What’s The Difference between Term vs. Whole Life Insurance?
Life insurance policies fall into two main
categories: term life and cash value life insurance. One option within the cash
value category is whole life insurance, although there are other types as well.
Understanding the key differences between term and whole life insurance will help you choose the best policy for your needs.
Term vs. Whole Life Insurance
There are two main differences between
term and whole life insurance: premiums and cash value.
Term Life Insurance
- Premiums: You can lock in level premium
payments for a specific term length, such as 20 years. Many term life policies
allow for renewal after the term ends, but renewal rates are usually very
expensive.
- Affordability: Term life insurance is
generally the most affordable type because it provides purely life insurance
coverage without accumulating cash value.
- Policy Termination: If you decide to end
a term life policy, you can simply stop paying premiums. If the policy expires
while you are still alive, there is generally no refund of premiums.
Whole Life Insurance
- Premiums: Whole life insurance also has
fixed premiums, which you typically pay for the duration of the policy.
- Cash Value: A whole life policy builds
cash value at a steady, fixed rate. You can access this money through a policy
loan or withdrawal.
- Policy Termination: If you decide to end
the policy, you should notify the insurer to receive the surrender value of the
policy.
Comparing the Cost of Term vs. Whole Life
Insurance
It’s challenging to make a direct cost
comparison between term life and whole life insurance due to their distinct
features. For those seeking long-term coverage, 30-year term life policies are
a good option. Banner Life (part of Legal & General America) and Protective
Life offer 40-year terms, which are currently the longest level terms
available.
Regardless of whether you choose term or
whole life insurance, your life insurance quotes will be influenced by several
factors:
- Age and Gender
- Amount of Coverage
- Current and Past Health
- Family Health History (Parents and
Siblings)
- Prescription Drug History
- Additional Factors (e.g., Driving
Record)
What Is Term Life Insurance?
Term life insurance is a contract between
the policyholder and the insurer, stating that the insurer will pay a specified
amount to the policyholder’s beneficiaries if the insured person dies during
the term of the policy.
When purchasing term life insurance,
individuals need to decide on the length of the term and the coverage amount.
Term life insurance policies come in
various types:
- Level Term: Offers consistent premiums
and death benefits throughout the term length, such as 10, 20, or 30 years.
After the term ends, renewal rates increase annually, or you can seek quotes
for a new policy if needed.
- Annual Renewable Term: Requires annual
renewal with increasing rates each year as the policyholder ages.
- Decreasing Term: Maintains consistent
premiums while the death benefit decreases over the term. A common type is
mortgage life insurance, where the death benefit reduces as the mortgage is
paid off, but premiums remain constant.
- Return of Premium Term Life: Returns
your premiums if you outlive the policy. This type is significantly more
expensive than other term life policies.
Benefits and Drawbacks of Term Life Insurance
Like any life insurance, term life
insurance has its pros and cons. Understanding these can help you choose the
best policy for your needs.
Benefits:
- Lower initial cost compared to whole
life insurance.
- Flexibility to choose term length.
- Provides straightforward death benefit
protection without cash value accumulation.
Drawbacks:
- No cash value component.
- Premiums increase significantly upon
renewal after the initial term.
- If the policy expires while you are still
alive, there is no payout.
Considering these factors will help you
find the term life insurance policy that best suits your needs.
What Is Whole Life Insurance?
Whole life insurance is a type of cash
value life insurance that remains in effect for your entire lifetime, provided
you continue to make the required payments.
This policy includes a cash value
component that grows over time. You can access the cash value through
withdrawals or loans, or you can surrender the policy and receive the cash
value, minus any applicable surrender charges.
Benefits and Drawbacks of Whole Life Insurance
Whole life insurance offers several
guarantees, but these come at a cost. Here are the pros and cons to consider:
Benefits:
- Lifelong Coverage: The policy remains in
force as long as premiums are paid.
- Cash Value Accumulation: Builds cash
value over time that can be accessed for loans, withdrawals, or policy
surrender.
- Fixed Premiums: Premium amounts remain
the same throughout the life of the policy.
- Guaranteed Death Benefit: Provides a
guaranteed payout to beneficiaries.
Drawbacks:
- Higher Premiums: More expensive compared
to term life insurance.
- Surrender Charges: Early policy
termination can result in surrender charges.
- Complexity: More complex than term life
insurance due to the cash value component.
Understanding these pros and cons can help
you determine if whole life insurance is the right choice for your financial
and coverage needs.
Compare the Features of Term Life vs. Whole
Life Policies
Premiums
Both level term life and whole life
insurance have fixed premiums, meaning your payments won’t change over time.
Life insurance companies typically offer various payment plans, such as monthly,
quarterly, semi-annually, and annually.
