The entire death benefit of a whole life policy is free of income tax, except in unusual cases.
If the policy is surrendered or canceled before death, any loans received above the cumulative value of premiums paid will be subject to tax as growth on investment.
In the US, life insurance will be considered part of a person's taxable estate to the extent he possesses "incidents of ownership.
Businesses may also have legitimate and compelling needs, including funding of:[6] While Term life may be suitable for Buy-Sell agreements and Key Person indemnification, cash value insurance is almost exclusively for Deferred Comp and S.E.R.P.'s.
This cash value can be accessed at any time through policy loans that are received income tax-free and paid back according to mutually agreed-upon schedules.
It is the difference between the policy's current cash value (i.e., total paid in by owner plus that amount's interest earnings) and its face value/death benefit.
The disadvantages of whole life are the inflexibility of its premiums and the fact that the internal rate of return of the policy may not be competitive with other savings and investment alternatives.
The level premium system results in overpaying for the risk of dying at younger ages, and underpaying in later years toward the end of life.
[8] The over-payments inherent in the level premium system mean that a large portion of expensive old-age costs are prepaid during a person's younger years.
The Death Benefit promised by the contract is a fixed obligation calculated to be payable at the end of life expectancy, which may be 50 years or more in the future.
(see non-forfeiture values) Most of the visible and apparent wealth of Life Insurance companies is due to the enormous assets (reserves) they hold to stand behind future liabilities.
[9] These reserves are primarily invested in bonds and other debt instruments, and are thus a major source of financing for government and private industry.
Cash values are an integral part of a whole life policy, and reflect the reserves necessary to assure payment of the guaranteed death benefit.
Thus, "cash surrender" (and "loan") values arise from the policyholder's rights to quit the contract and reclaim a share of the reserve fund attributable to his policy.
Policies purchased at younger ages will usually have guaranteed cash values greater than the sum of all premiums paid after a number of years.
It is a reflection of human behavior that people are often more willing to talk about money for their own future than to discuss provisions for the family in case of premature death (the "fear motive").
This means that the insurance company assumes all risk of future performance versus the actuaries' estimates.
On the other hand, if the actuaries' estimates on future death claims are high, the insurance company will retain the difference.
Non-participating policies are typically issued by Stock companies, with stockholder capital bearing the risk.
Since whole life policies frequently cover a time span in excess of 50 years, it can be seen that accurate pricing is a formidable challenge.
Actuaries must set a rate which will be sufficient to keep the company solvent through prosperity or depression, while remaining competitive in the marketplace.
The company will be faced with future changes in Life expectancy, unforeseen economic conditions, and changes in the political and regulatory landscape.
In the case of mutual companies, unneeded surplus is distributed retrospectively to policyholders in the form of dividends.
Sources of surplus include conservative pricing, mortality experience more favorable than anticipated, excess interest, and savings in expenses of operation.
[11] While the "overcharge" terminology is technically correct for tax purposes, actual dividends are often a much greater factor than the language would imply.
[12] {Milton Jones, CLU, ChFC} With non-participating policies, unneeded surplus is distributed as dividends to stockholders.
The company generally will guarantee that the policy's cash values will increase every year regardless of the performance of the company or its experience with death claims (again compared to universal life insurance and variable universal life insurance which can increase the costs and decrease the cash values of the policy).
Cash values are considered liquid assets because they are easily accessible at any time, usually with a phone call or fax to the insurance company requesting a "loan" or "withdrawal" from the policy.
Cash values are also liquid enough to be used for investment capital, but only if the owner is financially healthy enough to continue making premium payments.