Whole life insurance is designed to provide protection for your entire lifetime. Unlike term life insurance, a whole life insurance policy features a cash value component that will gain value over time from interest. As you make your payments, a percentage of them goes into a cash account and grows tax-deferred.
Understanding how a whole life insurance policy differs from term life insurance is key to avoiding costly mistakes. To help you get started in the right direction, here are 5 facts and myths you should know about whole life insurance:
1. Fact and myth: Whole life insurance is an investment.
Many insurance agents promote whole life insurance as a solid investment tool to diversify your financial portfolio. While this is true, your primary goal when buying a life insurance policy is to ensure that the death benefit payout will adequately care for your beneficiaries. While whole life insurance policies do offer some unique investment features, the death benefit should remain the primary focus.
For some people, whole life insurance is a way to set aside additional retirement savings. To do this, they borrow against the cash value of their policy to cover living expenses. Although this may seem like a smart option, financial experts recommend reserving this approach as a last resort. The cash value of your policy should only be tapped if you have exhausted all other retirement-savings options such as your 401(k) and IRA accounts.
Using a whole life insurance policy as an investment may seem like a smart idea, but do not go into it without understanding all of the risks and expenses. If you do not need the additional life insurance and have ample retirement savings, using life insurance to fund your retirement may not be your best option.
2. Myth: Whole life insurance is only payable upon death.
Some whole life insurance policies include an “accelerated benefits” clause. This allows the owner of the policy to withdraw all or some of the payout in the event that the insured becomes terminally ill. Similarly, whole life policies feature a “chronic illness rider”. This rider lets the policy owner withdraw the death benefit early if the person insured develops a chronic condition or serious chronic illness. When the insured dies, the final payment is reduced by the amount of any monies that were paid early.
Typically, both of these benefits can be added to your whole life insurance policy for a small fee or at no charge.
3. Myth: You can borrow against the cash value of your whole life policy for free.
While it is true that you can borrow against the cash value portion of a whole life policy, it does come at a price. The cash value loan is tax-free as long as the amount of the loan does not exceed the amount you have paid into the policy. Insurance companies typically charge interest on the loan that will continue to accrue until the loan has been paid off.
If you die before repaying the full amount of the loan, the life insurance payout is reduced by the unpaid amount. This means that your loved ones will not receive the full amount that you intended to leave behind.
4. Myth: The beneficiary receives both the death benefit plus the cash value.
This can be one of the more confusing aspects of a whole life insurance policy. When the insured dies, the cash value of their policy is retained by the life insurance company. Policy beneficiaries receive only the face value of the policy. While some insurers do offer products that payout both the cash value and death benefit, they tend to come with much higher premiums.
5. Fact: Whole life policies do not require a medical exam.
Many whole life insurers do not require you to take a medical exam in order to purchase a policy. These policies are known as simplified-issue or guaranteed-issue whole life insurance policies. They are often marketed to people over the age of 50 to be used to cover funeral costs and other final expenses.
Keep in mind that these no-exam insurance policies typically offer much smaller payouts. In most cases, they offer a payout of no more than $50,000. Also, if the insured dies within the first few years of a guaranteed-issue policy, beneficiaries will not receive the full payout.
Finding the right life insurance policy for you and your family takes time and research. Be sure to consider both term and whole life insurance options before making a decision.