What Is Permanent Life Insurance?

Parenting often means being there for your child’s baseball game or helping them with an annoying school project, even if you couldn’t care less about sports or science project poster boards. Another item that’s necessary, even if it’s not the most fun? Getting a suitable life insurance policy. 

Life insurance can assure you that your surviving family members can afford the mortgage and other day-to-day expenses even if you were no longer around.

There are other reasons some people get life insurance, too, such as building a retirement nest egg. That’s where permanent life insurance, also known as whole life insurance, comes in: These types of policies offer both a cash value that accumulates during your lifetime and a death benefit for your loved ones.

Before you can decide which life insurance policy is the best fit for you, one of the first questions you’ll need to answer is: Do you want term or whole life insurance? (Those are the two main types of life insurance you’re likely to encounter.)

Note that Fabric sells term life insurance and doesn’t currently offer whole life insurance. That said, we think it’s important that you understand your options.

What Is Permanent Life Insurance?

Also called whole life insurance or cash-value life insurance, permanent life insurance provides coverage throughout your life. That’s different from term life insurance, which only covers you for a specific period of time (or “term”). 

As with other forms of life insurance, whole life insurance policyholders can designate a beneficiary to receive a death benefit. In other words, if you were to pass away, the person you designate would receive a sum of money that they could use for whatever they need—that could include your funeral expenses, paying off joint debt you left behind, paying off a mortgage or car loan, funding daily living expenses, covering a child’s college education or anything else.

A distinct characteristic of whole life insurance is that in addition to insuring against your passing, it also enables you to build “cash value,” money that can be accessed while you’re still alive. 

As a result of these additional features, whole life insurance policies tend to cost much more than term life insurance policies and tend to have more complex terms and conditions. They also have various expenses and fees that may affect the benefits you’d receive. 

Beneficiaries will receive their death benefit as tax-free earnings, but there may be some instances where life insurance proceeds could count as taxable income. For example, interest you earn can be taxed, according to the IRS. 

Different Ways to Use the Cash Value on Your Whole Life Policy

When a policyholder pays their premiums, a part of that money goes toward the policy’s cash value. Think of it as a savings or investment account that is held within your whole life insurance policy. 

Your cash value earnings depend on a few factors, such as market fluctuations. In most cases, your earnings are decided by your life insurance company. So if your policy states you'll receive 6 percent back each year, that's how much you'll receive regardless of market conditions. 

Although this is the most common way your earnings are paid, there are exceptions. For example, with an indexed universal life policy, earnings are based on how a stock market index like the S&P 500 performs. Your policy may have a cap as to how much you'll earn if the index performs, and you'll receive nothing if the returns are negative at the end of the year.

Some policies, called participating policies, pay dividends when the insurance company has a surplus of earnings, or an overpayment on an insurance policy. These dividends aren't taxable. 

Initially, the premium mostly goes toward administrative fees and building your cash value. Over time, more of it will go toward the insurance component as you become expensive to insure (the older you are, the more expensive it is to insure your life). That means that as time goes on, less of your premium will contribute to cash value. That said, your cash value keeps building and growing until it equals the amount of the death benefit. 

There are a few ways to access your cash value: making a partial withdrawal, withdrawing the dividends you earn and taking out a loan against your policy. Your insurance policy may allow you to withdraw up to a certain amount of your cash value, but doing so may affect your death benefit. As for receiving dividends as cash, that will also depend on your specific policy.

If you want to take out a loan, your insurer can use your cash value as collateral and allow you to do so. You’ll need to pay interest on the loan but not the principal amount.

Once you’ve accumulated enough cash value, you can also use that money to pay or reduce your monthly insurance premiums with no effect to your death benefit.

What Happens When You Use Your Cash Value

Whether you make a partial withdrawal or take out a policy loan, your death benefit will be negatively affected if you pass with the funds still outstanding. If you take out a loan, the death benefit for your beneficiaries will be reduced if you have an outstanding balance at the time of your death, including the interest owed. 

For instance, say you have a $100,000 policy and you took out a $20,000 loan. Let’s say you currently owe $1,000 in interest. If you pass before it’s paid back, $21,000 will be subtracted from the $100,000 death benefit. Your beneficiaries will receive $79,000 instead. 

If you’re simply making a withdrawal from your cash value, your withdrawal amount would be deducted from the death benefit. However the maximum amount you can withdraw will be determined by your insurer and you could be charged a withdrawal fee. Usually, the fee starts at 10 percent but goes down the longer you keep the cash value in your policy.

For example, if you have a $100,000 whole life policy and want to withdraw $5,000, your death benefit could be reduced to $95,000. Though many policies reduce the death benefit dollar for dollar, others may reduce to an amount that’s more than what you withdraw. That’s why it’s important to read your policy carefully. 

There could be additional ramifications for tapping into your cash value. For instance, if you decide to receive cash for your dividends (as opposed to having them reinvested in your insurance policy’s cash value), you will have to pay taxes if the amount is larger than what you’ve paid in premiums. 

