Whole Life Insurance: What It Is And How It Works

Whole life insurance is a type of life insurance designed for individuals who plan to have significant assets or have significant assets while also desiring to protect their family from an untimely death. Coverage does not expire as long as the policyholder's account is active and in good standing.

If you're looking to buy whole life insurance, check out Policygenius. You can get real, free quotes all in one place based on your situation. Both my wife and I used PolicyGenius to get affordable life insurance policies after we had kids.

The definition of significant assets is one where there is a high likelihood of one's estate hitting or surpassing the upper limits of the estate tax exemption. For 2024, the estate tax exemption amount is $13.61 million, a record high.

Once you cross the estate tax exemption amount, you end up paying roughly 40% in death tax on every dollar over. A whole life insurance policy helps mitigate tax liabilities.

For very-high-income people who have maxed out their 401(k) plans, IRA, Roth IRA options, and 529 plans, a whole life insurance savings strategy can make sense, especially if they have a need for life insurance.

Side note: if you have a high net worth, make sure you understand the latest capital gains tax rules. If you're also a homeowner, learn how to avoid capital gains taxes if you plan to sell.

What Is Whole Life Insurance?

There are two main types of life insurance:

  1. Term life insurance
  2. Whole life insurance

Term life insurance is the cheaper, more straightforward option. You pay a premium for a policy that lasts for a certain amount of time. The most common durations are usually 10, 20, or 30 years.

Once that time has passed, you no longer have life insurance cover as you no longer pay any premiums. The term life insurance policy has served its purpose of insuring your life for the desired period.

Whole life insurance is a type of insurance that covers you for your whole life. It is also called Permanent Life Insurance. Unlike term life insurance, whole life insurance will never expire as long as you are making payments.

The other unique thing about whole life insurance is that it combines a death benefit with an investment element. This is why it's more expensive than term life. Wealthier families use whole life insurance as a way to tax-efficiently invest in risk assets that can be passed down to heirs through proper estate planning.

With whole life insurance, some of the premium you pay is set aside into a savings account. The purpose is for the money to accumulate over time and earn interest. That savings account can be used to invest in the stock market and potentially other risk assets.

Here's a primer on all life insurance options. It's a great resource to learn more about the different types of life insurance available. When you're ready, follow these 7 steps on how to buy life insurance.

Best Whole Life Insurance Companies

The best whole life insurance companies tend to be the largest with the most capital and longest operating history. After all, you want your life insurance company to survive long after you do. Otherwise, who is going to pay out the whole life insurance policy?

Here is my list of the largest life insurance companies in the market today. Many have been around for longer than we have all been alive. They are well-capitalized and have good corporate governance given most are publicly traded companies.

When choosing an insurance company, look for four main things. Financial strength, long operating history, outstanding reputation, and great customer service.

For example, USAA is one of those companies as I have been a customer for over 20 years. I use them for my auto insurance and home insurance. But I will be changing life insurance companies once my term life insurance expires because they weren't competitive.

Always shop around for life insurance as there are many competing firms. Policygenius is the #1 marketplace where you can get real life insurance quotes all in one place for free. My wife used PolicyGenius to switch from USAA to Principal and got more coverage for less money.

How Whole Life Insurance Works

Like term life insurance, whole life insurance policyholders have to pay premiums for their policy. This can be done monthly, or annually. The premiums stay from the time you take out the policy until the time you stop paying for the policy.

The time you stop paying for the policy usually means you've passed away. Or, you may have decided you simply no longer need life insurance.

In the event of the policyholder’s death, one or more beneficiaries will receive the death benefit. A beneficiary could be a spouse, a business partner, child, a trust, a friend, etc. You determine who your beneficiaries are and can change them at any time. The death benefit is the amount of the purchased coverage plus a cash value.

For example, if your insurance policy has $1,000,00 coverage, that’s how much the death benefit will be to your beneficiaries.

The cash value is determined by the portion of the premiums that go into the savings account which the insurance company holds. You can use it to buy more coverage, borrow money against it, invest, or surrender the policy for cash.

Just be aware that if you don’t repay a loan, your death benefit will be reduced. In addition, it will disappear if you surrender the policy.

Related: Are Life Insurance Death Benefit Payouts Taxable?

Types Of Whole Life Insurance

Variety is the spice in life. Just like there are many different types of homes for sale, there are many types of whole life insurance policies you can buy. Here are the main types.

