Whole Life Insurance Explained

whole life insurance - woman meditation

What Is Whole Life Insurance

Whole life insurance is a type of permanent life insurance that provides coverage throughout the lifetime of the life insured. It offers protection and equity, guaranteeing that you will never lose your death benefit (unless canceled) and allowing you to build tax-deferred wealth (participating) over time.

A participating whole life insurance policy provides the insured an opportunity to save for retirement or even to become his or her own banker through the infinite banking concept.

This type of policy is also known as “traditional” life insurance. Whole life policies are different from term policies in that they provide permanent coverage for the insured’s entire lifetime, not just temporary death benefits.

Premiums paid on a whole life policy may build cash value that will grow tax-deferred within the policy through the guaranteed CSV and policy dividends accumulation.

In almost a decade of practice, what I’ve observed is that one of the main problems senior Canadians encounter is the risk of losing coverage at an old age since most Canadians are only covered with a term life insurance policy.

While it’s good to have term life insurance in the early years for temporary financial obligations, it’s also smart to implement permanent life insurance for one’s permanent financial obligations such as one’s own final expenses (funeral and taxes at death).

I’m glad that you’re doing your research on whole life insurance since many Canadians are under the impression that they no longer need their life insurance policy in their senior years.

father and child walking - whole life insurance

2 Types of Whole Life Insurance

Participating Whole Life Insurance

Participating whole life insurance is a type of whole life insurance that provides you with guaranteed lifetime coverage and the opportunity to participate in the earnings of the company’s whole life policies (dividends).

Although these payments are not guaranteed, most firms have rarely missed a year of distribution.

You can receive dividends payout in a variety of ways. In cash, used to buy more “paid-up” coverage, or kept inside your policy for tax-deferred wealth accumulation.

Beyond its insurance protection, a participating whole life policy has a tax-advantaged asset-growth component that can help you build a larger estate than you could in a taxable account. The cash value that accumulates in your policy grows free of annual taxation.

Non-participating Whole Life Insurance

Non-participating whole life is the other type of whole life insurance available today. The main distinction of a non-participating policy to a participating one is that it does not earn any dividends. While you still have the cash value component, your equity build-up is limited to premium surplus or guaranteed cash values.

While non-participating whole life insurance does not pay out dividends, it allows people who are interested in permanent insurance that offers guaranteed coverage and guaranteed level premiums to have access to this type of coverage.

Whole Life Insurance Policy – Duration

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As the term “whole life” suggests, a whole life insurance policy is designed to provide both “death protection” for the life insured’s “whole life”, unless of course when canceled or premium payments were stopped before the policy is considered to be paid-up.

Whole life insurance is the truest form of permanent insurance. The death benefit will stay in place regardless of market performance. Once paid up you’re guaranteed to have the death benefit for the rest of your life.

Generally, there are a couple of types of permanent insurance:

Whole Life – Provides coverage for your “whole life”. As mentioned, this is the purest form of permanent life insurance. In saying that however, the monthly premium may be restrictive, subjective of course as it depends on a person’s affordability and priority. If you’re risk-averse, then whole life is for you.

Universal Life – is a hybrid of term and permanent life insurance. It provides coverage, but the coverage duration is dependent on the amount of contribution, and the cash value accumulation is dependent on market performance. If you’re young, seeking asset growth, and you don’t mind market volatility. This can be your best bet. One thing to look out for with universal life insurance is your cost of insurance and the amount of your actual contribution to the policy.

Term to 100 Life Insurance – Provides coverage for up to age 100 but it does not have any cash values, so your coverage may be at risk of lapsing should you miss premium payments.

When a policyholder dies, a death benefit is paid to the beneficiary or beneficiaries. Upon cancellation, the cash value is paid out to the policy owner.

Whole Life Insurance Policy – Cost

whole life insurance cost

While the monthly or annual contribution required for a whole life insurance policy is relatively higher than a term life insurance, whole life policy costs generally stay level over time.

In essence, there’s really no guesswork with whole life insurance policies. What you see is what you get. When reviewing life insurance policies, (especially universal life), I always tell clients or prospects to go back to the actual signed illustration presented by the agent or advisor.

While the illustration isn’t your contract, the signed life insurance illustration is the basis of your contract.

Compared to other types of life insurance policies, the most important benefit that you can get from whole insurance is the peace of mind in knowing that not only is your death benefit guaranteed, your cost of insurance and your corresponding premium contribution will not increase over time.

So, there are no surprises.

The important thing is that you can afford to make the monthly contribution until your policy is paid up, preferably in 20-years (or 15-years with a few carriers).

Advantages of Whole Life Insurance

Guaranteed Death Benefit

Whole life insurance, whether participating or non-participating, offers guaranteed death benefits with an opportunity to increase in value over time. This is an important feature for any life insurance policy because the death benefit helps protect your beneficiaries against financial loss in the event of your death and can provide liquidity to pay final expenses or outstanding debts.

