Whole life insurance is the only type of life insurance containing the guarantee that it will be “in force” when you die, provided the premiums are paid as required. Designed to be in force for a long time, Whole life Insurance is classified as permanent insurance.
Whole Life Policies are of Two Principal Types:
- Ordinary Life Insurance
- Limited Payment Life Insurance
Ordinary Life Insurance
Ordinary life insurance is permanent life insurance designed so that premiums will be paid for your entire life. Although ordinary life insurance is typically issued with premiums that remain level for your lifetime, two other alternative ordinary life insurance products are available that offer different premium arrangements:
- Modified Premium Whole Life Insurance
- Graded Premium Whole Life Insurance
The defining characteristic of ordinary life insurance is that it generally provides permanent life insurance protection, at the lowest total premium outlay over the lifetime of the policy.
Modified Premium Whole Life
Modified premium whole life is life insurance that features a lower premium that remains level for an initial period, usually the policy’s first five years, and then increases to its ultimate premium and remains at that level for the remaining life of the policy. The initial premium is lower than the premium for an otherwise identical level premium ordinary whole life policy, and the ultimate premium is higher. It is best suited if you are unable to afford the needed amount of level premium ordinary life insurance but expect to increase your income before the ultimate premium level becomes effective.
As in level premium whole life insurance, the policy’s guaranteed cash value is exactly equal to the “face amount” when you reach the applicable mortality table’s limiting age.
Graded Premium Whole Life
Graded premium whole life insurance is life insurance under which premiums increase annually until they reach a particular level, usually after 10 to 20 years, at which time they remain level for the remaining life of the policy. The initial premium is normally quite low and could approximate the premium for a comparable one-year term life insurance policy. During the early policy years, the policy might not build much cash value, because the premiums are so small. When the premiums increase in later years, the policy’s cash value can build rapidly.
This coverage was designed in case your current income is limited. For example, if you are just beginning your career and anticipate higher earnings in the future and you eventually want permanent life insurance coverage. Like other whole life insurance policies, the policy’s guaranteed cash value equals its face amount at the applicable mortality table’s limiting age.
Limited Payment Life Insurance
Limited payment life insurance is also whole life insurance. However, just because whole life insurance protection extends for your entire lifetime does not mean that premium payments must also extend for your entire lifetime.
In an ordinary life insurance policy, premiums are designed to be payable throughout your entire life. At the applicable mortality table’s limiting age, premiums cease, and the death benefit—now equal to the policy’s guaranteed cash value—is payable to your as an endowment. Although an ordinary life insurance policy with its level premiums for life generally results in the lowest long-term premium level over the life of the policy, you may want to stop premium payments at or before the end of your working career. Limited payment life insurance was designed with this in mind. Typical limited payment life insurance policies are issued with a 10-year, 20-year, or to-age-65 premium payment period.
The policy that offers the shortest period during which premiums for a limited payment life policy are payable is a single premium policy. As its name suggests, there is only one premium payment.
The higher premium payments made under limited payment life insurance policies result in higher cash values in these policies during the premium-payment period. However, like other whole life insurance policies, the guaranteed cash value of a limited payment life insurance policy is equal to the policy’s face amount at your age at which the applicable mortality table assumes all people have died.
Whole life insurance, regardless of whether it is continuous premium ordinary life or limited payment life insurance, offers significant guarantees. Those guarantees apply to both the policy’s death benefit and its cash values. In return for the guarantees, whole life insurance policies tend to be somewhat inflexible.
For example, in a whole life insurance policy:
- Billed premiums must be paid within the grace period or the policy will lapse.
- Death benefit increases generally require the issuing of a new policy.
- Death benefit reductions normally require a distribution of cash value.
- Cash values can be accessed only through a policy loan or surrender.
Additionally, the long-term nature of the guarantees in whole life insurance policies requires that its assumptions concerning interest earned, expenses incurred, and mortality experienced be conservative.
This is because a life insurance policy could be in force for 60 or 70 years. Because we do not know what economic conditions to expect —so many years in the future— the assumptions used must be incredibly conservative or the insurer might be unable to meet its promises.
Have you had first-hand experience buying a Whole Life Insurance Policy? Whether it was positive or negative, we’d like to hear about it— Share your story!
Pros and Cons of Whole Life Insurance
As the US tax code has always bestowed favorable status on a whole life insurance policy, many agents are quick to tout the “upside” of paying expensive whole life insurance premiums vs. what’s required for a 20 or 30 year term or guaranteed universal life. However, like all financial products, there are major downsides too— which are usually ‘glossed over’ in the sales presentation.
PROS
- tax deferred growth & possible tax free distributions
- guaranteed premiums and the “forced savings”
CONS
- very significant penalties for early cancellation
- low contractually guaranteed returns on premium outlay
***BUYER BEWARE***
Most agents sell off “projected returns” touting historically favorable dividends or interest rates which harken back to the pre “great recession” days when insurers (and consumers) could generate meaningful positive returns on conservative, no risk investments.
Savvy consumers always weigh the pros and cons of any purchase and make decisions that best align with their objectives and circumstances.
That said, it’s difficult for many consumers to sort through all the clutter and resist the rosy sales presentation.
Some agents have perfected their pitch to suggest the recommended whole life policy can simultaneously provide adequate death benefits, adequate emergency funds, adequate retirement income, and …solve world hunger (okay, maybe that last one is a stretch … but you get the point).
The good news for consumers is trends seem to be changing somewhat. This is a result of a push back / lack of consumer confidence in the product. It’s important to be aware of the pitfalls of whole life insurance.
***When NOT To Buy Whole Life Insurance***
Whole life is a product that should NOT be purchased, unless one is absolutely convinced their insurance need is “permanent”, regardless of the age they pass.
Even if that’s established, smart consumers will compare the whole life strategy with another option —which has a death benefit guaranteed for life— Universal Life programmed at a premium level, which provides a “no lapse” guaranteed to age 121, kind of a “term for life” scenario.
Most importantly, whole life should never be purchased unless the premium is comfortably affordable.
This is a big concern in the middle income market. Consumers in this market can rarely get the robust death benefits they need to:
- pay off mortgages
- provide income replacement
- provide for children’s higher education
all necessary, in thee event of premature death – with a whole life product chassis.
Unfortunately, many who ‘buy into the sales pitch’, realize this —within just a few years of policy issue!— and then, cancel the policy: suffering a huge surrender charge that consumes almost all of the premium outlay.
Consumers in this market are far better off purchasing adequate death benefits via term insurance with a “locked” rate for 20 years or 30 years … and investing their discretionary dollars in traditional investments with low fees through discount brokers, no load index mutual funds or “robo advisors”.
One can achieve the same “forced savings” element with these investment products too, by signing up on a monthly bank draft basis; but can turn off the contributions —at any time, if/when ”life happens”— without incurring any penalties.
Fact is, there is a place for whole life insurance. But it’s in the upper income OR estate planning market.
Unfortunately, there’s not enough of the 1, 5, or 10 “percenters” out there to satisfy the sales quotas of insurance agents —and the profit targets of US Life Insurers— so… the “misrepresentation” continues.
Incidentally, insurers could solve part of this problem by spreading the commission paid for whole life sales over a longer time period, rather than fronting the vast majority of it out in the first year (why does the surrender charge have to be so high??) But… perhaps that’s a topic for another article.
The Bottom Line?
Let’s discuss your interest in Whole Life Insurance.
We can help you determine whether or not it is the best fit for you, based on your goals, your individual circumstances, and your budget.
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