Level Premium Whole Life Insurance

This policy offers premiums that will not increase or decrease over time. In addition, this is the most common type of whole life. Level premium whole life insurance policy makes sense to most since there is no change in premiums. When you conduct retirement planning and estate planning strategies, it's easier to model a fixed cost rather than a variable cost.

Limited Payment Whole Life Insurance

You’ll get life protection by making a limited number of premium payments (for example, for 20 or 30 years). People who take out a limited payment whole life insurance plan like the hybrid approach of having a term life insurance policy and a whole life insurance policy.

For example, you expect by age 65 to have all your kids out of the house, all your mortgage debt paid off, and have made enough money to last for the rest of your life. There's no need to bother contributing for more than 30 years, or after age 65. Your whole life insurance policy will have lots of value if everything works out.

Single Premium Whole Life Insurance

One of the most uncommon and unpopular whole life insurance policy is a single premium policy. You’ll pay a single, relatively large premium when issuing your policy and this will provide immediate cash value.

This policy is more attractive for wealthy seniors. However, if you are a young adult just starting off your career without a lot of assets, this is not an efficient policy. Instead, you're much better to get a term life insurance policy if you're just starting out your career.

Think about the single premium whole life insurance policy like an annuity. You pay a lump sum up front to get a guaranteed stream of income in the future.

Indeterminate Premium Whole Life Insurance

You’ll start off paying a lower premium when you start and usually gradually pay a higher rate after a certain guaranteed rate. This whole life policy helps with the arc of your wealth accumulation since most people start off poor and grow wealthier over time.

As a result, I like to think of this policy like an adjustable rate mortgage, where the payment is fixed for a certain period of time and then floats. The difference is, with an ARM, your interest rate could actually go down once the lock period is over.

What You Can Do With The Cash Value In The Whole Life Insurance

The cash value of a whole life insurance policy is the main difference between a whole life insurance policy and a term life insurance policy. Therefore, it's good to understand what a policyholder can do with the cash value while alive and after death.

  • Make partial withdrawals. If the money is not repaid, the withdrawals will reduce the policy’s death benefit — the payment to the beneficiary when you die.
  • Borrow against the cash value. You can take out loans for anything you’d like. You’ll have to repay them, though, with interest, to maintain the death benefit.
  • Withdraw all the cash value and surrender the policy. This will end the life insurance coverage. And, in the early years you will pay a surrender fee to the insurance company.
  • Use it to pay premiums once the cash value reaches a high enough level.

Here's how the cash value grows in value over time:

  • A whole life insurance policy guarantees a fixed rate of return on the cash value.
  • With indexed universal life, the cash value growth is tied to a stock index, such as the Standard & Poor’s 500.
  • With variable universal life, the cash value is invested in various accounts of stocks, bonds or mutual funds. This kind of policy offers the greatest potential returns. But, it comes with the risk that you could lose cash value if the investments tank.

How Much Whole Life Insurance Will You Need

Getting the right amount of life insurance depends on each individual. But in general, it is always better to over-insure than to under-insure. My general rule is to get the amount of insurance you think you need plus 10 percent. Due to lifestyle inflation, inflation, and the unexpected nature of life, it's always good to have an extra little buffer.

The main determinants of how much whole life insurance you should get include:

  • Liabilities: Mortgage, student loan, auto loans, credit card debt, company debt, etc.
  • Dependents: Non-working spouse, children, parents
  • Desire to support: Do you want to support your kids until they are 18, through college, or forever like some of my 40-year-old neighbors who still live at home with their parents
  • Estimated wealth: The wealthier you think you'll be beyond the estate tax exemption limit, the more you want whole life insurance
  • Outlook on taxes: The historical estate tax exemption amount, capital gains tax, and income tax levels can and will change in the future with different government regimes
  • Outlook for the markets: The more bullish you are, the more you may want to get a whole life insurance policy to take advantage of risk assets in a tax-advantageous way

At the very least, your whole life insurance policy should cover up all your liabilities and expected future liabilities. I personally like to have enough life insurance to cover all my liabilities and provide enough capital for my wife and children to live on for 10 years.

Smart tip: Please also consider getting life insurance before you go to a doctor to treat non-life threatening illnesses. The more you go to the doctor, the larger your medical record. The larger your medical record, the more life insurance companies have to increase your premiums.

