The death benefit is typically a set amount of the policy contract. Some policies are eligible for dividend payments, and the policyholder may elect to have the dividends purchase additional death benefits, which will increase the amount paid at the time of death. Death proceeds are non-taxable to the beneficiary and are, therefore, not part of taxable gross income.
The death benefit can also be affected by certain policy provisions or events. For example, unpaid policy loans, including accrued interest, reduce the death benefit dollar for dollar. Alternatively, many insurers offer voluntary riders—for a fee—that secure or guarantee coverage, including the stated death benefit. For example, two of the most common are the accidental death benefit and waiver of premium riders, which protect the death benefit if the insured becomes disabled or critically or terminally ill and are unable to remit premiums due.
Many policies allow the policyholder to designate that the funds from the policy be held in an account and distributed in allotments rather than as a lump sum. Interest earned on the holding account will be taxable and should be reported by the beneficiary. Also, if the insurance policy was sold before the death of the insured, there may be taxes assessed on the proceeds from that sale.
As is the case with any kind of permanent policy, it's important to thoroughly research all insurers being considered to ensure they're among the best whole life insurance companies currently operating.
For insurers, the accumulation of cash value reduces their net amount of risk. For example, ABC Insurance issues a $25,000 life insurance policy to S. Smith, the policy owner and insured. Over time, the cash value accumulates to $10,000.
Upon Mr. Smith’s death, ABC Insurance will pay the full death benefit of $25,000. However, the company will only realize a loss of $15,000, due to the $10,000 accumulated cash value. The net amount of risk at issue was $25,000, but at the death of the insured, it was $15,000.
Most whole life insurance policies have a withdrawal clause, which allows the policyholder to withdraw a portion of the cash value or cancel coverage, receiving a cash surrender value.