# How Whole Life Insurance Works

> **Definition**
>
> Whole life insurance policies allow owners to borrow or withdraw the cash value.

## What Is Whole Life Insurance?

Whole life insurance provides coverage throughout the life of the insured person. In addition to paying a tax-free death benefit, whole life insurance includes a savings component in which cash value may accumulate. Interest accrues on a tax-deferred basis.

Whole life insurance policies are one of several types of permanent life insurance. Universal life, indexed universal life, and variable universal life are others. 

### Key Takeaways

*   Whole life differs from term life insurance, which limits coverage to a specific number of years.
*   Most whole life policies feature level consistent premiums, which don't change over time.
*   Withdrawals and outstanding loan balances reduce death benefits.

![Whole Life Insurance](https://www.investopedia.com/thmb/zY0OjbzxcWR78YV6wZiTq43w1MU=/1080x0/filters:no_upscale():max_bytes(150000):strip_icc()/WholeLifeInsurance-273c776c0b234dbbb2bbfef4f71954de.jpg)

*Another benefit of whole life insurance is that it builds cash value over time. — Investopedia / Nez Riaz*

## How Whole Life Insurance Works

Whole life insurance guarantees payment of a [death benefit](https://www.investopedia.com/terms/d/deathbenefit.asp) to beneficiaries in exchange for level, regularly-due premium payments. The policy includes a savings portion, called the “[cash value](https://www.investopedia.com/terms/c/cash-value-life-insurance.asp),” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis. Growing cash value is an essential component of whole life insurance.

To build cash value, a policyholder can often remit payments greater than the scheduled premium to purchase extra coverage (known as [paid-up additions](https://www.investopedia.com/terms/p/paidup-additional-insurance.asp) or PUA). Policy dividends can also be reinvested into the cash value and earn interest. Over time, the dividends and interest earned on the policy's cash value will provide a positive return to investors, growing larger than the total amount of premiums paid into the policy. 

The cash value offers a [living benefit to the policyholder](https://www.investopedia.com/articles/personal-finance/082114/6-ways-capture-cash-value-life-insurance.asp), meaning the policyholder can access it while the insured is still alive. To access cash reserves, the policyholder requests a withdrawal of funds or a loan. Withdrawals are tax-free up to the value of the total premiums paid.

Interest is charged on [policy loans](https://www.investopedia.com/terms/p/policyloan.asp) with rates varying per insurer, but the rates are generally lower than you’d get with a personal loan or home equity loan.

However, withdrawals and unpaid loans also reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could chip away at the death benefit or even wipe it out entirely. 

> **Fast Fact**
>
> Whole life insurance is different from term life insurance, which only provides coverage for a certain number of years, rather than a lifetime. Term life does not have a cash savings component and only pays out a death benefit. 

## Whole Life Insurance Cash Value

A cash value life insurance policy is similar to a retirement savings account in that it allows investments to accumulate tax-deferred interest.

Part of each premium payment goes toward the policy's cash value, which can be withdrawn or [borrowed against](https://www.investopedia.com/ask/answers/111314/how-can-i-borrow-money-my-life-insurance-policy.asp) later in life. The cash value of a life insurance policy grows quickly when the insured is young. But because more of the premium is needed to cover the cost of insurance as the insured ages, the cash value grows more slowly as they get older due to the higher risks associated with age.

The insured can access their policy’s cash value by borrowing against it the cash value or by [withdrawing money](https://www.investopedia.com/articles/pf/08/life-insurance-cash-in.asp) in a partial cash surrender. Surrenders will reduce the final death benefit of your policy. 

You can also use the cash value to cover your monthly premium payments instead of paying out of pocket. Or you can surrender the whole policy to receive the entire available cash value (minus any [surrender fees](https://www.investopedia.com/terms/s/surrendercharge.asp)). However, the policy will be terminated and the death benefit will no longer be available to your beneficiaries.  

Some companies in the U.K. and Australia offer [insurance bonds](https://www.investopedia.com/terms/i/insurancebond.asp) with their policies, which provide some tax advantages.

## Whole Life Death Benefit

The dollar amount of the death benefit is typically specified in the policy contract. But it can be changed in some instances. 

Some policies are eligible for [dividend payments](https://www.investopedia.com/articles/personal-finance/011816/guide-dividendpaying-whole-life-insurance.asp), and the policyholder may elect to use the dividends to buy paid-up additions to the policy, which will increase the [amount paid at the time of death.](https://www.investopedia.com/articles/wealth-management/032516/life-insurance-increasing-death-benefit.asp)  

> **Fast Fact**
>
> Death proceeds are non-taxable to the beneficiary.

