You Asked:

What is a whole life insurance policy? — Sherry, Manchester, N.J.

Marshall Brain Answers:

If you look at an article like How Life Insurance Works, there are two big categories of life insurance: 1) term life insurance and 2) permanent life insurance.

Term life insurance is pure life insurance. You might buy $100,000 in term life insurance. You pay some amount of money per month (depending on your age, your health and the length of the term) for some term of coverage. For example, you might buy a 20 year term policy. You pay, say, $20 per month for 20 years, and the policy covers you during that time. If you die during the time you are paying these monthly premiums, your beneficiary gets $100,000.

With a whole life insurance policy, there is no term (that’s why it is called permanent life insurance). You will be paying for the insurance for the rest of your life. It does provide life insurance just like a term policy does. But in addition, part of your monthly premium goes into something like a savings account. So over time your policy gains a cash value, and you can cash it in at any time to recover the cash value. Or, when you die, your beneficiary gets the face value of the policy plus the cash value.

So, with a whole life policy, you pay more per month for $100,000 in coverage. But the policy earns money over the long haul.

You might ask, “why would anyone want to use a life insurance policy as a savings account?” If you get a good rate of return on the cash value, then the advantage is that you are earning that rate tax-free.

The problem has been that many whole life policies don’t offer a particularly good rate of return. And there are a lot of fees associated with life insurance compared, say, to a bank account or some mutual funds. Therefore you are often better off getting term insurance and investing money in your own account, rather than letting a life insurance company do it.

But if you have a policy with a top-rated company with a long history (do the research into the company), and the cash value has a good rate of return (ask!), and if you are in it for the long haul (the first few years, fees and commissions tend to eat up the whole premium), the cash value does add up. And, unlike a mutual fund, the value of the policy doesn’t go down if the stock market crashes.

Here are two other perspectives on insurance. Suze Orman is not fond of whole life:

Dave Ramsey doesn’t like whole life either: