People often want to know that their family’s financial needs will be met in the event they pass away unexpectedly. The most common vehicle for this is life insurance. But people who research their options often lack the tools to evaluate term versus whole life insurance. Getting a good handle on both types of life insurance would be time-consuming. The best way to figure out which one is right for you is by learning the difference between term and whole life insurance.
Term vs. Whole Life Insurance
Term policies are much simpler to understand. They typically cost less but only remain in force for a defined period. A whole life policy, as the name implies, remains in effect for the length of the policyholder’s life. Whether you prefer term or whole life will depend on many factors. Understanding both types of policies will help you make an informed decision and buy life insurance coverage that suits both your needs and your budget.
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. The length of term life insurance agreements varies. Some agreements extend for only one year, but they often remain in effect for 10 or 20 years or to a specified age.
Term life insurance is simple. The policy offers no cash value unless the insured person passes away. Should the insured person outlive the policy, their beneficiaries would receive no benefit.
Term life insurance premiums can increase over time, but premiums tend to be low because this insurance does not guarantee a payout. Under certain conditions, insurance companies can convert term policies to whole life policies at the request of the insured person.
- Cheaper than whole life insurance
- Simple to understand
- May be converted to whole life insurance
- 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.
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, serving as forced savings 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.
- You can borrow tax-free
- Guaranteed for life
- More flexible
- Premiums are higher
- Unpaid loans will be deducted from the death benefit
Difference Between Term Life and Whole Life Insurance
Here’s a comparison chart of the differences between term life and whole life at a glance.
|Term Life Insurance
|Whole Life Insurance
|Varies; can last for a period of years or to a specific age
|Variable, but usually lower than whole life policies
|Payable only if the policyholder dies while the policy is in effect
|Guaranteed Cash Value?
Each insurance type comes with pros and cons that make it difficult to decide which is best. The choice should be based on the factors most likely to help the family cope with the loss of a loved one.
Costs: 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 is cheaper for three essential reasons. For one, when the insured outlives their policies, they receive no payout at all. Secondly, term policies do not have a savings aspect, so policyholders don’t pay extra money that the insurer saves on their behalf. Third, insurers can increase premiums to offset inflation and rising costs. This eliminates the need to charge excessive premiums from the onset.
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. Hence, the cost differential narrows over time. In a world where rising prescription costs and other factors pressure family budgets, the level premium offers some relief.
What Happens if You Live Longer Than Your Term Life Insurance?
As the name implies, term insurance only runs for a specified period. In cases where the insured outlives the policy, the beneficiaries receive nothing. Conversely, whole life insurance stays in effect for one’s entire life and the death benefit is guaranteed.
A term policy has no cash value and does not pay the beneficiaries anything unless the insured dies while the policy is in effect. Hence, it isn’t worth much under any other circumstance.
The whole life policy includes the savings component, and part of each premium payment goes into a tax-deferred savings account. The value of the policy thereby increases over time. Some policies also pay dividends. In some cases, the insured can take out a portion of the cash value for retirement. The policyholder can also take out a loan against the policy, though they have to repay the money, possibly in the form of reduced benefits. Death benefit payouts are generally not subject to taxation for either type.
How To Choose Between Term and Whole Life Insurance
Numerous factors determine whether a term or whole life policy better suits your needs.
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. Someone who has trouble saving money might fare better with a whole life policy. 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.
You might also benefit from a whole life policy if you hold substantial non-liquid assets. 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.
In addition to deciding which type of life insurance to buy, you must contend with choosing the best life insurance company for your needs. Many rating agencies offer reviews to help you evaluate the companies and their offerings. You might also want to consult with a certified financial planner or independent financial advisor when making these decisions.
Understanding the Life Insurance 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.
The title page contains the name, plan type and the signature from an agent representing the insurer. This page might also describe the terms of the “free look period,” or the length of the period where the insured can terminate the policy without penalties.
The policy should also list the benefit amount, premium, name of the insured, policy issue date and number and the rate class. Definitions, tables, settlements, riders and a signature page typically appear at the end.
In some cases, the insurance agreement consists of the application itself and a grace period. It could also include an incontestability provision that limits the insurer’s ability to void the policy due to inaccurate information in the application.
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.
In the event the right choice remains unclear, consider working with a financial advisor who can help you evaluate your needs and what you can afford. A fiduciary advisor — one who is paid for the services they provide versus the policies they sell — is your best bet, according to a recent GOBankingRates’ guide on How To Find the Best Financial Advisor for You. The advisor’s advice can ultimately help you make the most suitable decision and give your family the financial resources they’ll need following a devastating loss.
Cynthia Measom contributed to the reporting for this article.
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