Should I Keep My Whole Life Insurance Policy?

Whole life insurance policies are a type of permanent life insurance that combines a death benefit with a cash value component. Policyholders often re-evaluate these policies due to shifts in their financial circumstances or a deeper understanding of the product. This article provides clarity for those considering whether to maintain their existing whole life policy, exploring its mechanics, key retention factors, and available options.

Understanding Your Whole Life Policy

A whole life insurance policy provides coverage for the insured’s entire life, as long as premiums are paid. It features a guaranteed death benefit, paid to beneficiaries upon the insured’s passing. This death benefit is generally not subject to federal income taxes for the beneficiaries.

The policy’s cash value component grows over time on a tax-deferred basis. A portion of each premium contributes to this cash value, which earns a guaranteed rate of interest. Some policies, known as participating policies, may also pay dividends, which can further increase the cash value. These dividends are generally not taxable unless they exceed the total premiums paid into the policy.

Premiums for a whole life policy are fixed and guaranteed not to change. While cash value growth is minimal in early years due to administrative costs and insurance charges, it accelerates over time as more premium is allocated to the cash value account and compound interest takes effect. The cash value can be accessed by the policyholder during their lifetime through withdrawals or loans.

Factors Influencing Your Decision

Consider your whole life policy’s alignment with current financial needs and goals. If the policy was purchased for estate planning, its relevance depends on your current estate’s size and structure. If your financial objectives have shifted, such as prioritizing retirement savings or debt reduction, assess the policy’s contribution to these new goals.

The affordability of fixed premiums is another important consideration. Whole life premiums are typically higher than term life insurance for the same death benefit. If premium payments have become a financial burden, or if funds could be better utilized for other high-priority financial goals like paying down high-interest debt or increasing contributions to retirement accounts, re-evaluate. The opportunity cost of continuing to pay premiums should be weighed against potential returns from alternative investments.

Review the policy’s guaranteed cash value growth and, if applicable, its dividend history. The guaranteed growth rate for cash value ranges from 1% to 3.5%. Understanding how the policy’s internal rate of return compares to other potential investment avenues is important for making an informed decision. Policy statements provide details on accumulated cash value and any dividends paid.

Changes in your health status can influence the decision to keep an existing policy. If your health has declined since the policy was issued, obtaining new life insurance coverage might be more expensive or difficult to qualify for. An existing whole life policy guarantees coverage regardless of health changes. Conversely, if your health has improved, you might qualify for better rates on new coverage, potentially making an exchange or new purchase more appealing.

Options for Your Existing Policy

Several options are available if your whole life policy no longer serves your needs. One common action is to surrender the policy, terminating the contract for its cash surrender value. Any amount received exceeding total premiums paid is considered taxable income.

Policyholders can access the cash value through a policy loan. Loans are generally not taxable, but interest accrues on the outstanding balance. If the loan is not repaid, the outstanding balance, including accrued interest, will reduce the death benefit.

Another option is to make the policy “paid-up.” This uses accumulated cash value to cover future premiums, eliminating out-of-pocket payments. When a policy is made paid-up, the death benefit typically reduces to an amount the existing cash value can support. The cash value and death benefit may continue to grow if the policy is dividend-paying.

A tax-free 1035 exchange allows you to move cash value from an existing life insurance policy into another life insurance policy or an annuity without immediate taxes on gains. This option requires funds to be transferred directly between insurers, and the policyholder must remain the same. This can be useful to switch to a policy with different features or lower fees.

You may also reduce the death benefit of your existing policy. This can lead to lower premium payments or faster cash value growth, depending on the policy’s structure. Reducing the death benefit can adjust the policy to better fit current financial realities while keeping some coverage.