Whole Life Insurance Is Very Commonly Misunderstood.
If you already own a whole life insurance policy... or if you are considering one... it is crucially important that you clearly understand this product and how it works.
Whole life insurance policies are more complicated than term life policies.
The result is... far too many people do not understand how whole life policies really works.
Also, there are significant cost differences between whole life policies and term policies.
Therefore, it is...
Very important to both your pocketbook and your family's financial security that you understand the difference between whole life and term life insurance.
So What Is Whole Life Insurance?
Whole life insurance is sometimes referred to as "Cash Value" insurance.
It is also, sometimes referred to as "Permanent" insurance.
The reason that whole life insurance is sometimes called "Permanent" insurance is that...
A whole life policy will remain in force (as long as the premium is paid)... unchanged in both face amount (coverage) and premium amount (cost) until... the insured reaches the age of 100 years old (hence the term "whole life").
The reason that whole life insurance is sometimes called "Cash Value" insurance is that...
Over time... a "cash value balance" is created within the policy.
This created "cash value balance" is only possible because you pay a much higher premium for a whole life policy than you would for the same amount of coverage with a term life product.
You pay extra to create the "cash balance".
The reality is this... part of your premium payment goes to pay for life insurance coverage in an amount equal to the "face value" of the policy.
Then, after all policy administration expenses are deducted, the remainder of your premium payment goes into your "cash value" account.
The insurance that is bought within the whole life policy is actually term insurance. The amount of term insurance is equal to the coverage amount or the "face value" of the policy.
So, essentially, what you have is... term life insurance coupled with a savings account.
However... This Savings Account Functions Like No Other.
With this kind of savings account...
You will typically own the policy for a year or two before any "cash value" shows up and is therefore available to you.
When it does finally show up... the insurance company will pay a little interest (normally not much) on the balance.
At this point... you will have access to the cash value and can use it for any purpose that you like.
However... you can only access it in the form of... a loan.
You will be charged interest on the loan.
And... you will pay it back.
What? You gotta be...
Wait a minute... I thought this was my money!
If it is my money... why would I have to borrow it?... why would I be charged interest?... why would I have to pay it back?
If That Bothers You... Consider This Poorly Understood Aspect Of Standard Whole Life Insurance Products.
Few people understand that... if the insured dies... the beneficiary does not get both the cash value and the face amount of the policy.
Instead, upon death... the beneficiary receives only the face amount of the policy. The insurance company retains the cash value.
Now, let's suppose that you own a whole life policy and you have borrowed from the cash value in the policy.
What happens if you die?
Your beneficiary will receive a death benefit in the amount of the "face amount of the policy" less the outstanding "loan balance and interest due."
So here is a word of caution...
If you want that cash value... then Do Not Die while the policy is in force!
Even though the cash value in your policy was created primarily by your premium overpayment... you can only access it... while the policy is in force... via a loan.
And... you will pay interest on this loan.
And... you will pay it back whether you are dead or alive.
How do you feel about that?
You pay extra premium to create a cash value balance and then... once it finally shows up and is made available to you... you can only access it via a loan with interest.
Does that sound like a good deal for you?
Or... is it a good deal for the insurance company?
Are You Thinking... How Can This Be So?
Well, the answer is... as long as the policy is in force... you do not own the cash value. The insurance company does.
So... when it comes to the cash value in a whole life insurance policy... there are only two ways that you can own and therefore have the cash value.
The first way is to... redeem (get rid of) the policy and the insurance company will send you a check for the cash value.
The second way is to... live to be 100 years old and then the insurance company will redeem the policy and send you the cash value.
If you desire to create "cash value"... it is much better to do so outside of any insurance product.
Simply saving into a money market account or investing in high quality mutual funds will provide a much better return on your money.
Then, at least... it will be your money. You will always have access to it. And, you will not have to borrow it or pay it back.
Finally, some whole life policies provide that at some point in time that the owner can have a “paid up” policy... and therefore, won’t have to pay the premium anymore.
If you currently own a whole life insurance policy and your goal is to end up with a "paid up" policy, then... just make sure that the amount of "paid up" insurance is adequate.
Normally the "paid up" coverage amount is much less than the current coverage amount. Make sure that you know what you have.
Please understand that I am not claiming that a whole life insurance policy is a bad choice for every situation. Everyone's situation and needs are different.
In fact, it could be argued that a whole life product might be a better choice compared to a term policy... if, that term policy requires you to re-prove your health at some point in time in order to renew or exchange it.
However, if you will review my discussion about
term life insurance
on this site, you will know what to look for in a term product and what to avoid.
I am, however, saying that...
For the vast majority of families... a term life insurance policy is a far better way to adequately and economically protect your family.
Here are a few cautions...
Never, ever... get rid of (redeem) any life insurance policy until the replacement policy is in force and in your hands.
Also, you should know that... some policies may charge a redemption fee or have various redemption requirements.
In addition, be aware that... the redemption of a whole life insurance policy (or any cash value type policy) can potentially create a tax liability for you.
If the cash value total received by you is more than the total of all of the premium payments made by you... then you must report the difference on your personal tax return... as income.
The good news is... the total cash value rarely exceeds the total premium payments. Therefore... most of the time... the cash value will not be taxed.
Here is a link to the IRS website.
and then select "Publ 525".
In the Table of Contents, look under Misc. Income, Life Insurance Proceeds, "Surrender of Policy for Cash".
Finally, always consult with your life insurance agent, your financial adviser and/or your tax adviser prior to redeeming any life insurance policy.
"Because It Matters"... Jim
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