How Does Whole Life Insurance Work?

Whole life insurance offers permanent coverage over your entire lifetime. You only can be dropped if you get behind on paying premiums -- you can't be dropped if your health deteriorates. Term insurance, on the other hand, remains in effect only for a fixed period of time. In addition, whole life builds up a cash value, and some policies pay dividends.

Qualifying and Rates

The requirements to qualify for whole life coverage depend on the particular policy and the insurance company. Some companies require a medical exam, while others only require you to answer questions about your health. If you're accepted, the rates you'll pay generally depend on how much coverage you want and your age and health at the time of purchase. For the same coverage amount, young and healthy people pay less than older applicants in poorer health. In any case, you won't need any more medical exams after you're accepted.

Paying Premiums

Whole life typically costs 3 to 5 times as much as term insurance for the same dollar amount of coverage, according to Money Crashers. However, many traditional whole life policies charge level premiums, which are guaranteed never to change. If you have term insurance, on the other hand, you may be able to renew it after the term, but the premiums typically increase because you're older.

Other types of whole life policies may be a better option for some. Limited payment whole life requires paying premiums for a certain number of years, such as 20. After that, the insurance is paid-up, Indeterminate premium policies adjust the premium based on the company's performance, but they can't exceed a fixed amount. You also can opt for single premium whole life and make only one large initial payment to secure your coverage.

Participating and Non-Participating Insurance

Some whole life policies, called participating policies, pay dividends based on the company's performance. Dividends aren't guaranteed, but when they arrive you can use them to purchase more paid-up coverage or pay your premiums. Alternately, you can leave the dividends with the company to earn interest, or take the amount in cash. Dividends are tax-free unless they exceed the amount you paid in premiums.

Policies that don't pay dividends are called non-participating policies.

Cash Value

Some of your whole life premiums go toward building up cash value, which gradually replaces insurance in guaranteeing the death benefit. You'll also earn interest on the cash value of your policy every year. Some policies have a final maturity date, when the cash value equals the death benefit. If you're still alive, the company will give you the money at that point


  • You can borrow against your whole life policy's cash value, and the loan isn't subject to income taxes. If you die without paying it off, however, the debt and interest reduce the death benefit.

You can surrender all or part of your policy to get the cash value, but this reduces or eliminates your coverage. It also may give you taxable income, and some insurance companies charge surrender fees.

Who Can Benefit

Whole life is advantageous if you want guaranteed insurance over your entire lifetime, regardless of health problems.

If you're already contributing the maximum to retirement accounts such as 401(k)s, whole life provides another avenue for tax-deferred savings. The Internal Revenue Service doesn't tax the yearly increase in your cash value because you've paid taxes on the premiums.

The ability to borrow tax-free against the cash value could be helpful if you want to save for an early retirement or to pay college bills. Unlike tax-deferred retirement accounts, you don't pay a penalty to take money out before 59 1/2.