If the prospect of lifelong payments for
whole life insurance isn't appealing, some policies offer shorter payment
schedules with higher payments, such as single premium life insurance or
policies with a set number of payments over a certain period (e.g., 10 years).
This can provide more budget flexibility later in life.
Payouts
Both whole life and term life policies
provide a payout called the death benefit, which is guaranteed and paid tax-free
to your listed beneficiaries.
The key difference is that coverage with a
term life policy ends if you do not renew it after the level term period. If
you outlive your term life policy and do not renew it, no death benefit is
paid.
Cash Value
Term life insurance does not build cash
value, whereas whole life insurance includes a cash value component that grows
over time at a fixed rate.
This guaranteed cash value growth is a
significant reason why whole life insurance is considerably more expensive than
term life insurance. Policyholders can access the cash value by taking a loan
against it or making a withdrawal. Any outstanding loan or withdrawal amount is
deducted from the death benefit.
Typically, any remaining cash value
reverts to the insurance company when you pass away, and your beneficiaries
receive the policy's face value minus any unpaid loans or withdrawals.
If you want lifelong coverage without the
high cost of whole life insurance, consider guaranteed universal life
insurance.
Ending a Policy
Your financial needs might change over
time, and you may find you no longer need life insurance.
- Term Life Insurance: You can stop paying
premiums to terminate the policy. Since there’s no cash value, there’s no money
to walk away with.
- Whole Life Insurance: You may have
accumulated cash value that you can receive if you surrender the policy. If you
don’t inform your insurer that you want to surrender the policy, the insurer
may use the cash value to continue paying premiums on your behalf until the
cash value is depleted. To avoid this, contact the insurer to receive the
surrender value, which is the cash value minus any surrender charges.
How to Choose Between Term Life and Whole Life
Insurance
When deciding between term life and whole
life insurance, consider your specific reasons for buying a policy. If you need
coverage to replace your income for a set period, such as until your youngest
child finishes college, term life insurance is a more affordable option than
whole life insurance.
Term Life Insurance May
Be a Good Fit If:
- You want to cover specific debts, like a
mortgage, in case you pass away.
- You want to ensure your children’s
college tuition is covered.
- You need life insurance coverage until a
certain milestone, like retirement.
Whole Life Insurance May
Be a Good Fit If:
- You want lifelong coverage.
- You wish to fund a life insurance trust.
- You have a dependent who requires
lifelong financial support, such as a special needs child.
- You want a policy that builds cash value
you can access during your lifetime.
- You want to ensure there’s a death
benefit for funeral expenses, regardless of when you die.
Can I Switch Life Insurance Policies?
Life circumstances and financial needs can
change, making it necessary to switch life insurance policies. Here’s how you
can adapt your coverage:
Changing Term Life to
Whole Life Insurance
Many term life policies include a
conversion option, allowing you to convert to a permanent policy. Check your
policy for the conversion period and available permanent policy options.
Changing Whole Life to
Term Life Insurance
If you have built up cash value in a whole
life policy, you might be able to switch to a paid-up term life policy using
the cash value. Your insurer can provide details on the length of the new term
policy based on your cash value.
Pairing Term and Whole
Life Insurance
It’s possible and sometimes beneficial to
have multiple life insurance policies. For instance, you could have a whole
life policy for funeral expenses and a 30-year term life policy for income replacement
during your working years. This strategy, known as laddering, can provide
comprehensive coverage for different needs. A financial advisor can help you
determine if laddering is right for you.
Alternatives to Term and Whole Life Insurance
Beyond term and whole life insurance,
there are other options:
Guaranteed Universal Life
Insurance (GUL)
GUL offers a level death benefit and fixed
premiums but builds minimal cash value. It’s the lowest risk and typically the
cheapest type of universal life insurance.
Indexed Universal Life
Insurance (IUL)
IUL policies base cash value growth on an
index, like the S&P 500. They offer flexibility in adjusting premiums and
death benefits but come with high fees that reduce cash value.
Variable Universal Life Insurance
(VUL)
VUL policies link cash value to
sub-accounts with stocks, bonds, and fixed interest options. These policies
allow you to adjust premiums and death benefits but require active investment
management, affecting cash value gains and losses.
Burial Insurance
Also known as final expense or funeral
insurance, burial insurance is a whole life policy with a small death benefit
for final expenses. Typically guaranteed issue, these policies don’t require a
medical exam but are more expensive.
Supplemental Life
Insurance
Employers often offer group life insurance
policies at low or no cost. These policies are tied to employment, so coverage
ends if you leave your job. Supplemental life insurance is useful but shouldn’t
replace your individual coverage.