How Does Permanent Life Insurance Work?

Lynda Taylor is an assistant director of Risk Product Development at Northwestern Mutual.

In today’s fast-paced world, it’s essential to establish a solid financial foundation that can withstand the test of time. One financial tool that can help is permanent life insurance, which offers a unique opportunity to secure your loved ones’ future while enhancing your own financial security. Here we’ll answer common questions about life insurance and explain why we think permanent life insurance is worth it.

Permanent life provides financial protection for your loved ones when you’re no longer here. Whole life, universal life and variable universal life are the main types of permanent life insurance. They all give you lifelong coverage,¹ so your beneficiaries get the payout when you pass away. As you pay premiums over the years, this type of insurance also builds cash value that you can use for anything you want, at any time.² 

Depending on the type of insurance you choose, you could have the chance to earn annual dividends, too.³ At Northwestern Mutual, we don’t have shareholders. So when we finish the year better than expected, we’re able to return the money to policyowners as dividends. This foundation of mutuality and our industry-leading long-term value allow us to expect to pay nearly $7.3B in dividends in 2024 to policyholders.

Key facts about the permanent life insurance death benefit

The death benefit is the most important part of life insurance. It’s the money paid out to your beneficiaries when you pass away. It’s important to get the right amount, which is usually much more than the cost of a funeral. For example, you may need enough death benefit to cover missed income that your family was counting on. And many people use the death benefit to leave behind a legacy that passes tax-free to loved ones.

Quick online life insurance calculators can give you a reasonable gauge of how much life insurance you need, but it takes an expert to pinpoint the right amount and the right type. Your advisor will get to know you and then help you figure out which type of life insurance is best for you—and exactly how much you need.

Once you do pass away, your beneficiary will make a claim to receive the death benefit. Then the insurer will review the form and documentation to verify the payout. At Northwestern Mutual, we typically complete the review process within five to seven business days after receiving the documents.

How much does whole life insurance cost?

Many factors can affect the cost of a policy. (That’s why we value working with you to fully understand your situation and needs.) The amount you pay is known as your premium. It will depend on things like:

• Your coverage amount,
• Your age,
• Your health, and
• Add-ons called “riders.”

When you apply for the policy, you plan to pay until you reach a certain age, like 100, or over a certain number of years. And some companies allow you to choose how often you’ll pay the premium: monthly, quarterly or yearly. Most people prefer to pay monthly and set up automatic payments from a bank account. One way that you may be able to pay less premium out of pocket is to apply dividends toward your payment.

How do whole life insurance dividends work?

Many insurance companies also strive to pay extra money out to you as dividends, which aren’t guaranteed.

When the company does pay them, you usually choose exactly how the payout works. You can allow your cash value to grow more quickly. Or you can put dividends back into your policy and increase your death benefit. You could also choose to use your dividends to pay your premiums. Doing that means you may not have to pay as much out of pocket. But that also means you won’t accumulate as much cash value.

One of the great things about life insurance dividends is that they are not typically taxed. That’s because they are considered a return of premium. Be sure to talk through your options with your financial advisor and a tax professional to help ensure you’re making the best choice for yourself.

What can I do with permanent life insurance cash value?

Permanent life insurance is designed to be a safety net that provides money to loved ones when you pass away. But it offers additional benefits that can be really powerful. Over time, it accumulates cash value that makes your policy a flexible financial tool.

One common way to make use of it is to borrow against the cash value. This can help with things like an emergency expense, a great opportunity or even making it through down markets in retirement. Once you have accumulated cash value, you can borrow against it for any financial need.

A policy loan gives you quick access to cash should you need it. You simply fill out a form, and the insurance company sends you the money within a couple of days.

Life insurance loans typically do not affect your credit because your policy is the collateral for the loan, and there’s no set repayment schedule. (But it’s worth noting that your loan will accumulate interest, so the balance will increase if you don’t make payments.) There’s no loan approval process, which means your credit score is unaffected when you get the loan.

If you still have a loan against your policy when you die, the death benefit will be reduced by the amount of the loan. And if the loan balance gets too high, the insurance company will surrender, or “lapse,” your policy to pay the loan, which can result in a negative tax consequence.

Your policy should always be personalized for you—considering any dependents you have, your financial situation and your health. Your Northwestern Mutual financial advisor can help you pinpoint the type of policy and the amount you need. Your advisor can also take a broad look at your money and help you identify blind spots and opportunities that might otherwise be overlooked. You can see how to use multiple financial options that work together to help you protect and grow your wealth.

¹ Assumes that all premiums are paid. The amount of your payments will directly affect your policy’s cash value, as well as your ability to maintain coverage in the future.
 

² Your policy’s cash value typically becomes a useful source of funds only after several years of premium payments, which allows the cash value to build up. Each method of utilizing your policy’s cash value has advantages and disadvantages and is subject to different tax consequences. Surrenders of, withdrawals from and loans against a policy will reduce the policy’s cash surrender value and death benefit and may also affect any dividends paid on the policy. As a general rule, surrenders and withdrawals are taxable to the extent they exceed the cost basis of the policy, while loans are not taxable when taken. Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon policy termination or the death of the insured. Repayment of loans from policy values (other than death proceeds) can potentially trigger a significant tax liability, and there may be little or no cash surrender value remaining in the policy to pay the tax. If loans equal or exceed the cash value, the policy will terminate if additional cash payments are not made. Policyowners should consult with their tax advisors about the potential impact of any surrenders, withdrawals or loans.

³ Dividends are reviewed annually and are not guaranteed. Some policies may not receive dividends in a particular year or years even while other policies receive dividends. For universal life products, in lieu of dividends, experience is reflected through changes to nonguaranteed charges and credits.