As traditional permanent life insurance, you’re guaranteed that you’ll never run out of death benefit, not unless if the policy is canceled.

Whole Life Insurance Saves You Money

In whole life insurance, cash accumulates on a tax-advantaged basis. It’s possible to write checks from the policy for any reason, and it’s also possible to borrow against the cash value without penalty. In this way, whole life insurance provides immediate savings from day one through “forced savings” – the cost of your life insurance is deducted from your bank account or earnings each month.

Whole life insurance is based on traditional underwriting standards, so it’s very easy to qualify especially during your younger years.

Your insurer calculates the premium rate based on your age, health history, and several other factors that help determine your risk as a policyholder. The younger you are when you apply for whole life insurance, the lower your premium rate will be. This means more savings and less of a financial burden for you and your family in the event of your death.

Guaranteed Level Premiums and Cost of Insurance

A whole life insurance policy guarantees level premiums and level cost of insurance. This means that your monthly or annual contributions are guaranteed to stay level until your policy is paid up or over the life of the policy in the case of “life-pay” contracts.

Potential for Dividend Growth

You may have heard some agents claim that there is no cash value accumulation with whole life insurance, that’s because they’re referring to non-participating whole life policies, which means that the policy does not participate in the profits of the carrier’s whole life policies.

Non-participating whole life insurance policies do not have the potential for dividend growth.

In contrast, participating whole life policies do have the ability to accumulate cash value from dividends paid on a quarterly basis by the carrier of a participating policy.

These dividends are not guaranteed but are based upon the profits earned by the company on their other whole life insurance policies, unlike universal life insurance, whose cash value growth depends on market performance.

The dividends are not guaranteed to be paid out, but they do usually earn 2-4% annually depending upon what carrier is issuing the policy and how long you’ve owned it. Also, note that these dividends are not subject to income tax and will remain as such until they are withdrawn from the policy.

It’s important to be aware of this distinction and make sure you ask about dividends before you buy whole life insurance, as there is a difference between traditional participating and non-participating policies, and some agents will try to sell you non-participating whole life insurance when participating may actually make more sense for you.

Potential for Dividend Payout

whole life insruance - dividends

Depending on how your whole life insurance policy is structured, you may have the option to take your dividends out of your policy as cash or use them to purchase paid-up additions which would directly increase your death benefit.

If you choose not to take them out as cash, then the dividends will continue to grow tax-deferred until they are withdrawn by you at a later time – which can be beneficial for someone who is looking to pass on a larger estate.

If you’re planning to receive dividends payout it’s important to consider the tax consequences of taking dividends on an annual basis.

Depending on the amount of coverage and contribution, if your annual dividends payout isn’t that big to provide you with a material amount of passive income, I would suggest that you get a dividend option that leaves the dividends inside your policy to either buy more insurance, to accumulate over time, or to lower your monthly contribution.

A knowledgeable advisor will be able to help you make the best decision for your situation and work with you to design a policy that provides the maximum benefit based on your needs and financial objectives.

Whole Life Policy Does Not Expire

Another notable advantage of a whole life policy is that it does not expire. This means the policy stays in effect, as long as you do your part of the contract (i.e. maintain your contribution ’till it’s paid-up) unless when you cancel the contract.

In most cases, whole life insurance policies stay in place throughout the life insured’s lifetime.

Can Fund Your Retirement

insured retirement plan with whole life

Participating whole life policies have the ability to fund or supplement your retirement (depending on contribution).

As mentioned above, a participating whole life insurance policy has the ability to build cash value which empowers you to build compounded wealth in addition to your death benefit.

The accumulated cash values can be accessed through direct withdrawals (not advised) or leveraged through a bank collateral loan at retirement.

In certain types of policies, you can take a policy withdrawal from the accumulated cash value in your policy. Since this method reduces the total cash value, it also affects future growth and reduces the death benefit. If any amount of your withdrawal exceeds the pro-rated policy adjusted cost basis (ACB), that amount is considered a taxable disposition, creating taxable income.

Over time, your accumulated cash values may have increased your whole life coverage; withdrawing these cash values may reduce your overall coverage death benefit amount, as well as future cash value growth. Plus, you may also have to pay taxes on any amount of the withdrawn cash values that exceed the policy’s pro-rated adjusted cost basis or ACB, which is considered a taxable disposition.

Instead of making direct withdrawals or surrendering whole or part of the policy to access your cash values at retirement, you can either do a policy loan or better, a bank collateral loan.

The best way to access your accumulated cash values at retirement is to use your whole life policy in conjunction with a bank collateral loan, rather than withdrawing the money or completely surrendering your whole life policy, or even doing a policy loan. Using this method, you will remain covered and you can continue to grow your policy’s cash value while also accessing cash through a bank loan strategy.

