What Is Whole Life Insurance, and Do You Need It?

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You have a family to protect and a legacy to leave, and you know a life insurance policy can help you do that. But with so many coverage options, it can be hard to choose.

There are two main types of life insurance: Term life insurance and whole life insurance. Both options offer a tax-free death benefit to your heirs, but beyond that, they function differently.

Let's explore whole life insurance, including what it is, how it works, how much it costs and how it compares to term life coverage. That way, you can decide which policy might be right for you.

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What is whole life insurance?

Whole life insurance is a form of permanent life insurance, which means the coverage remains in force until you die, as long as you pay your premiums.

The death benefit, sometimes referred to as the face value of the policy, gets paid to your life insurance beneficiaries once your heirs file a claim and provide the insurer with a copy of your death certificate.

Generally, your beneficiaries will receive the funds in a lump sum. However, your insurance company might be willing to pay in installments or through an annuity.

On the other hand, term life insurance provides protection for a set period – often 10, 20 or 30 years. If you die within the term, your heirs will receive the death benefit, but if you die after the term ends, your heirs get nothing.

The cash value of whole life insurance

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In addition to a death benefit, your whole life policy builds cash value (albeit slowly). This gives you options to use your life insurance while you're still alive. You can borrow from or withdraw it similar to the way you'd borrow from a 401(k).

You might also have the option to use that cash value to cover your premiums or purchase more coverage.

When you pay your premium, the money gets split between your insurance coverage, your cash value account and the insurer's expenses.

Your cash value will grow faster when you're younger because your actual insurance costs less since you're a lower risk. However, it can still take many years to accumulate a meaningful sum.

Your insurance company will pay a fixed interest rate on your cash value balance, helping it grow. Generally, the rate will be lower than you could get investing the money in the stock market, but higher than you could get stashing the funds in a traditional savings account.

Tapping into your cash value might help you if you're in a financial pinch, but doing so can have consequences.

For instance, taking a partial withdrawal or not repaying a loan can result in a lower death benefit for your heirs. If you use your cash value to cover your premiums and the money runs out, you must start making payments again, or your policy will lapse.

In addition, your heirs will only receive your policy's death benefit. Your insurance company will retain any cash value in your account after your passing.

Important note: While whole life insurance death benefits and cash value contribution withdrawals or loans are generally tax-free, any investment gains in your cash value account will likely be taxable when you take out those funds. That makes it all the more important to plan for using up your cash value in retirement.

Other features of whole life insurance

Your whole life policy might include additional benefits and features, such as dividend payments or riders. If your insurer issues participating policies, you're eligible to receive dividends.

If your insurer issues non-participating policies, you won't receive any dividends. Depending on your policy's rules, you might be able to apply your dividends to your cash value account or use them to buy more coverage.

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The riders (addendums to your policy) you choose can enhance your financial plan. One popular policy addition is the living benefit rider. Under this rider, you can get a portion of your death benefit in advance if you're diagnosed with a terminal illness (generally with a prognosis of a year or less). You can use the money to cover your medical care.

Another popular rider is the waiver of premium rider. If you become disabled and unable to pay for your policy, your insurance company might allow your coverage to remain in effect as though your payments were made on schedule.

Whole life insurance premiums

Most people pay their whole life insurance premiums monthly. However, your insurance company might allow you to pay for your policy in a lump sum (very high upfront cost) or over a limited number of installments.

Your insurance company might also offer a modified premium schedule, where required payments start low and increase after a set number of years.

Whole life insurance costs

Since a whole life insurance policy lasts until you die and allows you to build and access cash value, it costs significantly more than a term life policy featuring the same death benefit.

These are the current average annual premiums for $500,000 in whole life coverage on non-smoking insureds, according to NerdWallet:

20-year-old female: $2,260
40-year-old female: $4,968
20-year-old male: $2,548
40-year-old male: $5,525

For comparison, here are the average annual premiums for $500,000 in term life coverage for non-smoking insureds in good health over a 20-year term:

20-year-old female: $211
40-year-old female: $340
20-year-old male: $243
40-year-old male: $410

Term life coverage costs a fraction of whole life coverage.

Use the tool below, in partnership with Bankrate, to explore some of today's best life insurance offerings:

Pros and cons of whole life insurance

Whole life insurance has pros and cons, such as:

Pros

Coverage lasts your entire life.
Your beneficiaries will get a payout upon your death.
Your policy builds cash value that you can use in several ways.
Your policy might earn dividends.
Optional riders can enhance your policy's value.

Cons

Coverage can be very expensive.
Your cash value account balance can take many years to build.
Tapping into your cash value can put your policy at risk.

Is whole life insurance right for you?

When you're trying to determine which type of life insurance is right for you, ask yourself a few questions:

Why do I want this coverage? If you just want to protect your family while your kids are still in school, a less-expensive term life insurance policy might be your best bet. However, if you want to leave your heirs a financial gift no matter how long you live, a whole life insurance policy may be worth it.
Can I afford the premiums? The thought of building up cash value is nice. But as you can see above, the price difference between term and whole life insurance is substantial. Before committing to substantially higher premiums, make sure your budget can comfortably accommodate the monthly spend.
Are there better alternatives? Instead of whole life, some financial experts recommend obtaining a term life insurance policy and investing the difference in premiums to get protection and build wealth for future generations. However, this strategy may not work for you.

If you're unsure what kind of life insurance you need, consider speaking with an insurance agent or financial adviser for personalized guidance.

Laura has been a freelance writer since 2018. Her work primarily focuses on managing your money, navigating your career, and running a successful business. Her words have been featured in Yahoo Finance, US News & World Report, and many other publications. She earned her MBA and a Bachelor's in Psychology during her previous career in human resources.