Whole Life vs. Term Life

What is going to happen to your family when you are gone?  For a lot of people, this is the most frightening thing about death.  When you purchase life insurance, you are buying some peace of mind both for you and for your family, and removing some of the uncertainty from the equation.  There are different types of life insurance, though, and the products differ substantially.  You will need to learn the difference between whole life insurance and term life insurance to figure out which one is best for you.

What is Term Life Insurance?

This is usually the type of life insurance policy that people think about when they consider getting life insurance.  It is the most basic type, and fulfills the most basic function of giving your family some financial resources to fall back on if you die.  Premiums on term life insurance are usually paid monthly, but some plans have annual premiums instead.

If you shop for term life insurance, you will select a “term” of coverage.  This is the amount of time the protection is for.  Most term life insurance policies will cover you for 10, 20 or 30 years.  If you outlive the term of the policy, you don’t get back your premiums, unless you choose a more expensive “return of premium” term life insurance policy.  These premiums cost more, but if you outlive the term, you are given back your premiums.  Shorter and longer terms are also available, and there are also lifelong “permanent” insurance policies (often whole life insurance policies; many term policies also can convert to these types later).  Some plans are specifically designed to help cover mortgage payments.

Premiums on term plans are often locked in for a certain number of years, after which they will begin to increase each year.  There is generally a guaranteed amount of coverage as well.  When shopping for a term policy, you will want to make sure you know exactly what you are getting and how it will work.

What is Whole Life Insurance?

Whole life insurance is called what it is because it is supposed to cover you for the whole of your life.  Instead of purchasing coverage only for 20 or 30 years, you will be receiving coverage for your family which will last the rest of your life.  Whole life insurance has another noteworthy difference which sets it apart from term insurance as well.  Remember how you can only get back your premiums on term life insurance if you purchase a special type of policy which pays them back at the end of the term if you are still alive?  With a whole life insurance policy, you have the option of extracting a percentage of your investment into your own insurance policy.  This is called “cash value.”  Through cash value, you can retrieve a percentage of your premiums should you need them while you are still alive.

Just as there are several different types of term life insurance policies available, there are also several different types of whole life insurance.  These are called universal, variable life, and variable universal insurance.  With a universal whole life insurance policy, you pay a monthly premium.  Part of the monthly premium is invested in a low-risk investment vehicle.  You may borrow against this part if you wish, or cash out part of its value.  The rest is not available to you, but will be available to your dependents if you die.

Variable life insurance allows you to choose the investment vehicle for the portion of your money which gets invested.  Your choices are limited to the options which the company gives you.  Whereas a smaller amount of money is invested with the universal insurance, a larger amount is invested with variable life insurance.  So this type entails more risk, since you stand to gain or lose more money (and so do your family members).

The third type, variable universal life insurance, unites the ideas of variable and universal insurance.  A certain amount of money is guaranteed to your survivors if you die, but the rest may be invested however you choose, within the options the company permits.  The flexibility and risk associated with this type of insurance are both more moderate.  Why use life insurance as an investment vehicle anyway?  It’s a tax shelter; you don’t pay any taxes on the money you make this way.

Whole vs. Term Life Insurance

Which type of insurance is better?  Let’s do a quick comparison between the two main types of insurance so you can see at a glance the differences between them:

Term Insurance:

  • Covers you for a set term.  The term may be 5, 10, 20, or 30 years, or some other length of time.
  • Offers a guaranteed death benefit.
  • Does not allow you to withdraw the money you put in later as cash.  The only way to get back any amount of the money you invest if you survive the term is to pay for a more expensive “return of premium” policy.
  • Only pays out the benefit amount if someone actually passes away.
  • Are less expensive on average than whole life insurance policies.

Whole Insurance:

  • Provides coverage for the entire duration of your life, however long you live.
  • May offer a guaranteed death benefit, if you select a policy that does.
  • Allows you to borrow against or cash out part of your premiums if you need the money for something when you are still alive.
  • Allows you a tax-free investment vehicle, albeit a relatively constrained one subject to the insurance company’s discretion.  How flexible or inflexible it is depends on the policy.
  • Are more expensive on average than term insurance policies.

A lot of people are not even aware that whole life insurance exists.  It was very common during the mid 20th century for breadwinners in families to purchase term life insurance to coverage their loved ones.  For many people today, signing up for term life insurance represents habitual thinking.  Term insurance still makes some sense for some people, but not for everyone—or even for most people.

How do you decide which type of insurance policy to buy?  Term insurance may make sense for you if you are already in your older years or you have a health condition which makes it unlikely that you will live past the duration of the term.  Unfortunately, it can be difficult by that point in time to find term coverage.  Still, you would not want to overpay into a whole life insurance policy if you don’t need one, and can get term insurance.

For a person who is healthy or young, however, a whole life insurance policy would probably make a lot more sense.  You do not have to worry about outliving your policy and getting nothing back, and you might even grow your personal accounts by investing smartly.  If you have an emergency and you need money while you are still alive, you can pull cash out of the investment—and if you do die, your family still receives a benefit.  Shop around for the best deals, and ask yourself the right questions to make sure you get the policy which suits your needs.