What is Participating Whole Life Insurance and What are the Pros and Cons?

Understanding Life Insurance Part 2

You’ll hear many arguments for and against whole life insurance. Whole life insurance can create a cycle of cash but could have tax consequences. These are the pros and cons of the policy. But many people wonder what whole life insurance truly is and if the benefits of the policy would help them. Here we cover how whole life insurance works, all of the pros and cons of it, and how it compares to term insurance.

How Does Whole Life Insurance Work?

Participating Whole Life Insurance (PWLI) is a contract that remains in force for the insured’s whole life and typically requires premiums to be paid every year. The contract is between the policy owner[i] and the insurance company where the insurance company contractually guarantees to pay to the beneficiaries of the contract a certain death benefit upon the death of the insured; and to share with policy owners (participants, policy holders) the excess profits the company generates. This sharing of excess profits is referred to as dividends but is considered a refund of premium according to current tax law in the United States. Therefore, these dividends are not currently treated as taxable income in most cases.[ii] 

Whole Life Insurance Pros and Cons

The ability to collateralize a policy is one of the major pros of whole life insurance. PWLI contracts provide for the buildup of something called cash value. This cash value is contractually guaranteed to be made available to the policy owner through the policy loan and/or surrender provisions. These provisions allow the policy owner to collateralize their policy and borrow money from the insurance company, or to surrender death benefit and withdraw equity from their policy. This cycle can help with the accumulation of wealth and the creation of a financial legacy. 

On the other hand, a  loan which is taken from the insurance company against a policy in this manner will be subject to interest and if this interest and future premiums are not paid, the contract may lapse and the loan will then be considered a withdrawal and could be subject to taxation.[iii] If the life insurance plan isn’t managed well, it could become a tax liability, which is the main con of whole life insurance plans.

That being said, if the loan interest and premiums are paid according to the contract, the policy will not lapse and the owner of the policy can use the capital borrowed for whatever need or purpose intended. The only requirement to initiate a policy loan is to assign the policy to the insurance company for security, by either making a phone call or completing a simple loan request form. Policy loans alter the death benefit of the policy and may alter the dividends that are paid in some PWLI contracts.

The policy loan provision of PWLI polices guarantees a relative liquid source of equity which can be borrowed and self- managed. When done appropriately, with the assistance of a good consultant, this positive cash flow can be used to create more value, wealth and abundance. It can also create the ability to increase policy premiums and therefore allow you to repeat this cycle. Because of this cycle of positive cash flow, the pros of having whole life insurance can outweigh the tax con.

Whole Life Insurance vs. Term Life Insurance

When discussing whole life insurance, one of the most common questions is about the difference between whole life and term insurance. While both policies involve premiums that result in a death benefit, there is no accumulation of cash value with term life insurance. A term life insurance policy only covers someone for a period of time, and there is only a death benefit if they die during this coverage. Term insurance policies can be cheaper though, short term.

Whole life insurance can be, initially, more expensive than term, but it also creates an accumulation of wealth that can be collateralized or borrowed. This process can help build a financial legacy as well as provide a death benefit. There are pros and cons to both whole and term life insurance. Choosing which is right for you depends on your circumstances and financial goals.

The Bottom Line

The guaranteed loan provision found in contracts of PWLI are rewarding to those who understand and manage them accurately but if not managed well could end up causing a policy to lapse or create a tax liability for the owner.

Life Benefits can help you by:

  1. Properly designing PWLI policies which meet your needs
  2. Accurately aiding you in the management of your policy loans
  3. Carefully guiding you on how your premiums and loan repayments can and need to be paid
  4. Continually providing you the answers you need to meet your current and future needs
Part 1. Understanding Life Insurance
Part 3. The 7 Biggest Lies You’ll Hear About Life Insurance