If you are thinking about taking out a life insurance policy that is easy to understand and does not require too much of your attention, you should consider traditional, or whole, life insurance. This is the classic insurance product: a policy that you pay over your lifetime so that a payout to your designated beneficiary will be made when you die. And in the meantime, it also generates "living benefits" that you can take advantage of.
In this article, we will explain in detail what traditional life insurance is and how it works. We will also give you an overview as to the different types of insurance available and which might be of most interest to you.
Traditional Life Insurance: Table of Contents
What is Whole Life Insurance
Permanent life insurance is one of the main life insurance offerings on the market. Compared with term or fixed period insurance, which establishes a set policy duration after which the coverage is terminated, permanent life insurance does not have an expiration date.
Thus, as long as you pay your monthly premiums, the insurance stays in effect. Ideally, the policies are created for a very long term length: the hope is that the insured dies at as old an age as possible. In any case, permanent life insurance makes a payout when the insured dies. This payout, or death benefit, is then collected by the beneficiaries stipulated by the client.
As such, these are classic and relatively uncomplicated products. You purchase them, pay the premiums, and they guarantee that your beneficiaries receive money when you are no longer with them. In addition, however, this insurance has a very interesting savings component: part of what you pay is allocated for investment and may generate extra benefits. In this sense, permanent life insurance is also a savings tool. Therefore, permanent life insurance is very popular among people who want to want to avoid the costly taxes that large inheritances tend to be subject to. It is also in high demand by those who want to leave a legacy to their successors, ensure a smooth transition for their business, or even fund their funeral expenses. They are also a very interesting option for families with children who are thinking about the future.
Management of these savings and investment components is the most important factor when choosing one of these policies. Some are more stable, other more variable and flexible, so you should know what their characteristics are before choosing one. These features divide permanent insurance into several types:
- whole or traditional life insurance,
- universal life insurance
- variable life insurance
- and universal-variable life insurance.
In this article, we will pay special attention to whole life insurance, also called traditional or ordinary life. It is the most conventional permanent insurance, and therefore, the simplest with regards to its features and functioning.
How Whole Life Insurance Works
As we have seen, this concept behind this product is relatively simple, and so the way it works is also quite easy to understand. It involves relatively few elements, and they behave in a stable and predictable manner. When purchasing whole life insurance, you should keep certain characteristic features in mind. They are:
- Conditions for qualification. As for all life insurance, in order to qualify for whole life insurance, you must pass a medical exam and declare your age and lifestyle habits. The insurer will want to know if you smoke, if you practice risky sports, or if your work entails serious hazards. It is also typical for the insurer to require blood tests and other medical studies. If you are in delicate health, are older, or have a risky lifestyle, the insurance company can deny you insurance because they consider you to be too high of a risk for them to assume. Or, they may impose very high monthly premiums.
Many people try to avoid this by lying and hiding information from the insurance company. You should avoid this behavior and answer the questions they ask as honestly as you can. If you lie and are found out, the insurer will cancel your insurance. This is one of the main mistakes people make when taking out an insurance policy.
- Term length of the policy. For starters, whole life insurance is created to last your entire lifetime, regardless of how long you live, and when you die the insurance company will make the payout. In some cases, policies expire when the insured reaches a very advanced age, such as 95 or even 100 years old. In some cases, the payout is made in the holder’s lifetime.
- Beneficiaries. These are the people that you designate as recipients of the death benefit. They will collect the payout money when you die, and you can name as many as you want. In addition, you can name alternative beneficiaries if the main beneficiaries die before collecting the benefit, and you can also determine what part of the money corresponds to each beneficiary. Alternative beneficiaries can be secondary or tertiary; that is, people who are second or third in line to access the benefit. It is also common to name a trust fund as a beneficiary, where the manager will administer the money in accordance with your wishes. Some people choose to leave the money to charitable institutions. In any case, remember to always notify your beneficiaries of their status and the existence of the insurance. Also, if you leave the payout as part of your inheritance without designating specific beneficiaries, the legalization process for the inheritance can make it so that your inheritors must wait a long time to receive this money. Be careful not to make mistakes when choosing your life insurance beneficiaries.
- Payout. This is the money paid out by the insurance company when you die. It is important for you to negotiate this well when you take out the insurance, because this category of whole life does not usually allow changes to the payout or death benefit. You should know that whole life insurance constitutes one of the insurance types that allocates the most amount of money for payouts to the loved ones who will collect the policy after your death.
In addition, remember that the beneficiaries will not have to pay taxes on that money. In general, the payout for whole life policies does not include anything but the value stipulated for that item. However, there are specific cases in which a bit of extra money is included.
- Monthly premiums. The only condition for the company to cover your death is for your monthly premium payments to be up to date. Here we are dealing with level premiums: you will always pay the same amount. With this type of long-term insurance, the insurance company is assuming very low risk: most people will live for many years. This makes your risk very low while you are young, so the premiums should be lower; when you are older, your risk is greater, so the premiums should be very high. In order to avoid these fluctuations, the insurance levels them and you overpay in the initial years.
- Cash value savings. In the case of whole life policies, the insurance company uses this premium overpayment to implement a mandatory savings mechanism with guaranteed interest. In the long term, benefits are generated which complete the payout. Using this money, the insurance company also levels out your premiums in old age so they will not be too high. In addition, as the benefits accumulate, there comes a time when the law requires them to be paid out. This is called cash value and it is defined as extra earnings that the insured has available to them in the long term, which can be used to amortize premiums or spend on whatever the insured would like.
