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What Is Whole Life Insurance?

By Selena Maranjian - Updated Mar 7, 2017 at 2:33PM

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The answer to the “What is whole life insurance?” question is this: It's financial protection, plus an investment.

Life insurance can help you protect and care for your loved ones. 

The answer to the "What is whole life insurance?" question is relatively straightforward: It's a form of life insurance designed to not only pay out upon death but also to accumulate cash value, as an investment. Let's take a closer look at it to see if it makes sense for you.

What it is
There are several different kinds of whole life insurance, and the most common one is referred to as ordinary life, straight life, or traditional whole life, among other things. It features premiums that are fixed, or "level," throughout the existence of the policy. If you're quoted a whole life premium price that seems a bit steep, remember that the premium is likely to stay the same, even for decades -- and it may even decrease some, as you might receive dividends along the way. That's a plus, as is the fact that over time, inflation will essentially make it cost less. Other kinds of life insurance can offer lower initial premium rates, but those rates might rise over time.

The value of the payout upon death is typically fixed, but you forfeit that if you stop paying the premiums prematurely. (Many policies no longer require premiums after age 95 or 100.) That's an important point to consider, as it's estimated by the Society of Actuaries that 39% of whole-life policies are terminated within the first 10 years. You don't forfeit the cash value that has accumulated in the investment part of the policy, though. You receive it, but it won't make up for the premiums you have paid -- though you will also have enjoyed financial protection during the period you paid your premiums.

Consider term life insurance instead
Whole life insurance isn't your only option. A compelling alternative is term life insurance. Before discussing it, let's review why you might need life insurance in the first place. A key reason is to protect the income stream that you represent for others. If anyone is depending on you and the income you'll produce -- think, for example, of your spouse and kids and any other dependents such as parents -- then you should ensure that their lives won't be financially derailed if you die. You might also want life insurance to cover college expenses for your kids if you die, or pay off your mortgage at that point, or to pay for funeral expenses, or to protect the income your business gets from a key employee. There are lots of reasons. Many of them, though, aren't lifelong reasons.

Once your kids are grown and on their own, you probably don't need life insurance to keep them from financial harm. Once they're out of college and once your mortgage is paid off and once you have enough in the bank to cover your funeral expenses, then the need for life insurance may no longer exist. If you see your life insurance need as temporary -- even though you might anticipate needing it for 20 years -- you should consider term life insurance.

Term life insurance will typically cost you less, and will only be in effect as long as you need it. (Its premiums may rise over time, though.) It won't offer a cash-value investment component, but remember -- that doesn't mean you can't have investments of your own on the side, which may well grow more effectively. After all, the stock market has averaged annual gains of close to 10% over many decades, and solid dividends yielding 3%, 4%, or more can be found among many well known companies. A simple, inexpensive index fund is likely to outperform any whole life insurance policy's investment component.

When whole life insurance makes sense
Whole life insurance can make sense if you want or need to be covered for your entire life. You may, for example, have one or more dependents who will need financial support for the rest of your life. You might simply want to set up a big payout for your loved ones when you die.

Many people are also drawn to whole life because of the certainty of it: The premiums are fixed, the ultimate payout is known, and a cash balance accumulates on a schedule. It may not be as effective an investment as stocks or even some bonds, likely growing considerably more slowly, but it's more dependable -- to a degree. That last caveat is because a life insurance policy is only as dependable as the company you bought it from. Be sure to choose a healthy, highly rated one.

There's no single answer to the "What is whole life insurance -- and is it for me?" question that fits all. For many people, term life insurance is the better buy. But for some, whole life insurance makes a lot of sense.

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