Whole Life Insurance - Part 1

Whole life is a policy in which the premium remains level for the whole of the insured's life. It is relatively easy for the actuaries to design.

The whole life premium is the result of calculating the increasing annual insurance costs per $1000 of amount at risk, spreading them over the life of the insured, and at the same time accumulating a portion of the policy owner's payments in the policy each year. This reduces the amount at risk and eventually results in zero amount at risk at age 95 or 100, at which time the death benefit is entirely policy owner money.

The level premiums are more than sufficient in the early years of the contract, during which time the insurance company has a significant amount at risk because the policy owner's cash-value account has not built up very significantly, and the premiums are less than adequate in the later years. You will note that in the latter years of the policy, the most significant part of the death benefit is provided by the policy owner's cash value. The insufficiency of the annual premium in the later years is offset by the overpayment of premium in the early years, along with the earnings on those overpayments, that compounds income tax-free and creates a cash reserve that reduces the insurance company's amount at risk.

You will note that the portion of the contract that is "life insurance" (insurance company money, net amount at risk) decreases with age. The result is that even though the cost per $1000 increases each year as you get older, you have to buy fewer units, eliminating both cost and life insurance by age 100. At age 100, the death benefit is entirely policy owner money, plus the income tax-free earnings on that money.

The amount you could take out while living is equal to your death benefit. That does not mean that if you reach the age of 100, you would want to cash in your policy and take the money, because then you would have to pay income taxes on all the gain in the policy. But if the proceeds are eventually paid out as a death benefit, no income taxes have to be paid.