What is Whole Life Insurance & How Does it Work?
Life insurance is a contract between a life insurance company (the insurer) and a person who pays for insurance (the insured). When you purchase a life insurance policy, you agree to pay the insurance company premiums (payments) for an agreed upon amount of time, and the insurance company agrees to pay your beneficiaries a specified amount of money should you die during the time the policy is in effect.
Types of Life Insurance
There are two main kinds of life insurance: whole life and term life. Within these two main categories, there are many insurance products.
How Whole Life Is Different from Term Life
There are two main differences between whole life and term policies. The first difference is that as you make payments on a whole life policy it accrues value, and you can cash it out at some point in the future. Unlike a whole life policy, a term policy has no monetary value beyond its term; that is, it does not grow in value nor can you cash it out. You might think of the difference between them as you think of the the difference between buying a house or renting.
The second main difference between whole life and term insurance is their relative cost. Whole life policies cost more than term policies. Here again the analogy between renting and owning holds up, at least in the short term.
Why Buy a Whole Life Policy
Some people think of a whole life insurance policy as a kind of savings account because you can cash it out at some point in the future. However, financial advisers often suggest that you you can make your money work harder by putting your funds into a savings account or the stock market rather than into a whole life insurance policy. Not only that, but in the early years of a whole life policy there may be significant restrictions on the withdrawal of funds. So you should not purchase a whole life policy with the idea that it is really a savings account. That said, there are sound reasons for choosing a whole life policy. They are:
• Guarantee of payout at death
• Guarantee of increase in cash value
• Ability to make a lump sum payment for coverage through end of life
• "Enforced" savings if you are not able to do so otherwise
How to Afford a Whole Life Policy
The cost of your policy is based on your year of birth, gender, socio-economic status (generally equated to ZIP Code), and health status (smoker versus non-smoker).
Most life insurance companies allow you to choose whether to pay your life insurance premiums annually, semi-annually, quarterly, or in some cases, monthly. The total annual cost is usually more for smaller but more frequent payments, both to discourage this payment behavior and because there is a real cost of administration.
Additionally, with whole life policies, you may be able to apply the current cash value of your policy toward future premiums in the event that you are unable to make those payments on time. There is often language in your contract that permits automatic triggering of deductions from the cash value when a payment is a certain number of days late. The purpose is to help both you and the insurance company keep the policy in effect. As you can see, implicit in this arrangement is the insurance company's belief that you really want them to provide an insurance policy, not a savings account.
