How Does Whole Life Insurance Work?


Beyond the fact that whole life insurance is a permanent policy that will last your lifetime, the policy’s cash value and fixed premiums are important to understand. Fixed premiums are the amount you pay for your policy. With whole life insurance, you can usually decide how long you want to pay your premiums. You could choose to pay higher premiums for 20 years so that they’re finished by the time you’re retired, or opt to pay lower premiums until you’re 100, for example. Either way, your premiums won’t change over the years. 

Then there’s the cash value component. With a whole life policy, the cash value of your account grows at a rate set by your insurance provider, although you may have the option to add any dividends to your cash value, growing it further.  Other permanent life insurance policies come with a cash value component, but that cash value grows differently. Universal life policies grow their cash value at a rate tied to a specific interest rate, like the rate of a money market account. Variable life policies invest the cash value, and the rate of growth depends on the performance of the investment. 

For people looking for permanent life insurance with level premiums and a fairly predictable cash value growth, whole life insurance delivers. The Insurance Information Institute (III) reports that whole life is the most popular type of permanent life insurance policy. 

The biggest draw of having a cash value on your life insurance is that it gives you a way to use your life insurance while you’re alive. In many cases, once it reaches a certain amount, you can use the cash value to pay your premiums.  You can also withdraw the savings or borrow against it during your lifetime for any reason, such as paying for a child’s or grandchild’s college tuition, says Laura Adams, author and host of the Money Girl podcast.

Just be advised that any withdrawals or outstanding loan balances will reduce your death benefit by the amount you’ve taken out. Still, it may be worth it to use your cash value when you need to. If it’s still sitting in your account when you die, it reverts back to the insurance company. Unless your insurance policy specifies otherwise, beneficiaries are only paid the death benefit of a whole life insurance policy, not the cash value. Jeremy Schneider, the founder of Personal Finance Club, cautions anyone from considering life insurance policies as an investment. “It’s an insurance product,” he says. “If your financial advisor is recommending you buy whole life insurance, you don’t have a financial advisor, you have an insurance salesman.”

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