The death benefit can also be affected by certain policy provisions or events. As mentioned before, unpaid policy loans (including accrued interest) reduce the death benefit dollar for dollar.

Alternatively, many insurers offer voluntary [riders](https://www.investopedia.com/terms/r/rider.asp)—for a fee—that secure or guarantee coverage, including the stated death benefit. Two of the most common such riders are the accidental death benefit and waiver of premium riders, which protect the death benefit if the insured becomes [disabled](https://www.investopedia.com/life-insurance-disabled-people-5220199) or critically or terminally ill and is unable to remit premiums due.

Beneficiaries may also have decisions to make about how the death benefit is paid. The default option is to receive a lump-sum payment. But some policies also allow beneficiaries to choose to get the death benefit in installments, or to convert it to an annuity. An annuity may pay out for a set amount of time until the death benefit is exhausted, or it could pay out for the life of the beneficiary. The death benefit continues to earn interest until it is paid, and that interest may be taxable. 

> **Important**
>
> As is the case with any kind of permanent policy, it's important to thoroughly research all insurers being considered to ensure they're among the best whole life insurance companies currently operating.

## Uses of Whole Life Insurance

As with any kind of life insurance, a whole life insurance policy gives individuals and their families financial security against the loss of a breadwinner. For families that rely on the income of a single person, a whole life policy can provide financial security against the sudden loss of an income provider.

But unlike term life, whole life can also be used as an investment. Once the cash value has grown big enough, you may be able to withdraw or borrow from it to pay for large purchases such as a home. Some people also use whole life cash value to supplement their income in retirement when markets are low.

Whole life insurance is also useful for businesses as a contingency plan for the loss of a key employee or partner. If a key employee passes away, a whole life policy can provide a financial offset to the loss of their skills or expertise. If the deceased is part owner of the company, a whole life policy can provide the remaining owners with enough capital to buy out the deceased partner's share of the business.

## Types of Whole Life Insurance

There are several main types of whole life insurance, categorized based on how premiums are paid.

*   [**Level Payment**](https://www.investopedia.com/terms/l/levelpremiumlife.asp): Premiums remain unchanged throughout the duration of the policy. This is the most common type of payment plan.
*   [**Single Premium**](https://www.investopedia.com/articles/pf/05/singlepremlife.asp): The insured pays a one-time large premium, which funds the policy for life. But this type of policy is almost always a [modified endowment contract](https://www.investopedia.com/terms/m/modified-endowment-contract.asp), which has tax consequences. 
*   [**Limited Payment**](https://www.investopedia.com/what-is-limited-payment-life-insurance-8348603): As the name suggests, you pay a limited number of payments. Premiums will be higher than they would be in a level-payment situation, but you’ll only pay them for a certain number of years. 
*   **Modified Whole Life Insurance**: The opposite of a limited payment policy, this type of whole life insurance offers lower premiums than a standard policy in the first two or three years, and higher-than-standard premiums in the later years. It is more expensive in the long run.

Whole life insurance policies are further distinguished as participating and non-participating plans. With a non-participating policy, any excess of premiums over payouts becomes profit for the insurer. However, the insurer also assumes the risk of losing money.

With a [participating policy](https://www.investopedia.com/terms/p/participation_policy.asp), any excess of premiums is redistributed to the insured as a dividend. This dividend can then be used to make payments or increase one's policy coverage limits. However, dividends are not guaranteed and often vary each year, as they are primarily based on the company’s financial performance. 

## Whole Life Insurance vs. Term Life Insurance

Whole life insurance is similar to term life insurance, in that both types of policies offer a payout upon the death of the insured. However, there are important differences. While whole life insurance offers a guaranteed death benefit for the entire lifetime of the insured, a term policy only pays out if the insured dies within a certain time frame—usually 10, 20, or 30 years.

There are other considerations as well. In order to provide greater benefits, a whole life policy requires significantly higher premiums than a term policy with the same coverage limit. Whole life premiums are typically fixed throughout the policy duration, while term rates increase at each renewal as the insured grows older.