Disadvantages of Whole Life Insurance

Whole life insurance is considered permanent coverage, so it comes with some downsides. You may need to put up with these disadvantages in order to benefit from the positives of a whole life insurance policy:

Higher Premiums

The cost for whole life insurance policies seems higher than other types due to the savings component and guarantees. For some people, the benefits provide plenty of return, while others may find that they’re paying too much for a product that provides below-average returns.

Without really understanding the benefits of whole life insurance, people will naturally gear toward a term life policy purchase when presented with whole life and term life insurance quotes. That’s because term life insurance presents a lower monthly premium, well at least during the first 2 renewals, after which it can get more expensive over time, and without any cash value accumulation to boot. Thus, term life is not an efficient life insurance solution for long-term coverage.

When looking for permanent coverage, you either go with whole life, universal life, or a term to 100 coverage. So, if whole life’s required monthly contribution seems restrictive, well-funded universal life insurance or a term-100 may be an option.

Not Flexible

Another disadvantage of whole life insurance is it isn’t a flexible type of life insurance, while it’s a set and forget policy in most cases, you can’t lower or increase your premiums, if you’re not a fixed income earner, you may want to consider universal life insurance instead.

Cash Value Build-up Takes Time

Cash value build-up with whole life insurance takes time, that’s because a portion of your monthly premium has to go toward your cost of insurance and policy fees, at least in the first couple of years. Once all fees are paid out, all premiums will go toward cash value build-up. This can take anywhere from 10 to 20 years.

But once your whole life insurance policy starts building up its cash value, it’s pretty much guaranteed that you’ll start earning a return on the money, despite market conditions. The only catch here is it takes time before that happens depending on how old you are and when you start building up cash value.

Policy Loans Aren't Without Interest

When you apply for a policy loan, interest is charged on the outstanding loan balance, if you do not repay it before you die, the insurance company takes it out of your death benefit and your beneficiaries will receive the net of your loan and its corresponding interest.

May not be an Ideal Wealth Accumulation Vehicle

Whole life insurance may not always be the best option when seeking investment growth. As you already know, that cash value accumulation inside a whole life insurance policy isn’t dependent on market performance. This means that the cash values you accumulate inside your policy may be less than what you could get stand-alone investments or universal life insurance.

Who Should Buy a Whole Life Insurance Policy

Whole life insurance is best for someone who is looking for a guaranteed, permanent life insurance policy. It’s also advisable for people who are looking to grow wealth inside a life insurance policy but are risk-averse. While the overall growth may be lower compared to when you’re investing in the stock portfolios, you don’t have to deal with market ups and downs.

With whole life, there are no negative returns.

In general, I compare permanent life insurance to a home purchase. You make your monthly contribution into your asset, and you grow equity from inside that asset over time.

When it’s paid up, you have the option to dispose of it to access your equity or keep it for the rest of your life.

Similarly, you could actually leverage your asset with a bank to use the bank’s money for retirement, instead of yours. This way, your equity continues to grow, your beneficiaries remain covered yet you’re able to fund your retirement.

Whole Life Insurance vs. Term Life Insurance

If budget isn’t a concern, whole life insurance is generally a better option than term insurance because it provides you with a lifetime, guaranteed death benefit and a participating plan allow you to accumulate wealth overtime on a tax-advantaged basis.

Term life insurance, on the other hand, only provides death benefits. The cheapest life insurance you can get is a 10-year term life insurance but I always say this with a caveat, because it’s only cheap in the first 10-years. So really, you should only get term life insurance for your temporary financial obligations like a short-term debt for income replacement purposes.

Whole life or any other type of permanent life insurance covers financial obligations that do not go away; an example of which are costs that may arise as a result of a person’s death.

Whole life insurance provides guaranteed life insurance protection that does not expire. With whole life insurance, you will pay a level monthly premium that is guaranteed for the duration of your life (or 20-years). Guaranteed means that even if you celebrate your 100th birthday, your beneficiaries still receive the face amount of coverage.

whole life vs term life

Choosing an advisor for your needs

A professional financial advisor can help you decide on the right type of life insurance that meets your needs, budget, current situation, and future goals.

Life insurance is one of the most important financial decisions you will ever make.

It can help protect the financial well-being of the people you care about against the potential financial risks that may arise as a result of death. 

Life insurance gives your family peace of mind in knowing that their lifestyle is secured in case of premature death of any of the breadwinners.

It covers unforeseen expenses such as funeral costs, and other financial obligations, like potentially pay for education or replace a breadwinner's income.

If you're not sure as to what type of life insurance is right for you, we can guide you by determining what your current obligations are, what needs protecting, and what your future goals are.

Please don't hesitate to book an appointment with us at your most convenient time.

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