Benefits Of Whole Life Insurance

  • It's permanent. Unlike term life insurance, which expires after an agreed upon term limit, whole life insurance covers you for your whole life as long as you are paying the premiums. It will never expire, so there’s no chance that you’ll outlive the policy.
  • Premiums are fixed. Most whole life policies are level premiums, which means even if you get sick or get terminal cancer, your premiums don't go up. Of course, you can choose to get different types of whole life insurance.
  • Investment component. Unlike term life insurance, whole life insurance as an investment component that may generate positive investment returns over the long term.

Here are more reasons to get whole life insurance.

Negatives Of Whole Life Insurance

  • Higher premiums. Whole life insurance is significantly more expensive than term life insurance due to higher commissions and rates. The main reason for the higher premiums is because part of the premium is going into the cash value portion of the policy that builds over time. Think about a whole life insurance as getting out an amortizing mortgage versus an interest-only mortgage.
  • It's for life. Given whole life insurance is to cover you for your entire life, you can't cancel unless you stop paying your premiums. But that's not so bad. You just waste money up front getting the premium and paying any commissions. The longer you have your whole life insurance policy, the more worth it it might be as you amortize the startup cost over a longer period of time.
  • Not as straightforward. Although whole life and term life both insure your life, some folks can get intimidated by all the vernacular surrounding whole life. Hopefully, this article helps explain things better. When you do get life insurance, the insurance professional can further answer any questions.

If you are still unsure if whole life insurance is the right choice for your needs, explore all the different types of life insurance available. You may find a simple term life insurance policy is suitable, or perhaps you may like something more complex like indexed universal life insurance.

High whole life insurance rates explained

Whole life insurance’s high premiums come with the territory; permanent life insurance policies tend to be costlier than term life insurance policies.

The premiums are exceptionally high for whole life insurance because the policy lasts your entire life, although you only pay premiums until a certain age or for a certain number of years. Unlike other forms of life insurance, you retain coverage even when your premium payments are over.

Your policy premium’s actual rates will be determined by the life insurance classification you fall into. There are four life insurance classifications:

  • Preferred Plus
  • Preferred
  • Standard Plus
  • Standard

Below are some factors that affect your whole life insurance premium:

AgeThe older you are, the more you will have to pay for life insurance.
Height and weightInsurance companies look at your height and weight to see if you fall into a healthy or risky range.
Medical examYour examiner will determine your health status. Any medical conditions, prescriptions, surgeries, diagnoses, or mental illness will be evaluated to determine your level of risk.
LifestyleDangerous hobbies, such as scuba diving or skydiving, or a risky job will put you in a lower life insurance classification.
Tobacco usePossibly the most important factor, smokers receive the lowest health classification and the most expensive life insurance premiums regardless of health or other lifestyle factors.
Criminal historyA felony on your record can warrant you for a poor life insurance classification, depending on how long after the charge you apply.
Substance abuseA few beers won't affect your insurance premiums, but insurers will look to see if you abused drugs or alcohol.
Family historyFamily health history can be an indicator of future risk and could affect your life insurance classification.
RidersAdding a rider to a life insurance plan provides additional coverage, but at the cost of higher premiums.

Whole Life Insurance For The Motivated And Wealthy

Whole life insurance is great for those who want to get life insurance for life and not have to re-up their policy whenever something changes. For example, I took out a 10-year, $1 million term policy in 2014 when I was 37 years old. Now that I have two kids at 42 years old, I have to go through the process of getting a new life insurance policy.

Further, our family wealth has increased by a lot since I retired in 2012 thanks to the bull market and my entrepreneurial endeavors. A term life insurance policy wasn't able to capture the S&P 500 gains, only my various investments.

In retrospect, I should have gotten a whole life insurance policy before I had children. Life insurance is an act of kindness. If you are motivated, plan to get wealthier, and plan to have a family or have a family, getting whole life insurance is not a bad idea. I recommended at least getting a term life insurance policy.

Check out Policygenius, the #1 marketplace where you can get real life insurance quotes all in one place for free. They help you see what's out there so you can make the best life insurance decision for you and your family.

I've met the founders multiple times and they are great people who've really provided an easier way for consumers to smartly shop for life insurance.

About the Author: Sam worked in finance for 13 years. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis, taking care of his family, and writing online to help others achieve financial freedom too.

Sam started Financial Samurai in 2009 and has grown it to be one of the largest independently owned personal finance sites in the world. You can sign up for his free private newsletter here.