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How Whole Life Insurance Polices Work

Deanie Canales

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A whole-life insurance policy is actually two products in one: a permanent life insurance policy and a tax-deferred investment account. The advantage to this arrangement is that the policy can provide both a death benefit and a cash reserve policyholders can call upon in emergencies.

Permanent Life Insurance Policy
The advantage to a permanent life policy is that it can provide coverage as long as the insured is alive. The coverage begins as soon as the policy is purchased and will never lapse.

It should be noted that the coverage from many permanent policies will end when the covered reaches a certain age usually 90. There are some whole life policies that will remain in effect at a longer age. Read the policy to see it should tell you if there is a maximum age for coverage.

Generally you will pay a large upfront premium when you purchase a whole life policy. That covers the cost of the lifetime death benefit. You will have to pay regular premiums but the amount of the premium should stay the same for the life of the policy. This can enable you to lock in low insurance costs for the rest of your life.

Investment Account
The cash value feature of a whole life insurance policy allows you to add extra funds whenever you want. This gives you some important benefits including tax-deferment. Money placed in the policy will not have to be reported on your federal income tax return. That can enable a person to save a large amount of cash without increasing his taxable income.

Taxes will be due on this tax when it is taken out of the policy. Since the IRS regards these policies as investment vehicles a 10% tax penalty will be charged if people under 59½ years of age take funds out. This penalty is in addition to the normal income tax.

It is also possible to borrow against the funds in a whole life policy. That can provide emergency financing for an individual or family. You should only borrow against an insurance policy in an emergency situation.

Another advantage to this arrangement is that funds invested in the policy will increase the size of the death benefit. Since insurance policy death benefits are normally not subject to income this is a good way to leave money to loved ones.

Protection of Money
Another advantage to whole life insurance policies is the protection that they give to funds. If it is insured by a major insurance company with a AAA rating there is little or no possibility that the money will be lost it will be there. This as is safe as a bank account and it is tax deferred.

Laws in many states specifically protect whole life policies from creditors and lawsuits. That means a debt collector cannot garnish the funds in a life insurance policy and it cannot be included in a lawsuit settlement. Not every state offers this protection so it might be a good idea to move to one that has it.

Another limitation to this protection is that a policy maybe subject to the laws of the state that issued it. That means a whole life insurance policy could be vulnerable to lawsuits and debt collection efforts from other states. It would also be vulnerable to actions filed in federal court.

Steven Hart is a freelance writer and a Financial Advisor from Cary, IL. He writes about Annuity topics like Annuities Explained , Fixed Income Annuity , and Annuity Leads


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