When Cash Value Can Be Helpful

Despite the drawbacks of tapping into your cash value, Brian Haney, the founder of The Haney Group, a multi-lines insurance brokerage and advisory business, says that tapping into your cash can be a good idea especially as you grow older.

Haney says that people who use their whole life policies in order to supplement their retirement income can benefit from taking small, tax-free distributions. In other words, withdrawing the cash value portion of your policy can make financial sense if your need for life insurance goes down while your need for retirement funds increases. 

For example, say you took out a $250,000 policy when you were 35 because you wanted to make sure your spouse could pay off the mortgage and cover some of your child’s education expenses if you were to pass prematurely. Now that you’re 55, your home is paid off and your child is about to graduate college, so you don’t need that much coverage. If this were a whole life policy, it might make sense for you to take withdrawals from your cash value so you can use the money in retirement, rather than waiting to leave it upon your death.

Of course, in a situation like that, you might also have been served by a 20-year term life insurance policy that would’ve covered you for the duration of your mortgage and your child’s education—once the term ended, you would’ve been able to stop paying your monthly premiums because you no longer needed that financial cushion. And you could’ve used the financial wiggle room provided by term life’s lower premiums to fund your retirement accounts in the meantime.

What If I Want All of My Cash Value?

Liquidating the entire cash value of your policy means surrendering your policy. Doing so means you’ll no longer be covered (your beneficiaries won’t get a death benefit if you pass away). But if you’re OK with that, then you’re able to take out the entirety of the cash value you’ve accumulated. Depending on the policy, you may be required to pay surrender fees, reducing the amount you’ll receive. 

Haney tends to advise his clients against surrendering their policies for this very reason. Instead, he recommends clients establish “a strategy for systematically taking withdrawals.” Haney says that policyholders may be able to withdraw up to a certain amount—called the basis in your policy documents—without incurring a tax bill.

Other Types of Whole Life Insurance

“Whole life insurance” can be an umbrella term that encompasses many different flavors of coverage and payment structures. By definition, all of these offer coverage for your entire life rather than for just a specific number of years. They all offer some form of cash value, as well.

Here are a few common variations within the world of permanent life insurance:

• Universal life: With universal life insurance, you can increase or decrease your death benefit later on. The cash value portion earns interest at a predetermined rate set by your insurance company. 

• Variable universal: Variable life insurance policies have a death benefit as well as a separate account that policyholders can invest in stocks, bonds and money market mutual funds. There is more risk associated with this type of policy because it’s possible to actually lose money. On the other hand, because it’s linked to the market, the cash value has the ability to grow faster. Some policies will guarantee that your death benefit won’t fall below a certain amount if your investments don’t fare well. Even still, your death benefit and cash value may decrease. 

• Indexed universal life: Policyholders can link their cash value to index funds, potentially earning more than what they would with a regular universal life policy. The contract usually stipulates a maximum and minimum amount of earnings growth since it’ll be based on market fluctuations. This means that unlike a variable life policy, an indexed universal life policy won’t suffer any loss in cash value even if the funds don’t do well. 

These are a few common examples, though we’ve counted as many as 15 different types of life insurance you might want to know about.

Reasons to Consider Permanent Life Insurance

To be clear: whole life insurance policies aren’t for everyone. They’re usually best for those who want to guarantee money for their beneficiaries when they die. For instance, if you have a child with special needs or dependents who will rely on you for the remainder of their lives, this money can be used to fund their daily expenses.

If you anticipate that your beneficiaries might need to pay estate taxes (this only applies if you have a sizable estate—over $11.7 million in 2021) then a whole life policy can provide the money to do so. It’s best to consult a tax professional if you want to make sure your beneficiaries don’t need to sell off parts of your estate to pay the tax bill. 

Another reason to consider whole life insurance is if you can’t qualify for life insurance that is medically underwritten. Many policies (including the one sold by Fabric) now offer accelerated underwriting, which means your health situation is taken into account but you may be able to receive an offer without undergoing an exam. Often that’s accomplished by looking at things like your prescription and medical records. 

If, however, you wouldn’t be approved for medically underwritten life insurance, you might consider a “guaranteed issue” or “simplified issue” life insurance policy that could help you get coverage even if you have major health problems. These are whole life policies that tend to have high premiums and lower death benefits. Many life insurance policies for seniors are guaranteed issue permanent life insurance, meaning that no medical exam is required but the coverage limits may be lower, often maxing out somewhere around $25,000. If you no longer take care of young children, this could be a good way to help your family deal with your final expenses.

On the other hand, there are cases in which term life insurance may serve your needs for a much lower price. This type of policy covers you for a fixed period of time and is designed to only provide a death benefit. Ideally, the policy ends when you no longer have need for life insurance. 

Whatever type of policy you choose, you’ll want to keep the financial needs of your beneficiaries at the forefront in order to choose the features that meet their needs—and your budget.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards. This article has been reviewed and approved by a compliance professional who is a licensed life insurance agent.

Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.

Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.

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