Term vs. Whole Life Insurance: What’s the Difference?
Written by
Will Healy
Edited by
Emily Gadd
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If you’re shopping for a life insurance policy, you’ve probably seen term and whole life insurance policies. The biggest difference between these policies is the period of time the policy holder is covered. However, this factors into the price of the policy and other important factors. Here’s how to decide which policy is right for you.
| Benefits | Term Life Insurance | Whole Life Insurance |
|---|---|---|
| Duration | Varies; can last for a period of years or to a specific age | Life |
| Cost | Variable, but usually lower than whole life policies | Usually higher |
| Death benefit | Payable only if the policyholder dies while the policy is in effect | Guaranteed |
| Guaranteed cash value? | No | Yes |
| Premium increases? | Yes | No |
What Is Term Life Insurance?
Term life insurance is insurance that covers a person, often the head of a household, for a specified period. Should the insured person pass away while the policy is in force, the beneficiary would receive a specified payout.
How Term Life Insurance Works
The length of term life insurance agreements varies. Some agreements extend for only one year, but they often remain in effect for 10 to 30 years. Term life insurance offers no cash value unless the insured person passes away. If the insured person outlives the policy, their beneficiaries would receive no benefit.
Term life insurance premiums can increase over time, but premiums tend to be low because payouts aren’t guaranteed. Under certain conditions, insurance companies can convert term policies to whole life policies at the insured person’s request.
Pros
- Cheaper than whole life insurance
- Simple to understand
- May be converted to whole life insurance
Cons
- Rates are expensive if you start later in life
- Has an end date
What Is Whole Life Insurance?
Insurers often refer to whole life insurance under names such as straight life or ordinary life. It is insurance that covers the policyholder for the remainder of their life.
How Whole Life Insurance Works
This insurance works in a less straightforward manner. Although the premium never increases, it’s disproportionately high during the early years, when the policyholder is younger and less expensive to insure.
Part of the premium is held in reserve, working similarly as a savings account that build cash value and keep premiums level even when the policyholder is older and more expensive to insure. That cash component and the fact that whole life insurance guarantees a payout upon death means that these policies tend to charge much higher premiums than term policies.
Pros
- You can borrow tax-free
- Guaranteed for life
- More flexible
Cons
- Premiums are higher
- Unpaid loans will be deducted from the death benefit
Is Whole Life More Expensive Than Term?
The amount you can afford to pay for life insurance could determine whether you choose term or whole life insurance. When the premium is the overriding factor, term life insurance is likely the most prudent decision.
Term Insurance Price Factors
Term insurance is cheaper for three main reasons.
- When the insured outlives their policies, they receive no payout at all.
- Term policies do not have a savings aspect, so policyholders don’t pay extra money that the insurer saves on their behalf.
- Insurers can increase premiums to offset inflation and rising costs. This eliminates the need to charge excessive premiums from the onset.
Whole Insurance Price Factors
Although quotes for whole life insurance tend to run higher than for comparable amounts of term insurance, term insurance premiums increase as the policyholder ages while the whole life premium remains constant.
This narrows the cost differential over time. In a world where rising prescription costs and other factors pressure family budgets, the level premium offers some relief.
Which Is Better: Term or Whole Life Insurance?
Many different factors determine whether a term or whole life policy better suits your needs.
Who Should Consider Term Life Insurance?
- Families. Term insurance might work well for young families, who tend to hold mortgages and other debt and might also need to provide for young children.
Who Should Consider Whole Life Insurance?
- Someone Who Has Trouble Saving Money. The policy’s forced savings provision can leave your beneficiaries some money upon your death. It might also provide collateral to help you qualify for loans, fund your retirement or pay out cash dividends.
- Wealthy Estates. Wealthy estates can face hefty estate taxes upon a person’s death. This could force your heirs to divest property or a business simply to cover the tax. A whole life policy can leave your heirs some cash by which they can cover this tax without compromising the family’s wealth.
Common Misconceptions About Whole Life Insurance
Here are some common myths about whole life insurance.
Myth: Whole Life Policies Don’t Need Monitoring
Fact: Changes in dividends and insurance costs can affect how well the policy performs over time. Ordering an “in-force” policy illustration every few years can evaluate the potential performance of your policy, so you’ll know if your policy is on track with your goals.
Myth: Whole Life Insurance Is an Investment
Fact: Whole life insurance is primarily a way to provide a death benefit — not to serve as an investment. While whole life policies do accumulate cash value, using this value for loans or withdrawals reduces the death benefit and can even cause the policy to lapse. It’s best to think of whole life as life insurance first and an asset second.
Myth: Policy Loans Don’t Affect the Policy
Fact: Policy loans come with interest charges, and the dividends paid on the borrowed amount are often lower than on unborrowed funds. Over time, this can reduce the policy’s cash value and overall performance, so it’s important to weigh the impact before borrowing.
Common Misconceptions About Term Life Insurance
Here are some myths regarding term life insurance.
Myth: Term Life Insurance Is Expensive
Fact: Term life insurance premiums are based on factors like age and health, so the younger and healthier you are when you apply, the lower your premium will likely be. Term life provides substantial coverage at a lower cost than permanent — or whole — life insurance.
Myth: It’s Hard To Qualify for Life Insurance
Fact: Many term life policies offer simplified underwriting, which means a medical exam isn’t required. Instead, you may only need to provide basic health information when you apply. Additionally, insurers often offer online applications, which makes applying for term life insurance less of a hassle.
Myth: Employer-Provided Life Insurance Is Sufficient
Fact: While many employers offer a basic life insurance policy, it may not provide enough coverage for your family’s needs should something happen to you. In this instance, you might decide to add supplemental coverage. Additionally, workplace-issued policies may end when you leave your job or retire, which will require you to seek coverage elsewhere.
Alternatives To Whole Life or Term Life Policies
If whole life or term life policy isn’t right for your needs, here are some other options to consider.
1. Universal Life Insurance
Universal life insurance is a permanent policy that provides permanent coverage and builds cash value. Like whole life insurance, it offers both a death benefit and a cash value component based on current market rates.
Additionally, premiums are flexible and can be adjusted as needed, which gives you control over payments throughout the policy term.
2. Guaranteed Issue Life Insurance
Guaranteed issue life insurance doesn’t require a medical exam and is designed for individuals who might not qualify for traditional policies due to health issues. And while the death benefit is smaller, premiums are more affordable and the policy allows those with pre-existing conditions to access coverage.
3. Final Expense Insurance
Final expense insurance is designed to help cover end-of-life expenses, like funeral costs and medical bills. Like guaranteed issue life insurance, it offers low premiums and a modest death benefit, which makes it an affordable option. Most final expense policies don’t require a physical exam, but some insurers may ask basic health questions before approving your application.
The Bottom Line
Choosing the more suitable type of insurance policy is an exercise in determining your needs and measuring them against what you can afford. Those who need to cover finite and temporary circumstances typically fare better with term life insurance. Individuals and families who want to build cash value and have a guaranteed cash payout upon the policyholder’s death would have their needs better met by a whole life policy.
Before you purchase life insurance, read the application carefully and get clarification on any part you don’t understand. Policyholders should read their policies thoroughly to make sure they understand their coverage.
Cynthia Measom contributed to the reporting for this article.
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