Basic Forms of Whole Life Insurance

Basic Forms of Whole Life Insurance

Remember, whole life insurance provides a fixed, level death benefit or permanent protection with a cash accumulation feature. It's characterized by a fixed, level, or predetermined premium for life (or up to the age of 100).

The policy's cash value increases with each premium payment. A fixed interest rate is paid on the cash value, which, in a traditional policy, is also fixed for the life of the policy. Therefore, the cash value buildup of a whole life policy equals the face amount at age 100. The contract also includes nonforfeiture options or values if the policy owner wants to surrender the policy.

Although it's been presented that whole life premiums are calculated as if they were payable to the age of 100, they don't necessarily need to be paid this way. There are several different whole life insurance policy types to accommodate different premium-paying periods. The three most common types of whole life insurance are straight whole life, limited-pay whole life, and single-premium whole life.

Straight Whole Life Insurance Policies

The most basic form of whole life insurance is straight whole life, also known as ordinary whole life. Straight whole life insurance is the standard definition of whole life insurance as described up to this point. It's whole life insurance that provides permanent level protection with level premiums from the time the policy is issued until the insured's death (or age 100). This continuous premium, or whole life, plan is characterized by level, or fixed, premiums as long as the contract remains in force.

Limited Pay Whole Life Insurance Policies

The advantage of this type of whole life insurance policy is that it allows the policy owner to cease paying premiums after the limited payment period. At this point, the policy is entirely paid-up for life, and no future premiums are required. However, as with a straight life plan, the policy matures or "endows" at age 100. A predetermined, level premium for a limited payment period characterizes a limited payment whole life policy. There are several types of limited-payment policies, such as 10-pay life, 20-pay life, 30-pay life, and life paid-up at age 65.

For example, a 20-pay life policy is a whole life insurance policy in which premiums are payable for 20 years from the policy's inception, after which no more premiums are owed. A life paid-up at 65 policy is a whole life policy in which the premiums are payable to the insured's age 65, after which no more premiums are owed.

Premiums for these policies are higher than for a straight life policy because they are paid for only a limited period (i.e., 10 years rather than to age 100). Once payments are complete, the policy is paid-up for life, meaning no additional premiums are due. Upon the insured's death, the death benefit will be paid to the designated beneficiary. Although the policy is paid-up earlier than a traditional straight whole life policy, it will still not "mature" until age 100 since the contract has been predetermined. Since the premiums for these policies are higher than those for a traditional straight whole life policy, they are often said to have a more substantial savings element or a greater emphasis on savings than traditional straight whole life contracts.

Since the insurance company is receiving its money in larger premium payments, the cash value builds more quickly than in a straight life policy. Additionally, cash values build up even faster during the premium-paying years than during the non-premium-paying years. After the premium-paying period, the cash value continues to grow, but more slowly, until the policy matures and the cash value equals the face amount again at age 100.

Single Premium Whole Life Insurance Policies

Single premium whole life insurance is the most extreme form of a limited-payment policy. The policy is characterized by a lump-sum or single premium payment. The policy is fully paid up upon the payment of a lump-sum premium. Some single premium plans exist, which require two premium payments, such as a "dual premium" policy.

Common traits of a single premium whole life policy include:

• An immediate cash value is created
• Part of the premium is used to set up the policy's reserve
• Over time, the policy owner will pay less for the policy than if the premiums were paid annually
• Single premium life is defined as a modified endowment contract by the IRS

A single premium whole policy is initially the most expensive whole life policy. However, over the life of the contract, the single premium life policy is the least expensive compared to a straight life policy.

It should be noted that the IRS considers single premium policies to be a hybrid of a living investment and life insurance, known as a modified endowment contract (MEC). While these policies offer a tax-free death benefit like other cash value policies, some of the living benefits are restricted. For example, the IRS treats policy loans differently. Unlike loans against other whole life policy cash values, loans against a MEC's cash value are considered taxable distributions.

For example, meet Pam, a 45-year-old successful entrepreneur who recently sold her tech startup. With a significant amount of liquid assets, Pam is looking for a way to ensure her family's financial security while also making a smart investment. She decides to purchase a single premium whole life insurance policy with a face amount of $500,000. The insurance company calculates the lump-sum premium required for this policy is $150,000. Although this is a substantial upfront cost, the policy provides Pam with an immediate nonforfeiture cash value, tax-deferred cash value growth, and cost efficiency over the life of the contract compared to a traditional straight whole life policy — along with the $500,000 death benefit that provides financial security for her family.

A Summary Table of Whole Life Policy Characteristics