How Does an Insurance Company Give Interest to a Whole Life Policy?
When choosing a life insurance policy for yourself, you have many options. The primary purpose of life insurance is to provide death benefit protection that pays off any outstanding financial liabilities that you have when you die. One type of life insurance is whole life insurance. Whole life insurance provides basic death benefit protection and a cash value savings. Make sure you understand how whole life works and how interest is credited to the savings before you purchase this type of insurance.
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Function
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Premiums are paid to the life insurance company and invested on your behalf. The guaranteed interest that's credited to the whole life policy is generated by an investment in the insurance company's general account, which contains a variety of fixed investments such as bonds. However, the general account also contains real estate and even some stocks. Some types of whole life insurance pay dividends to the policy. Dividends are often regarded as a return of your premium dollars, but dividends are a function of the insurance companies' other investment activities, as well as their mortality experience. Mortality experience refers to the amount of claims the insurer had to pay over the previous year. If claims were low, then the money that the insurance company retained is paid out as a dividend.
Significance
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The significance of whole life policy interest is that there's a guaranteed rate specified in the policy. This rate ensures that you know in advance exactly how the policy will perform throughout your entire life. Any additional interest from dividends isn't guaranteed, but it does provide additional earnings to the policy.
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Benefits
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The benefit of a whole life policy is that you receive guaranteed cash values and guaranteed death benefits. This means that you don't have to worry about what the future value of your contract will be. As long as you pay the required premiums, your policy remains in force for your whole life. Whole life policies also enjoy tax-deferred growth on all of the cash value building up inside of the policy. Policy cash values may be borrowed against, tax-free, during your life for any reason.
Disadvantages
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The disadvantage to a whole life policy is that your policy's interest rate is often quite low. Due to the guaranteed nature of whole life, the policy pays an interest rate low enough that the insurer can sustain it over the course of your life. Consequently, your whole life policy may not become an investment that returns a substantial amount of money to you.
Considerations
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When considering a whole life policy, determine what you want the policy to do for you. Certain whole life policies focus more on death benefit protection than cash value accumulation. If you would like to build substantial cash values in your policy, then a high cash value policy is ideal. The highest cash value policies are limited-pay, dividend-paying whole life policies.
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