When should I consider buying a whole life policy?
Whole life insurance is generally used when the need for life insurance is lifelong, or permanent. In addition it has a built-in savings element since you will pay premiums and hence build up a cash value within the policy. Additionally, whole life insurance may be used as a part of your estate planning.
Premiums for whole life insurance can be much higher than premiums you would pay initially for the same amount of term insurance, but they are smaller than the premiums you would eventually pay if you were to keep renewing a term insurance policy until the insured's later years.
Whole life insurance is a good choice for you if you want to ensure that you have a life insurance policy in place for your entire lifetime and can comfortably afford the premiums, or if it fits within the framework of your estate or retirement plan.
How does whole life insurance differ from term life insurance?
Whole life insurance is designed to provide coverage on the insured for the insured’s entire life as long as premiums are paid and the policy has not been surrendered. On the other hand, term life insurance provides coverage only for a fixed period that is stated in the policy.
What are the main types of traditional whole life policies available for purchase?
Non-Participating Whole Life Insurance
A non-participating whole life policy has a level premium and face amount during your entire life. The advantages of such a policy are its fixed costs and relatively low out-of-pocket premium payments. Since the policy is non-participating it does not pay you any dividends.
Participating Whole Life Insurance
A participating whole life policy pays dividends. The dividends represent the favorable experience of the company and result from excess investment earnings, favorable mortality and expense savings. Dividends can be paid in cash, used to reduce your premium payments, left to accumulate at a specified rate of interest or used to purchase paid-up additional insurance which will increase your face amount of coverage. Dividends are not guaranteed to be paid to you.
Within the two broad categories of traditional non-participating whole life insurance and participating whole life insurance there are various whole life plans that are available for you to choose.
Level Premium Whole Life Insurance
Level premium whole life insurance features premium payments that are level and are required to be paid as long as the insured is living. In the early years the premium is more than enough to pay the current cost of insurance protection. The excess, including interest earnings, makes up the deficiency of premiums in later years when annual premium is not sufficient to pay annual cost of insurance. These extra premiums are held and invested by the insurer, creating the "cash value" of the policy.
Limited Payment Whole Life Insurance
If you want to pay premiums for a limited time, the limited payment whole life policy gives you lifetime protection but requires only a limited number of premium payments. Since the premiums are paid over a shorter span of time, the premium payments will be higher than under the ordinary whole life plan. Limited payment plans can provide for the payment of premiums for a set number of years e.g. 10 payment or 20 payment whole life insurance. Limited payment plans can also be based on age e.g. whole life paid up at age 65 or at age 85.
Single Premium Whole Life Insurance
Single premium whole life is a limited payment whole life insurance plan with one relatively large premium payment due at issue. The policy is fully paid up and no further premiums are required. Due to the single premium payment the policy will have an immediate cash value and loan value which could be significant depending on the amount of the single premium payment. Since a substantial single premium payment could be involved, this type of plan may be viewed more as an investment-oriented type of whole life insurance product.
Indeterminate Premium Whole Life Insurance
An indeterminate premium whole life policy is similar to ordinary whole life plan of insurance except that it provides for adjustable premiums. The company will charge a "current" premium based on its current estimate of investment earnings, mortality, and expense costs. If these estimates change in later years, the company will adjust the premium accordingly but never above the maximum guaranteed premium stated in the policy.
Will the scheduled premium payments for whole life insurance change over time?
Generally, in a traditional whole life policy, the scheduled premium payments remain level. Premiums are generally the same (fixed) every year the insured is alive. The premium payment consists of both life insurance protection and savings. These two elements vary over the life of the insured, but the total scheduled premium payment remains the same for the life of the traditional whole life policy. Some traditional whole life policies however provide for a modified premium payment schedule where the required premium payments may be lower in the early years and then increase to a higher amount which will then remain level for duration of the policy. Be sure to check the data page or specifications page of your policy (usually page 3) to determine the amount of your premium payments and the period for which they are required to be paid.
What is “cash value” and how does it differ from the face amount of the whole life policy?
The face amount is the amount of coverage you wish to provide your beneficiaries in the event of death. The cash value is the value that builds up in the policy. The minimum cash values are set by the Insurance Law and reflect an accumulation of your premiums after allowances for company expenses and claims. When you are young, your premiums are more than the cost of insuring your life at that time. Over time the cash value grows, usually tax-deferred, and the owner may be allowed access to that money in the form of a policy loan or payment of the cash value. The face amount of your policy will be higher than your cash value especially in the early years of your policy. If you surrender your policy you will receive the cash value not the face amount. If you die your beneficiaries will receive the face amount.
May I surrender a whole life policy for its cash value?
Generally, in a traditional whole life policy, yes. Over time, the policy accumulates a cash value, which is similar to building equity in a home. When a policy is surrendered, the owner is entitled to at least a portion of the cash value. The actual amount that the owner receives will depend whether there are any outstanding loans or unpaid premiums that can be deducted from the cash value.
May the policy owner borrow money from the whole life policy?
Generally, yes, to the extent that there are sufficient funds in the cash value to secure the loan. There may be a waiting period of up to three years before a loan is available. If the policy owner borrows from the policy, the cash value is used as collateral, and interest is charged at the rate specified or described in the policy. Any money owed on an outstanding policy loan is deducted from the benefits upon the insured's death or from the cash value if the policy owner surrenders the policy for cash.
Will I need to pay premiums for the rest of my life to keep the whole life policy in force?
