The benefits of whole life insurance are numerous. They can ultimately be broken down into two main categories: the death benefit and the living benefits. Most people understand what a death benefit is at the basic level... when I die, my beneficiaries will receive a certain amount of money. And this is absolutely correct. But what many people do not know about are the living benefits that whole life insurance can provide.
So let's start by diving into the Living Benefits of Whole Life Insurance as these are the benefits which are are most commonly unknown or misunderstood...
Living Benefit #1: Cash Value Accumulation
As you pay premiums into a whole life insurance policy, you will gain access to a growing cash value. How fast or slow this cash value accumulates depends on the type of policy, structure of the policy (aka: riders), your health rating and the company you choose. But in any case, this cash value will eventually become greater than the cumulative premiums paid into the policy and begin providing a positive internal rate of return. When the policy cash value equals the cumulative premiums paid, the policy is dubbed breakeven. There is no right or wrong answer as to how soon or how long it should take to get to breakeven, but this is the point after which you will begin to realize positive returns on your cash.
Cash value can be accessed via withdrawals or, more commonly, with policy loans. Why would I want to loan my own money back to myself, you might ask? Well, the beauty of this system is that when you take out a policy loan, you are not actually loaning your money back to yourself. You are receiving funds from the insurance company and leaving your entire cash value within the policy to remain growing, undisturbed (at least true for non-direct recognition policies, but that is a discussion for another time).
Another benefit of utilizing policy loans to access cash value is the tax treatment of policy loans. When you use withdrawal as your method for pulling cash from the policy, you will be able to pull cash out tax free up to your basis (in other words, up to the amount that you have put in). Any dollar withdrawn beyond this amount will be subject taxation. However, when utilizing policy loans, you can withdraw up to almost the entire cash value (typically 95%+ for most carriers) tax free as it is indeed a loan.
Another benefit of utilizing policy loans is that there is no fixed repayment schedule, allowing for ultimate flexibility and control over your money. Policy loan repayments are paid 100% towards principal meaning you will be able to pay down policy loans quicker than you would with a traditional amortized loan schedule or HELOC. The interest on policy loans are simply accrued throughout the year and dealt with on policy anniversaries.
Living Benefit #2: Tax Deferred Gains
Gains within the cash value portion of a whole life insurance contract grow tax deferred. This means that as long as you keep capital gains compounding within the policy and refrain from withdrawing above the basis, you can continually delay paying capital gains taxes on the growth. This is yet another reason policy loans are most often preferable as you will keep the full cash value in place and continue compounding gains while deferring capital gains tax. This tax deferral can ultimately turn into true tax free gains by passing on the death benefit, which will always be higher than current cash value (until the end of the policy contract, which is typically age 120+, at which point cash value and death benefit will be equal), as a tax free inheritance to your beneficiaries.
Living Benefit #3: Guaranteed Growth
Whole life insurance carries with it some very valuable guarantees, one of which is guaranteed growth in the cash value. This means that, while cash value can be lower than cumulative premiums in the earlier years due to front-end loaded expenses, the cash value will contractually guarantee to never drop in value compared to previous years. You will know upfront what your worst case scenario will be.
This guaranteed growth rate used to be 4% across the board, but due to recent Section 7702 changes in 2022, this has been reduced to as low as 2%, with guaranteed rates now varying somewhere between 2-4% depending on product and company. When we say 4% guaranteed growth, this does not mean you will be earning a net return of 4% every year. The 4% is a gross amount and, after deducting mortality & other expenses, will ultimately produce a final net return.
Living Benefit #4: Non-Guaranteed Growth (Dividends)
The other component to policy growth is the non-guaranteed growth, also known as the dividend. Most companies announce their dividends each year and have recently been somewhere in the 5% to 6% rate range. These are again gross amounts, with each company applying varying amounts of expenses which deducted from the dividends to create the final net dividend applied. In general, with dividends, whole life policies can expect to reach long-term internal rates of return of around 4-5% (with current dividend rates). And while dividends are in fact not guaranteed, most if not all of the major mutual life insurance companies have paid a dividend each and every year for well over 100+ years.
Now that we've covered some of the crucial Living Benefits at length, let's discuss some deeper understanding of the death benefit...
The Death Benefit
As mentioned above, the death benefit is commonly understood only at its most basic level. While the main purpose of the death benefit involves passing a tax free cash benefit on to your loved ones, there are also be many other creative and advanced estate planning designs that include the use of a life insurance death benefit.
Beneficiaries are not limited to just spouses, kids and close family. Organizations such as charities, trusts, and businesses (such as for key employee policies, buy-sell agreements, etc) can also be named a beneficiary.
Trusts can be used in a number of different strategies with some examples provided below:
Set up an irrevocable trust and name it your beneficiary. Set your desired beneficiaries as heirs of the trust. As the death benefit now goes to this trust upon death, the death benefit will be excluded from the estate and thus excluding this amount from the federal and state estate tax calculation. While the federal tax threshold is incredibly high ($12.92 million in 2023) and is really only applicable to wealthy individuals, those who live in states that impose an estate tax could find some benefit from this strategy.
Set up a trust which has your children beneficiaries named as the heirs to the trust. When they reach a specified age and are no longer minors, the death benefit proceeds will be dispersed according to your wishes. This means they may not be paid out in a lump sum, which can be a wise decision as many of these trusts are set up for the child to receive benefits at age 18 or 21.
While this is not an exhaustive list of strategies that one can utilize with trusts and life insurance, I hope it at least provided some insight into some of the more common strategies used.
There a multitude of reasons why a business would be named beneficiary of a life insurance death benefit, and I plan to cover this in much more detail in a later post. From buy-sell agreements, to payment upon the passing of a key employee to help alleviate financial difficulties during the search for a replacement, to an ESOP (employee stock owned) company receiving a death benefit at the passing of an employee owner in order to buy out the employee owner's shares, the use cases for businesses to utilize life insurance contracts and the death benefit coverage they provide is vast.
Conclusion
Whole Life Insurance brings with it a number of impressive benefits including a highly accessible cash value that grows tax deferred, guaranteed and non-guaranteed growth via dividends, and a tax free death benefit to pass on a legacy to family members and charities or to fulfill some other more functional or financial purpose. I hope this brief introduction to the benefits of whole life insurance was helpful and that you continue your journey into learning as much as you can about this asset. The benefits truly are incredible and the use cases for whole life insurance are nearly endless!
**For those of you who are wondering, "Ok wait... you covered all of the benefits but deliberately left out all of the possible downsides it seems. What's up with that?". Good eye! I wanted this post to be just about the benefits and what Whole life Insurance offers as a product. I do plan on creating a post in the near future that will address these very concerns.**