What Is Whole Life Insurance?
Whole life insurance is a type of permanent life insurance.
By permanent, we mean a single policy that lasts throughout the policyholder’s lifetime without the need for renewals.
A whole life insurance policy includes additional guarantees beyond the death payment normally paid through other life insurance policies.
One guarantee is that the policy builds cash value.
Another is that each policy includes an investment component with a guaranteed or non-guaranteed rate of return.
This form of insurance might appeal to individuals that want a “buy and forget” insurance product.
There’s never a concern the death benefit will go down and there’s no need to renew or buy ongoing policies.
Plus, premiums remain flat throughout the individual’s lifetime.
How Does Whole Life Insurance Work?
The majority of premiums paid on the policy go towards the insurance product and fees and commissions.
However, a small portion of every whole life premium also goes into a cash account that builds value.
Insurance companies invest the money in this cash account and the policyholder receives a return.
The return may be guaranteed at a modest interest rate or paid out in dividends as a non-guaranteed return.
Dividends are usually reinvested back into the account to add to the death benefit.
However, they can also be withdrawn like cash when requested.
While in the account, profits remain tax-free.
The policyholder can also withdraw funds without paying tax, provided the amount is less than the adjusted cost basis of the value in the cash account.
However, withdrawals greater than the adjusted cost basis of the value of the cash account are taxable as they represent investment gains.
Withdrawals also reduce the amount of the death benefit that will eventually be paid to the beneficiary.
Policyholders can also take out a loan on the cash value account.
The loan is tax-free, but the policyholder must pay interest on the loan and repay the loan itself.
Otherwise, the outstanding loan reduces the death benefit.
Term vs Whole Life Insurance
When buying term life insurance, the policyholder buys a policy for a set period called a term.
Common terms are 5, 10, 15, 20 and 30-years.
The insurer only pays out a death benefit if the policyholder dies within the policy term.
The insured needs to continually renew their policy or buy another to maintain coverage.
They may also pay more at the end of each term as one of the factors used in premium calculations is the policyholder’s age.
Whole life insurance does not have a set term.
Premiums are set when the individual buys the policy and they do not change.
There’s no need to renew as the policy provides continuous coverage until death.
A small portion of whole life insurance premiums goes into an account that accumulates cash value.
This amount can be used for loans or cash withdrawals.
|Whole Life Insurance||Term Life Insurance|
|Period Covered||Lifetime||Only for length of policy|
|Premiums||Fixed||Increase at renewal|
|Cash Surrender Before Maturity||Yes||No|
|Borrow Against Policy||Yes||No|
|Death Benefit for Beneficiary||Yes||No|
|Can Sell Policy||Sometimes||No|
|Health Assessment Required||Initial exam only||Depends on insurer|
Advantages of a Whole Life Insurance Policy
The following are some of the most notable advantages of a whole life insurance policy:
- Lifelong protection – no need to renew or buy new policies.
- Stable premium – premiums do not increase throughout the life of the policy.
- Accumulates cash value – a small portion of every premium goes into an account where profits grow tax-deferred.
- Loans available – policyholder can borrow against the cash value account, often at a low interest rate.
- Living benefits – financial options through withdrawals or loans should the policyholder’s situation change.
- Potential estate planning benefits – can use funds in a whole life cash value account to establish a trust to care for an heir or to pay estate taxes.
Disadvantages of a Whole Life Insurance Policy
The following are some of the most notable disadvantages of a whole life insurance policy:
- Costly – whole life insurance policies cost significantly more than other insurance products as they offer lifelong coverage.
- Inflexible – can’t increase or decrease coverage or adjust premiums.
- Cash value builds slowly – it takes many years to accumulate cash value as only a small portion of premiums are paid towards it.
- Interest charged on loans – insurers charge interest on loans borrowed against the cash value account.
- Unpaid loans reduce death benefit – beneficiaries receive less money if the borrowed money is not repaid within the policyholder’s lifetime.
- Use-it-or-lose-it – policies differ greatly, but some insurers state if the policyholder doesn’t withdraw the cash value within their lifetime, it is absorbed by the insurer at death instead of being passed on to the beneficiary.
- May pay less than other investments – the interest earned in a whole life insurance policy may be less than other investment products.
Frequently Asked Questions
- What is the catch with whole life insurance?
It may take decades to surpass the premiums paid compared to the accumulated cash value of the policy. Guaranteed rates of return are often very low and only a small portion of each premium goes into the account each time.
Non-guaranteed rates of return are higher, but it still takes many years to achieve the breakeven point between premiums paid and the cash value in the account. Plus, non-guaranteed rates are paid in dividends. Low bond yields in recent years have led to a decrease in dividends through some insurance companies.
- Who offers whole life insurance in Canada?
Individuals can buy a whole life policy from a licensed insurance agent or broker, or directly from a Canadian insurance company. All insurers and reinsurers operating in Canada must be licensed. Oversight is through the Office of the Superintendent of Financial Institutions of the Government of Canada.
According to Canadian Life & Health Insurance Facts 2021, more than 150 life and health insurers and their subsidiaries and affiliates operate in Canada.