THE BLOG
08/03/2016 12:28 pm ET Updated Aug 04, 2017

5 Questions To Ask Before You Buy A Whole Life Policy

By Barbara Marquand

Whole life insurance is pricey and it's meant to last the rest of your life -- so if you're thinking about buying it, make sure it's the right decision.

Unlike term life insurance, whole life insurance doesn't just cover you for a certain period. It also includes a savings account known as its cash value, which builds over time. You can eventually borrow against the cash value or surrender the policy for the cash.

Here are five questions to ask yourself before buying a whole life policy.

1. Do I really need whole life insurance?

Whole life serves a purpose, but not everybody needs it. If you need only temporary coverage that lasts until you've paid off debts or seen your kids through college, then term life insurance is your best bet. It's cheap for young and healthy people.

Whole life can be a good option if you:

  • Have a large estate that will be subject to taxes when you die. The federal government taxes individual estates worth at least $5.45 million and the estates of couples worth at least $10.9 million. Your heirs could use the life insurance payout to cover the tax bill.
  • Want to provide money to heirs for a funeral and final expenses or leave a legacy, even if you spend every dime of your retirement nest egg.
  • Are the parent of a lifelong dependent, such a child with special needs. A life insurance payout can fund a special needs trust.
  • Maxed out contributions to tax-advantaged retirement savings accounts and want a safe place to grow cash over the long haul as part of a diversified portfolio.

2. Can I afford whole life insurance?

Whole life costs much more than term life in part because a portion of your premium payments goes into the cash value savings account. Your interest rate and death benefit are also guaranteed.

However, it takes many years to build up substantial cash value. If you decide you can't afford the policy after only a few years, you'll be out a lot of money and have little or no cash value to take with you. You'll also pay a fee to surrender the policy during the early years.

If you need permanent coverage but can't afford it, consider buying a term life insurance policy that can be converted to whole life. And whether you're buying term or whole life, get quotes from several insurance companies.

3. How much coverage do I need?

The amount will depend on how you want to use the insurance. If you want it for estate planning purposes, for instance, the payout should cover the estate taxes your heirs would owe. If you'd like it to pay for final expenses, it should cover your funeral and any debts you'll leave behind. The national median cost of a funeral with viewing and burial was about $7,200 in 2014, according to the latest data from the National Funeral Directors Association.

4. How will the cash value grow?

The cash value in a whole life policy has a guaranteed annual return. If the company is a mutual insurer, you might also receive annual dividends. A dividend is a share of a company's surplus.

But dividends aren't guaranteed. Each year, a mutual company decides whether to declare dividends and how much to share with policyholders. The dividends you receive will be based on your policy's cash value. You'll be eligible to earn higher dividends the longer you keep the policy and let the cash value grow.

5. How strong is the insurance company?

Check the financial strength ratings of the companies you're comparing. Find them online from rating firms such as A.M. Best. Choose a company with at least a B+ rating.

A life insurance agent can walk you through how a whole life insurance policy works. It's also a good idea to talk to a fee-only financial planner -- one who doesn't earn commissions off product sales -- about your overall finances and how life insurance fits into the bigger picture.

Barbara Marquand is a staff writer at NerdWallet, a personal finance website. Email: bmarquand@nerdwallet.com. Twitter: @barbaramarquand.