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Life Insurance: Providing Security for Your Survivors

Whole Life Insurance

The traditional whole life policy, also called ordinary life or straight life, is basically a life insurance policy with a savings component. The premium, which is substantially higher than the premium for term insurance, is level and guaranteed for the life of the policy, which can either be to age 95 or to age 100 (some companies go up to 121 now). The death benefit is also guaranteed by the insurance company.

As you make your premium payments—annually, semiannually, quarterly, or monthly—part of your payment goes towards a guaranteed cash value, which offsets the amount of insurance the company is required to pay for in the event of your death. In a sense, you are pre-funding your own death benefit. As the cash value increases each year, the amount of pure insurance in the policy decreases. This way, the insurance company is able to guarantee you a level premium. When you die, assuming the policy is still in force, the company pays you the face amount, which includes the cash value, less any money borrowed from the policy.

Say you have a $100,000 whole life policy. You die in year ten. The cash value is $9,000 and there are no outstanding loans. Your beneficiary gets $100,000. But what if you had borrowed $5,000? Your beneficiary gets $95,000 ($100,000 death benefit minus the $5,000 loan).

The premiums in a whole life policy are "bundled." This means the company determines a fixed premium and does not visibly break out the charges for the cost of mortality, the contract expenses, or the investment assumptions it uses to determine its premiums. The premium, regardless of the company's experience, is fixed.

Whole life policies are sold by mutual life insurance companies and stock life insurance companies. Mutual life insurance companies generally sell participating policies, which are the most popular type. This means that the policyholder shares in the overall experience of the company. The company puts a little cushion in its premium to protect itself against any adverse conditions. As long as the company does well, the policyholder receives a dividend at the end of the year. The dividend is considered a return of the unused portion of the premium. Dividends are usually non-taxable. If you're considering whole life, you're usually better off with a participating policy.

Many top-rated life insurance companies have a strong history of paying increasing dividends. Policyholders can use their dividends in different ways. They can:

  • Take the dividend as cash
  • Use the dividend to reduce the premium
  • Leave the dividend with the insurance company to accumulate at interest
  • Use the dividend to buy paid-up additions
  • Use the dividend to buy term insurance

The most commonly used dividend selection is buying paid-up additions (PUAs). These are small pieces of additional whole life that have cash value. A $100 dividend may equal $500 or more in death benefit, depending on your age. Over time, paid-up additions increase the total cash value (guaranteed cash value plus paid-up additions) and the actual death benefit.

Paid-up additions are also used as a means to help diminish the premium in the later years of the policy. While premiums are due every year (until the policy matures at age 95 or 100), you may be able to stop your out-of-pocket premium payments at some future point (10 to 15 years) by surrendering paid-up additions and using either part or all of your future dividends. While this can help your overall cash flow, it means you will build up less cash value and your death benefit will not increase substantially.

Limited Payment policies, such as 20 Pay Life or Life Paid-Up at Age 65, are another form of whole life insurance. The premiums are higher than ordinary whole life, and the guaranteed cash value accumulates faster because the premiums are guaranteed to stop earlier than in an ordinary whole life policy.

Advantages of Whole Life over Other Forms of Cash-Value Insurance

  • The premiums and death benefit are guaranteed. Regardless of changes in the dividend scale, your premiums remain fixed for the life of the policy.
  • The fixed-premium and the guaranteed yearly increase in cash value will prevent the policy from lapsing as long as 1) you pay the annual premium and 2) you pay the interest charges on any loans from the policy either out of your pocket or from the increase in cash-value in the policy.
  • If you add a Disability Waiver of Premium rider, the policy is said to be "self-completing." The insurance company pays the entire premium and you continue to build cash-value as long as you're considered disabled and not working. If you never went back to work, the company would pay your premium for life. Disability generally has to occur before age 60. In other types of cash-value policies, this waiver may only cover the mortality costs and contract charges.
  • Future dividends are based on the overall investment, mortality, and expense experience of the company. In a decreasing interest rate environment, dividends will drop more slowly than policies that are based on current interest rates, since dividends are based on the company's overall investments.

Disadvantages of Whole Life Insurance

  • If you want to increase the amount of insurance you own, you need to apply for a new policy.
  • The premiums are generally higher than other forms of cash-value life insurance.
  • In many policies, borrowing from the policy will reduce your future dividends.
  • In many policies, there is no cash value until the third year. The policy is front-loaded with underwriting expenses and sales charges.
  • Even when you use your dividends to accumulate at interest or to buy paid-up additions, cash accumulated in the policy may not equal money put in until 10 to 14 years, or more, have passed. If you are using your policy as a "forced savings," this is definitely not a short-term savings plan.

Combined Whole Life and Term

These policies allow you to buy whole life insurance at a lower annual premium than ordinary whole life. The total face amount includes a base whole life policy; the remaining coverage includes term insurance and paid-up additional insurance. The base policy can generally be as little as 25% of the total face amount. Each year, the dividends buy less and less term insurance as more of the dividend buys paid-up additional insurance, replacing the term portion of the policy.

Eventually, the total face amount of the policy includes the base policy and the paid-up additional insurance—a complete whole life package. Making your insurance whole can take anywhere from 15 to 30 years, depending on the initial split between the base amount and term insurance, the age at which you start, and changes in the dividend scale.

IMPORTANT NOTE: Some policies guarantee the entire face amount (total death benefit) for the first 20 years or so, while others may only guarantee the total death benefit in the first year. If the dividend scale drops, you may have to pay more to keep the total term insurance portion in-force or accept a reduced total death benefit.

Interest-Sensitive Whole Life

Also known as excess-interest whole life, these policies are a hybrid between whole life and universal life. The premiums and the death benefit are fixed like whole life, but the policy doesn't pay dividends. The rate at which the cash value in the policy accumulates depends on the current interest rate, which is variable. It is the excess current interest over the guaranteed interest rate that allows your policy to accumulate at a faster rate than the guaranteed cash value.

What are the advantages of an interest-sensitive policy? The premiums are slightly lower than ordinary whole life. They appeal to those who like the borrowing features similar to those in a universal life policy. And, if the current interest rates are high enough, future mortality costs and expenses can be paid out of the accumulation account. You have the flexibility to use the accumulation account to pay one or more premium payments.

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