7. If you can’t pay your insurance premiums, you can use the cash value in the policy to do 1 of 3 things:
These costs are usually not detailed for you, but insurance agents are usually paid very well to sell whole life policies. That big commission check is coming from the high premiums that you're paying.
9. Whole life insurance could be used for estate planning.
This is because the insurance could be used by the beneficiary to pay any required estate taxes after you pass away. However I would argue that you should buy term life insurance instead. It's much cheaper and you can invest the money you saved by not buying an expensive whole life policy. You can accumulate your own investments that can be used by your beneficiary to pay any estate taxes.
10. You can get a type of whole life insurance called a participating policy.
A participating insurance policy means that the insurance company may pay you back some money each year. If they overestimated how much they should be charging all their clients for insurance they may pay money back to their clients that own participating policies. This payment is called a dividend. Dividends are rarely guaranteed to be paid out.
If you receive dividends, they can be used in several ways:
Whole life insurance can be a complicated subject. Hopefully this has helped make some sense of it.
To help you get a better understanding, here’s a list of 10 things you should know about whole life insurance:
1. It’s permanent.
Whole life is a type of permanent life insurance which means that it doesn't expire unless you cancel the policy, or you don't pay your premiums. This is one reason that whole life insurance is very expensive compared to term life insurance. Because this policy never expires, the insurance company knows that it’s not a matter of ‘if’ they will have to pay out money, but ‘when’ they will have to pay out money.
2. It has a built in savings account called the ‘cash value’.
This is another reason that whole life insurance is usually relatively expensive. A portion of your premiums are being put into a ‘savings account’ that is part of the policy. This ‘savings account’ is called the policy reserve or the cash value of the policy.
3. Poor returns on your savings.
Usually the interest on the savings is quite low and any growth is often lost due to inflation. A 3% interest rate on your savings during a year that has 3% inflation means you didn’t really get ahead with your savings.
(Inflation basically means an overall increase in the cost of goods and services. If the inflation rate in one year is 3%, then each dollar you have will be able to purchase 3% less than it did 1 year ago.)
4. If you want to access the cash value savings in your policy, you usually have to take it as a loan.
Even though it’s your money that is accumulating in the policy, if you want to access any of it you usually have to borrow it in the form of a loan. This is called a policy loan and you will be charged interest on that loan until it is paid back in full. Many whole life policies that I've seen said in writing that the insurance company would decide what the interest on the loan would be and they could change it 'from time to time' without any agreement from you required.
Imagine having a bank account that you regularly deposit money in. Then when you want to make a withdrawal, the bank tells you that the only way you can have any of your own money is to borrow it with interest. While you're repaying your own money, they could adjust the interest rate they're charing you whenever they feel like it to whatever rate they want. How would you feel if you had a bank that treated you and your money like this? Many whole life policies work just like this.
Often, the only way to get your money without having to pay interest is to cancel the policy.
5. If you take a loan from the cash value of your policy, it usually reduces the death benefit payable to the beneficiary of the policy.
This is best illustrated by example. Say your spouse has a whole life policy with a $100,000 death benefit payable to you when they pass away. Recently they took out a $25,000 loan from the policy to do some renovations on the house. If your spouse passes away while a $25,000 loan is still outstanding on the policy, you will likely only receive a $75,000 payout ($100,000 - $25,000 = $75,000).
(The death benefit is the money which must be paid to the beneficiary of your life insurance policy when you pass away. The beneficiary is the person that is supposed to receive the proceeds of a life insurance policy)
6. Any cash value in the policy is usually kept by the insurance company when you pass away.
An example of this would be if you had a whole life insurance policy for $100,000. You’ve had the policy for a long time and have accumulated $40,000 in cash value savings in the policy. If you were to pass away today, the beneficiary of your policy usually would only receive $100,000. The cash value in the policy is almost always kept by the insurance company, never to be seen again.
Going back to the bank account example we used earlier. Imagine if you passed away and your family went to the bank to make a withdrawal from your account only to be told that the account was closed and the bank was keeping all of the money. Whole life insurance policies often do this very thing.
7. If you can’t pay your insurance premiums, you can use the cash value in the policy to do 1 of 3 things:
- The insurance company will take the money from your cash savings as a loan to pay the premiums (subject to items 3 – 5 noted above). This is called an automatic premium loan.
- You can take your entire cash value and buy something called paid up insurance. This is a whole life policy that is paid in full and will require no more premiums to keep it in effect. Usually the value of this new paid up policy will be a lot lower than your current policy.
- You can use the entire cash value of your policy to buy a single payment term life insurance policy that has the same death benefit as your current policy. The length of the term will be determined by your current age and other health factors.
These costs are usually not detailed for you, but insurance agents are usually paid very well to sell whole life policies. That big commission check is coming from the high premiums that you're paying.
9. Whole life insurance could be used for estate planning.
This is because the insurance could be used by the beneficiary to pay any required estate taxes after you pass away. However I would argue that you should buy term life insurance instead. It's much cheaper and you can invest the money you saved by not buying an expensive whole life policy. You can accumulate your own investments that can be used by your beneficiary to pay any estate taxes.
10. You can get a type of whole life insurance called a participating policy.
A participating insurance policy means that the insurance company may pay you back some money each year. If they overestimated how much they should be charging all their clients for insurance they may pay money back to their clients that own participating policies. This payment is called a dividend. Dividends are rarely guaranteed to be paid out.
If you receive dividends, they can be used in several ways:
- You can receive them by cheque each year the insurance company issues them.
- You can have the insurance company invest the dividends for you and collect interest on them.
- You can use them to buy more insurance.
Whole life insurance can be a complicated subject. Hopefully this has helped make some sense of it.
Whole life definitely seems like a better option than term, I guess the key is affordability.
ReplyDeleteI think it is a good idea to shop around for your life insurance before committing yourself to a particular policy. I looked at several price comparison websites before deciding to go with AA life insurance. It is also important to know exactly what your policy covers you for so that you protect yourself correctly.
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