Whole Life Insurance: How It Works; Find everything that you should know

Whole Life Insurance: Life insurance is one kind of financial security that you plan out for your family in which if something unthinkable happens then the insurance company will provide the death benefit amount to the beneficiary or the nominee. The death benefit amount is the amount for which the insured individual has planned. The amount is transferred to the nominee in the case in which the insured individual faces death before the term ends.

Whole Life Insurance

Whole life insurance is a type of permanent life insurance which is meant to be there for your entire life. In this, a person will decide the amount for which he/ she need life coverage and the company from which you purchase the insurance policy decides the premium that should be paid by the person.

Whole life insurance is different from a life insurance or term life insurance, which is typically only available for a certain number of years, rather than a lifetime, and only pays out a death benefit. Interestingly, you can also convert your term life insurance - a type of insurance which is for a specified term of time - into whole life insurance. In the case of term life insurance if the insured dies before the term ends the company is entitled to pay the death benefit amount to the nominee of the policyholder. Also if the insured individual survives the term of the term policy he is left without life coverage.

For more details on Term Life Insurance

How and till when you can convert your term policy into whole life insurance?

The person who needs to convert his term policy into whole life insurance must get in touch with the insurance company six months before the term insurance policy ends and plan his future. Converting to another policy is a lot more beneficial than buying a new term policy or life insurance policy.

Planning for future refers to - if the insured decides that he needs insurance cover for, say another 20 years after his previous term expires. He can convert his same term insurance plan to whole life insurance or can renew the term insurance policy whichever is preferred.

In the case of whole life insurance, the amount for which the coverage is availed is called the "death benefit" by the company. This amount will be paid to the beneficiary of the policy when the policy gets matured. The premium which is to be paid to the company is the "locked-in" price. This means the amount of premium paid is unchangeable no matter what happens.

The amount of premium you pay every month is called the cost of insurance. You are covered under the policy for as long as you pay the premium. A part of the premium that you pay goes to the "cash value" part of the policy. The longer your policy lasts, the more cash value it builds up.

You must be wondering what cash value is and what are its uses and advantages. We will discuss it later. But first, we need to know how whole life insurance works.

So if you have purchased a whole life insurance policy you know what amount of premium will have to be paid monthly to the company to provide life cover to you. The premium which you pay is divided by the company into two parts. One part of it provides actual cover to the insured and the other part which is known as cash value goes into the cash value account.

Whole life insurance policy guarantees return on your investment. For this, the company invests part of your premium, which brings very low returns on your investment. These low returns are easier for the company to guarantee to the policyholder.

Every month when you pay your premium, a part of the premium goes into the cash value account. In the beginning, a major portion of your premium goes to the cash value account. This cash value amount is invested by the company to give returns which in turn increases the cash value of the policyholder. In later years more of the part of the premium goes towards the policy cover since the cost of the insurance increases over time as you age.

The matter of fact is that the insurance company gives you an unimpressive rate of return on your investment. You will notice that investing in other options is more beneficial than investing in life insurance. Therefore as advised earlier also, the life insurance policy of any type should not be considered as an investment. Instead, it should be looked at as just financial support to your family in case of unforeseen circumstances.

Cash value account is just like a savings account. You need to keep a track of your cash value. Once it grows over time you can either opt to borrow against it from the company or leave it as it is in the cash value account. In both cases, the insurance company is the one with an added advantage.

Suppose you borrow against the cash value from the company and if you face death during that period, the company only transfers the death benefit amount to the beneficiary after deducting the borrowed amount. And if you let the cash value remain with the company as it is, then also the company retains the cash value on the maturity of the policy and transfers the death benefit amount to the nominee.

Now, there are two different situations to handle if you borrow against your cash value amount from the company. Cash value amount can be tapped into any time you like. But beware! Most companies will allow you to borrow against the cash value of the policy or cancel or surrender the policy and claim whatever the cash value you made.

1) If you decide to borrow a loan against your cash value: When you have built some cash value, you can opt for a loan against whatever cash value has been built over time. But like any other loan you borrow you need to pay interest, that too against your own money. How insane is that! And to face the worse, if you fail to pay back the amount borrowed, the company deducts the amount from the death benefit.

2) You decide to surrender your policy when in need of liquidity: When you feel the need to liquefy your finances and decide to surrender your life insurance policy you can either opt for "cash surrender" or "cancellation" of the policy. You let the company know that you need to cash out your whole life policy. The company in return lets you know the cash value of the policy. But how much you receive depends upon the type of your particular policy, fees charged by the company and how long you have been paying into the policy.

You can notice here that no matter which way you tap into the cash value of the policy, it will never work out in your favour in the long run. You will have to settle for less cash value than the full value of the policy because you have invested less over the years. Also, your cash value loses a lot of its weight. Therefore whole life insurance is not a good choice as an investment, but a better choice as a life cover policy for entire life and financial security for your family if you do not see the maturity date of the policy you purchased.