For traditional whole life insurance, the amount and duration of premium payments are the same for as long as the insured is alive, but some whole life policies allow you to pay premiums in a single installment, or for a shorter period such as 20 years or until age 65. Premiums for those policies are higher since the premium payments are made during a shorter period. Additionally, dividends, while not guaranteed, in participating whole life policies may be used to pay some or all of scheduled premium payments if you so choose. Whole life policies may also be surrendered and the surrender value then used to purchase a reduced paid-up amount of insurance or used to provide term insurance coverage for a set period of time (extended term). In your whole life policy the available options can be found under what is called the “non-forfeiture” provision.
What is the federal tax treatment of whole life insurance cash values, dividends, and death benefits?
The "interest build-up" portion of the annual increase in the policy's cash value is not taxed annually pursuant to the Internal Revenue Code. Dividends generally are considered to be a "return of premium" and are not taxable as long as the dividends you have received do not exceed the premiums you have paid. Although life insurance death proceeds will not typically be subject to income taxation, they may be subject to federal estate taxation. If you own part or all of the policy when you die, the value of the policy can be included in your gross estate for federal estate tax purposes. State inheritance taxes and federal gift taxes may also apply to life insurance policies/proceeds under specific circumstances. Contact your tax adviser regarding questions about possible income, estate and gift tax consequences surrounding any life insurance you own or are contemplating buying. If the policy is surrendered for its cash value only the excess of the cash value over the amount of premiums you have paid less dividends is taxable.
What are some pros and cons of whole life insurance?
- Predictable, in most cases premiums are fixed for the life of the insured.
- The beneficiaries receive the death benefit no matter when the insured dies, as long as premiums were paid.
- The policy may build up cash value, which grows tax deferred.
- If you surrender the policy at a later date, the cash value, if any, will be returned to you.
- If you stop making premium payments you can receive the cash value or use that cash value to provide a paid up insurance benefit. The company must provide either extended term insurance coverage or reduced paid paid-up coverage. While it is not required that both options be offered many companies do make both available.
- A more complex product than term life insurance.
- Higher premiums than term life insurance.
- Could be costly if coverage lapses early.
Is there a period of time during which after I purchase my life insurance policy I can change my mind and have my money refunded?
Yes, the Insurance Law requires a “free look” period of not less than ten days nor more than 30 days from the date the policy is delivered to you. A policy sold by mail order must provide for a 30 day period, and a policy sold in a replacement situation must provide for a 60 day period. The insurer must refund to you any premium paid, including any policy fees or charges.
What happens if I forget to pay my premium by its due date?
For scheduled premium policies, the policy will provide for a 31 day or one month grace period within which you can still make your premium payment. Your policy will continue in force during that time. For policies in which the amount and frequency of premiums may vary, the policy must provide a grace period of 61 days.
If I pay my annual premium and then decide to cancel my policy, will I receive a pro rata refund of my premium?
An insurer is not required under the Insurance Law to refund any portion of your annual premium if you choose to cancel your policy during the year. However, if cash values have accumulated under the policy, you would be entitled to the cash surrender value.
What if I made a mistake in completing my application for a life insurance policy? Can the insurer void my policy?
A life insurance policy will be incontestable by the insurer after being in force during the life of the insured for a period of two years from its date of issue. The company may only contest coverage based on a material misrepresentation in the application. A misrepresentation is deemed material if knowledge by the insurer of the facts misrepresented would have led to a refusal of coverage. A misstatement of age or sex is not a material misstatement and not subject to the two year contestable period. If the age or sex of the insured is misstated, any amount payable or benefit accruing will be what the premium would have purchased at the correct age or sex.
If I forget to pay my premium and the policy lapses is there anything I can do?
For scheduled premium policies, the policy must provide for reinstatement of the policy within three years from date of default, unless the cash surrender value has been exhausted or the period of extended insurance has expired. In order to reinstate the policy, you must complete a reinstatement application and provide evidence of good health to the satisfaction of the insurer. In addition, you will be required to pay all the overdue premiums with interest (not to exceed 6%) and repay or reinstate any outstanding loans at the applicable policy loan interest rate. This reinstatement right is not required for polices in which the owner may vary the amount and frequency of premium payments.
If I take out a policy loan, what rate of interest can the insurer charge?
At the option of the insurer your policy will provide for either: 1) a fixed loan interest rate not to exceed 7.4% (payable in advance) or 8% (payable in arrears); 2) an adjustable rate subject to an 8% cap; or 3) an adjustable rate with no cap not to exceed the higher of: a) the Monthly Average Corporates yield shown in Moody's Corporate Bond Yield Averages for the calendar month ending two months before the date on which the rate is determined; and b) the rate used to compute the cash surrender values under the policy during the applicable period plus one percent.
What happens to a life insurance policy in the event of suicide of the insured?
If the insured dies by suicide during the first two policy years, the insurer will refund the premiums paid less dividends paid and less any indebtedness, including interest due and accrued. The face amount will not be payable. If the policy was issued as a result of a conversion from another policy, the two year suicide period runs from the issue date of the original policy.
What happens if my outstanding loans plus interest due exceed the policy loan value on my life insurance policy?
The insurer will provide you with at least 30 days notice before terminating your policy. During that 30 day period you have the opportunity to repay the outstanding loan and/or interest in order to avoid lapse.
In order to purchase life insurance I am told I must have an "insurable interest" in the person to be insured. What is "insurable interest"?
The Insurance law defines "insurable interest" as, in the case of persons closely related by blood or by law, a substantial interest engendered by love and affection. In the case of other persons, a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.
If there is a delay in an insurer paying the death benefit to the beneficiary when a death claim is made, is the beneficiary entitled to any interest on the death benefit?
Yes. The Insurance Law requires that interest, computed daily at the rate of interest currently paid by the insurer on proceeds left under the interest settlement option, be paid from date of death to date of claim. The timeframe for paying the death benefit must be reasonable.