In the case of whole life insurance, this cash value can be withdrawn tax-free or a loan can be taken out against future value at a low interest rate. But remember: if you die before repaying it, it will be deducted from the benefit received by your beneficiaries. On the other hand, if you decide to cancel your insurance or modify it, you can collect that amount in cash and keep it. This is known as surrendering a policy.
- Shares and dividends. As we have explained, in some insurance categories, whole life insurance includes shares in a financial investment product. In these cases, the insured can earn an extra sum from the investments the company makes with his or her money. This extra income can be reinvested to generate more cash value or accumulate with the payout. But dividends, which tend to be annual, are not guaranteed and may also experience losses.
As you have seen, cash value is the most important component of your whole life policy, so you should pay special attention to it. It is a feature of your policy that was created for you to save while you pay for your insurance. It creates mandatory savings, which is good for you, because it is an extra benefit that you can use in any way you want. And only you can collect it: with this type of insurance, your beneficiaries do not receive it, which is why you should think carefully about how to manage it.
In regards to the way your insurance functions, it is also important for you to know that all insurance companies let you add special clauses to your policy. If they are offered to you and you are not interested, you can reject them. These clauses serve to complement and give nuance to the insurance coverage and may vary widely. Some of the most typical life insurance clauses are:
- Accidental death benefit clause. If you die in an accident, your beneficiaries may receive an additional benefit.
- Accelerated death clause. If you are diagnosed with a terminal illness with a short life expectancy, by using this clause you can request your death benefit in advance and enjoy it during your lifetime. This may help you with treatment or hospitalization costs.
- Waiver of premium for disability clause. With this clause, you will not have to pay your insurance premiums in the event you are disabled and cannot continue your life normally. In this case, you must qualify for disability in accordance with the terms given by the policy.
- Child or spouse amendment or rider. In the case of children, this means adding new term insurance that covers your children for a period of time, for example, until they are 21 or 25. In the case of your spouse, there is a different term insurance product to cover him or her, and in general it implies combining the two policies.
- Policy purchase clause. This option offers the possibility of purchasing additional insurance without having to qualify again.
All of these and many other available clauses can modify your permanent life insurance. These modifications tend to make your policy more expensive or lower the death benefit, so it is important to carefully choose them carefully before adding them to your policy. If what you want is to maximize your insurance benefits, it is generally best to reject most clauses.
Categories of Whole Permanent Insurance
Now that you understand how whole life insurance works, and that any possible changes to the policy are related to elements such as cash value or premiums, you should be familiar with the main types of this insurance:
- Ordinary life insurance.
This is the most basic category. Premiums are always the same and there is a savings component that translates into cash value that can be withdrawn at a given time or used to request loans against future value.
- Limited pay life insurance.
In this category, premiums are only paid for a specific time. For example, you make payments until you reach a certain age or for a certain number of years. But in contrast to term insurance, the policy will stay in effect until you die. As you might imagine, monthly premiums are higher in order to cover the time you are alive after you stop paying. The advantage of limited pay insurance is that you will no longer have to pay premiums after a certain point and you can allocate your money for other purposes. In addition, since the insurance is paid off in a short time, the added value also adds up more quickly.
- Single premium life insurance.
In this type of insurance, the policy is paid completely in one initial and final payment, which is usually quite high. One single premium and your insurance is paid off forever. Payout is made when you die and you will not have to make periodic premium payments. However, single premium life insurance is very challenging because it requires you to have a significant amount of money available to pay all at once. However, this produce also generates cash value quickly and offers an interesting and reliable way to save.
- Modified premium life insurance.
With this form, the premiums are lower during the first part of the insurance life cycle because the savings component that translates into cash value is also lower.
- Participating whole life insurance.
Permanent life insurance policies are classified into participating or non-participating. In the case of participating policies, it is understood that your insurance will offer you participation in a financial product that may pay you annual dividends. Since they depend on the market, these dividends are not guaranteed, but if you receive them you can reinvest in premium payments, turn them into cash, or purchase additional insurance to improve your coverage. Most interesting is the fact that if the value of the dividends is less than the amount you have paid in premiums, you are not subject to taxes.
This information should give you a general idea of whole or traditional permanent life insurance and help you evaluate its main advantages and disadvantages:
- It is a very stable product, but with more modest returns: it generates savings, but not significantly. This is due to the fact that the investment and savings products chosen for these policies by insurers are very conservative.
- They pay benefits, but very small ones.
- Premiums are level, but tend to be high, especially if you take out a policy in your later years.
- This insurance produces cash value that is tax-deferrable, can be taken out as a loan, or can be used for money withdrawals.
- It incurs expenses and commissions that you should be aware of, because they can often be quite costly.
- You only have to qualify once, and the terms of the insurance will not fluctuate even if your health declines.
- You can surrender the policy if you encounter financial difficulties. When surrendering the policy, you keep the accumulated cash value but lose the coverage.
- The payout is not subject to taxes, so it is an interesting way to make sure your money gets to your inheritors without having to pay inheritance fees.
- It is not very responsive to your needs. If your life changes for the better, if you are in a good financial situation, or you are able to secure the future of your children or loved ones, you may no longer need as much coverage. If this is the case, you will be paying more than you need, and this insurance does not allow you to make modifications.
Finally, whole or ordinary permanent life insurance is among the most in-demand products by the clients of insurance companies. This may be the type of insurance that you are looking for, so thoroughly research all of the clauses and details of your policy. And remember, the law states that insurance companies must illustrate the different scenarios for each of their products in a way that is easy for potential customers to understand.
This article was updated on July 17, 2018.