The Differences Between Term and Whole Life Insurance

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Buying life insurance now helps protect your dependents later if you’re not around to take care of them. After you’re gone, your family can use the proceeds to cover funeral costs, mortgage payments, college tuition and other expenses.

There are two main types of life insurance: term and permanent. Term life insurance is the easiest to understand and has the lowest cost. Whole life is the most well-known and simplest form of permanent life insurance coverage, which tends to be more expensive than term, but offers additional benefits. Other kinds of permanent life insurance include universal, variable and variable universal.

Let’s take a closer look at term vs. whole life insurance.

Term life insurance
Term life insurance provides coverage for a certain time period. It’s often called “pure life insurance” because it’s designed only to protect your dependents in case you die prematurely. If you have a term policy and die within the term, your beneficiaries receive the death benefit. The policy has no other value.

Policies often have terms of one year to 30 years. The most common coverage term is 20 years, according to Life Happens, an insurance industry group. With most policies, the premium stays the same throughout the entire term.

Choose a term that coincides with the years your family would be most financially vulnerable, along with an amount they would need if you were no longer there to provide for them. The payout would replace your income and help your family pay for services you perform now, such as child care.

Ideally your family’s need for life insurance would end around the time the term expires: Your kids will be on their own, you’ll have paid off your house, and you’ll have plenty of money in savings to serve as a financial safety net going forward.

Whole life insurance
Like all permanent life insurance policies, whole life provides lifelong coverage and includes an investment component known as the policy’s cash value. The cash value grows slowly, tax-deferred, meaning that you won’t pay taxes on its gains while they’re accumulating. You can borrow money against the account or surrender the policy for the cash. But if you don’t repay policy loans with interest, you will reduce your death benefit, and if you surrender the policy, you’ll no longer have coverage.

Although it’s more complicated than term life insurance, whole life is the most straightforward form of permanent life insurance. The premium remains the same for as long as you live, the death benefit is guaranteed, and the cash value account grows at a guaranteed rate.

Some whole life policies are also eligible to earn annual dividends, a portion of the insurer’s financial surplus. You can take the dividends in cash, leave them on deposit to earn interest or use them to decrease your premium, repay policy loans or buy additional coverage. Dividends are not guaranteed, and only mutual insurers, which are owned by policyholders rather than outside shareholders, pay them.

Term vs. whole life insurance cost comparison
Term life is cheap because it’s temporary and has no cash value — in most cases, your family won’t receive a payout. Whole life premiums are much higher because the coverage lasts for a lifetime, and there’s a guaranteed rate of investment return on the cash value.

Choosing between term and whole life insurance
Term life is sufficient for most families who need life insurance, but whole life and other forms of permanent coverage can be useful in certain situations.

Term life is a good choice if:

  • You need life insurance only to cover a certain period, such as the years you’re raising children or paying off your mortgage.
  • You want the most affordable coverage.
  • You think you might want permanent life insurance, but can’t afford it. Most term life policies are convertible to permanent coverage. The deadline for conversion varies by policy.

Whole life, or another type of permanent insurance, is worth considering if you need coverage for the rest of your life, for example:

  • You want to provide money for your heirs to pay estate taxes. In 2016, estates worth more than $5.45 million per individual and $10.9 million per couple are subject to federal estate taxes. Without a life insurance payout, your heirs might be forced to sell off parts of the estate, such as heirlooms or property, to pay the tax bill.
  • You have a lifelong dependent, such as a child with special needs. Life insurance can fund a special needs trust to provide care for your child after you’re gone. Consult with an attorney and financial advisor if you want to set up a trust.
  • You want to spend your retirement savings and still leave a legacy or money for final expenses, such as funeral costs. With a whole life policy, your beneficiaries are guaranteed a payout.
  • You want to equalize inheritances. If you plan to leave a business or other property to one child, you could use whole life insurance to compensate your other children.

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