## Advantages and Disadvantages of Whole Life Insurance

Advantages

*   Lifetime coverage
    
*   Cash value you can use for loans, withdrawals, or premium payments
    
*   Guaranteed death benefit amount
    
*   Predictable premium payments
    
*   Tax-free loans
    

Disadvantages

*   More expensive than term life
    
*   Cash value may grow slower than with other policies
    
*   No flexibility to adjust the premium
    
*   Limited ability to adjust the death benefit
    

## Advantages Explained

*   **Lifetime coverage**: As with all permanent insurance, whole life insurance provides coverage until the insured’s death.
*   **Cash value you can use for loans, withdrawals, or premium payments**: Part of each premium payment accumulates as cash value, which you can withdraw or borrow against during your lifetime.
*   **Guaranteed death benefit amount**: Your death benefit is established when you sign up for your policy and stays the same while the policy remains active.
*   **Predictable premium payments**: Your premium is also fixed at issue and will not typically vary over your lifetime (unless you choose a non-level premium option).
*   **Tax-free loans**: While withdrawals of more than you’ve contributed to the cash value are taxed, policy loans are not.  
    

## Disadvantages Explained

*   **More expensive than term life**: Premiums of a whole life policy are usually significantly higher than term premiums because the policy accumulates cash value and covers you for your whole life. 
*   **Cash value may grow slower than with other policies**: The growth rate of your whole life policy’s cash value is fixed when you buy it, while returns on other types of permanent coverage (such as universal life) vary based on such factors as investment returns and interest rate fluctuations, so they could be higher.  
*   **No flexibility to adjust the premium**: Unlike universal life policies, whole life plans do not allow you to change your premiums.
*   **Limited ability to adjust the death benefit**: Your death benefit is also established when the policy is issued. While you cannot directly increase the original death benefit, you can use dividends to purchase additional coverage.  
    

## How Much Does Whole Life Insurance Cost?

On average, whole life insurance policies are significantly more expensive than term life insurance. Investopedia research using Quotacy found that the average monthly premium for a $500,000 whole life insurance policy ranges from $247 for a 30-year old female to $887 for a 60-year male. 

In contrast, monthly premiums for term life insurance range from $25 for a 30-year-old female to $241 for a 55-year-old male for the same amount of coverage.

## What Is the Difference Between Universal and Whole Life Insurance?

[Universal life insurance and whole life insurance](https://www.investopedia.com/articles/pf/07/whole_universal.asp) are types of permanent life insurance that offer guaranteed death benefits for the life of the insured. However, a universal life policy allows the policyholder to adjust the death benefit as well as the premiums. Higher death benefits require higher premiums. Whole life insurance, on the other hand, does not allow for changes to the death benefit or premiums, which are set upon issue.

## How Much Is Whole Life Insurance?

The cost of whole life insurance varies based on several factors, such as age, occupation, and health history. Older applicants typically have higher rates than younger applicants. People with a stellar health history normally receive better rates than those with a history of health challenges. The face amount of coverage also determines how much a policyholder will pay; the higher the face amount, the higher the premium. Also, certain companies have higher rates than others, independent of the applicant and their risk profile. It's also worth noting that for the same amount of coverage, whole life insurance is far more expensive than term life insurance.

## What Is Modified Whole Life Insurance?

Modified whole life insurance is permanent life insurance in which premiums increase after a specific period. Policyowners pay lower premiums than they would for a level premium policy during the first few years, and higher premiums in the later years. Traditional whole life insurance premiums, in contrast, remain the same throughout the life of the policy.

## The Bottom Line

Whole life insurance generally has a level premium and death benefit, and provides a guaranteed benefit upon the death of the insured, regardless of when they die. Part of the premiums you pay for a whole life policy go to a savings component known as the cash value. Those funds are invested with a guaranteed return, and after they’ve grown big enough, you can borrow from or withdraw from the cash value, tax-free. 

This and the fact that whole life covers you until death (as long as you pay your premiums) offer clear advantages over term life insurance, which only pays out if the death occurs within a specific time frame. However, whole life insurance also has significantly higher costs.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Publication 525, Taxable and Nontaxable Income](https://www.irs.gov/pub/irs-pdf/p525.pdf)." Page 23.
>     
> 2.  Internal Revenue Service. "[Life Insurance & Disability Insurance Proceeds](https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insurance-proceeds)." Select "Do I report proceeds paid under a life insurance contract as taxable income?"
>     
> 3.  Guardian. “[Can I Withdraw Cash from My Life Insurance Policy?](https://www.guardianlife.com/life-insurance/withdraw)”