What is whole life insurance?

You could say that whole life insurance, dating back to the year 1706, is the OG life insurance. Like the ORIGINAL original before life insurance sold out and got all mainstream on us ;). Jokes aside, whole life insurance is a type of permanent life insurance that covers you for life. Yep, life. That means you’re covered from the moment your plan starts until you pass away (as long as you keep your payments up, of course). You pay a fixed amount, either monthly or yearly, and in return, your loved ones get a fixed amount of money when you die. Pretty simple, right? Well, not quite. A whole life insurance plan also has a cash value you can take advantage of during your lifetime. This cash value is actually one of the biggest selling points of this type of life insurance vs. term life insurance. So with that said, let’s get into the specifics.

How does cash value life insurance work?

You may have heard whole life insurance also referred to as cash value life insurance, and that’s because they mean the same thing. So the way the cash-value side of things works is that you can basically borrow against your whole life plan while you’re still alive. A pretty-sweet perk, huh? Essentially, a portion of your payments A) cover your coverage (obviously) and then, B) also accumulate a cash value. So, your money grows and grows over time, and you can take it out as cash or a loan to pay for things like medical costs or your kid’s college tuition or home repairs. Yep, you can use this money to pay your plumber. And best of all, this is all tax-free—and that includes cash withdrawals, but only up to the sum of all your insurance payments

But remember, what goes out must come back in. That means if you take out, let’s say a $50k loan to pay for your kids’ college, you’ll have to pay it back before you die. If you don’t, you’ll reduce the amount of money your family may get when you’re no longer around, and that just defeats the point of getting the plan in the first place. You may also be in for one heck of a tax bill if you cancel the policy before you die, so try not to do that.

Overall, there are a bunch of risks associated with accessing this tempting cash value—from high interest to reduced money for your family to hair-raising tax bills and more. Taking money out could also affect your dividends (and we’ll get to those in a second). So proceed with caution. Because, while whole life insurance does have a ton of benefits, there are some significant trade-offs.

What’s the deal with dividends?

There’s also a little thing called dividends. Whole life insurance plan holders might be able to get payments known as “dividends,” depending on the insurance company. If you get your plan from a “mutual” company, then that’s akin to you having ownership in that company—a little piece of the pie, if you will. If that’s the case, you may be in for some sweet, sweet dividend payments at the end of each year, but only if your mutual insurance company had a good financial year. What that means is that dividends are not guaranteed. (Although, some companies have paid them out every single year for the past 160 years—and during the Great Depression even). Again, you can use this money to pay for your plan each month/year, you can use it to add additional insurance to boost your plan’s value, or you can use it for whatever your heart desires—it’s your money, after all. Also, dividends aren’t taxable (sorry, Mr. Tax Man) unless they are worth more than you’ve paid into your plan. Just something to be aware of (because nobody likes IRS surprises).

When is term life insurance the better choice?

We can’t give you the lowdown on whole life insurance without throwing in some cons relative to its cousin term life insurance.

First of all, the cost of whole life varies a lot depending on your age (like we always preach, younger = cheaper), health, etc. Because your loved ones get a guaranteed payout, your monthly or yearly plan cost is substantially more expensive than term life insurance—even if they are “level premiums” that don’t increase during the life of the plan. So details like age and health become even more important with whole life insurance.

And on that note, yes, it will cost more than you think. According to NerdWallet, the yearly cost of a $250,000 policy for a 30-year-old male would be $2,145 for whole life insurance and $223 or $150 respectively for a 30-year or 20-year term life plan. And for a 30-year-old female those numbers would be $1,904 vs. $191 or $133. That’s a pretty large difference. Also, if you want to compare the numbers for yourself, or just want a more personalized comparison, here’s a nifty little calculator that’ll do exactly that.

Additionally, although a whole life plan is with you for, well, your whole life, you have to ask yourself if you’ll even need life insurance after a certain amount of time? Once your debts are paid off, and your kids/future kids are in college, and your retirement kicks in, do you think you’ll still need that coverage? A term life plan keeps you covered during those uncertain years while you’re paying off a mortgage or raising kids. Once you’re financially comfy,  your “term” is usually up, and you usually don’t need to concern yourself with any more life insurance payments—that’s not the case with whole life.

And the final con? And yes, it is the elephant in the room: is life insurance really the best investment plan? And when we say investment, we mean it in the true sense of the word. Is buying a whole life insurance plan your best bet vs. investing that money via the traditional routes? Yes, life insurance can be seen as an “investment” in terms of investing in peace of mind. But ask yourself, can a term life insurance give you that peace instead? And can the extra money you would’ve spent on a whole life plan be put to good use elsewhere? Perhaps a tax-advantaged retirement account or something like that?

And with that said, always remember that ultimately, life insurance and traditional investments are apples and oranges, and while they share some similarities, they are not the same thing. Seems obvious, but you wouldn’t believe how often this gets screwed up.

The bottom line:

While term life plans are usually cheaper and serve the most basic purpose of life insurance which is peace of mind, whole life insurance plans offer a ton of other benefits—from guaranteed cash for your family when you die to even monthly/yearly payments to potential dividends that put a little extra money in your pocket. The cash value of a plan like this can even help pay your premiums over time.

In its essence, whole life is basically a life insurance plan that you don’t have to die for. But while all of that is tempting, don’t forget a few key things: Whole life insurance costs a fair bit more than term life insurance. It’s also a much more complex beast, so you’ll probably need to hire a financial pro to recommend the right plan for you. Also it may not be the right choice if you haven’t yet maxed out your contributions to tax-reducing accounts such as retirement or kids’ education accounts.

Still confused as to whether whole life insurance is for you? When in doubt, think about why you’re getting life insurance: Is it to simply make sure your loved ones are taken care of when you’re no longer around? Or are you equally interested in accumulating cash? Whatever your reason, you should have no problem finding a life insurance plan that’ll fit into your budget and satisfy your needs, whether it’s whole life insurance or otherwise.