Whole life insurance policies can come with different premium schedules. Some can be paid for in as few as 10 payments. Others can be paid for with premiums stretching over years to a certain age, like 65 or 100.
What’s the difference?
In terms of immediate protection, none. Purchasing a life insurance policy ensures that loved ones will have a death benefit to help carry on in the event of your untimely passing. That is guaranteed, no matter the timetable for premiums. (Calculator: How much life insurance do I need?)
But whole life insurance has another feature where the premium schedule can make a difference. This is its cash value component, essentially a pool of funds that builds up over time, tax deferred, and earns a rate of return guaranteed by the insurance company. (Related: Cash value explained)
Why is cash value important?
Cash value can be a source of funds used for any purpose through borrowing: college tuition, home improvements, or supplemental retirement income, for example.1 It can also be used to cover a premium payment and keep a policy in force in some instances. And the interest rates applied to cash value loans from insurance policies are typically more attractive than those available for personal loans.
Having cash value in a whole life insurance policy, then, can be a useful option in an overall financial portfolio in addition to providing protection.
So how do you build cash value?
Cash value builds up as you pay premiums. The more you pay in toward paying off the policy, the more cash value becomes available. That’s where the length of the premium schedule becomes important.
Essentially, shorter premium policies have higher annual premiums, but build up cash value more quickly. By contrast, longer premium policies have lower annual premiums, but don’t build up cash value as fast.
“One way to think about these choices is like a 15-year versus a 30-year mortgage,” said Doug Collins, financial planning director at Fortis Lux Financial in New York City. “You need to pay more monthly for the 15-year mortgage, but you will be done paying off your home sooner. And there can be other advantages, such as higher cash accumulation for shorter pay-period policies.”
Take, for an illustrative example, a 40-year-old, healthy woman (nonsmoker) buying a $250,000 whole life policy. What would be the difference between a policy paid up in 15 annual payments versus a policy where payments were stretched over 60 years until she reached age 100.2
For the to-age-100 policy:
- Annual premium payment: $3,265 to age 100
- Cash value after 15 years: $40,140
- Cash value at age 65: $81,900
- Cash value at age 100: $250,000
For the 15-pay policy:
- Annual premium payment: $6,473 for 15 years.
- Cash value after 15 years: $85,010
- Cash value at age 65: $117,168
- Cash value at age 100: $250,000
As this example illustrates, the 15-pay policy builds more than twice as much cash value as the 100-pay policy in 15 years.
“For certain clients, a 15-pay policy can be an awesome product,” said Elan Moas, an investment adviser representative with Coastal Wealth in Ft. Lauderdale, Florida. “It provides the protection of a to-age-100 policy, but it’s paid up after 15 years. Because of this, you have higher early cash value without any further premiums due after the 15th year. That coupled with the favorable borrowing rate means you can get a retirement income stream from the policy on very good terms.”
The values cited in this example would be guaranteed. They don’t take into account other factors that could increase cash value beyond the guaranteed level, particularly the addition and performance of possible dividends paid out by insurance companies on participating life insurance policies, which can be used to increase both the amount of life insurance and policy cash value.3 (Related: Understanding whole life insurance dividends)
Of course, this example only focuses on two types of premium policies. There can be a variety of choices. On top of that, premiums can be paid with different frequencies, from annual to monthly, to meet individual budget requirements. (Related: What premium plan may work for you?)
Additionally, there are other types of permanent life insurance that also have a cash value component, albeit it is built and grows in different ways. And while premiums for whole life insurance are level, premiums for those other types of insurance, like universal life insurance or variable universal life insurance, don’t have to be. (Term life insurance, which provides protection for a set number of years, does not have a cash value component.)
Many people opt to talk with a MassMutual financial professional, who can help lay out the options, generate illustrations like the ones above, and discuss what might be appropriate for an individual situation. (Need a financial professional? Find one here)
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1 Borrowing from cash value will reduce the policy's cash value and death benefit, increase the chance the policy will lapse, and may result in a tax liability if the policy terminates before the death of the insured.
2 The actual price of a life insurance policy will depend on a number of factors about the individual, including the amount of coverage, health, geographic location, occupation, and other risk factors.
3 Dividends are not guaranteed.