Understanding the difference between term and whole life insurance boils down to their cost and duration. Term life insurance is less expensive and provides coverage for a specific period. On the other hand, whole-life insurance is more expensive, provides lifelong coverage, and can build cash value, making it a more complex product.
With both types of policies, beneficiaries can use the payout for any expenses, such as funeral costs, mortgage payments, or college tuition. Depending on your needs, one type of life insurance may suit you better.
Term Life vs. Whole Life: Overview
To clarify the distinctions, here’s a brief overview of how each type of insurance works.
Term Life Insurance
Term life insurance is straightforward: it provides coverage for a set period, like 10, 20, or 30 years, and pays out if you die within that term. If you outlive the term, the coverage ends, and your beneficiaries receive nothing. Most term life policies are level-term life insurance, where the death benefit and premiums remain constant throughout the term. Another less common type is decreasing term life insurance, where the death benefit decreases over time while premiums stay the same.
The term length of your insurance should ideally match the financial obligation you’re covering. For example, a new parent might choose a 20-year policy to ensure coverage until their child is financially independent. Term life insurance is widely available, making it easy to compare quotes online.
Whole Life Insurance
Whole life insurance is the most common type of permanent life insurance and generally costs more than term life insurance. This is because it offers coverage that can extend to ages 90, 100, or even 120. Additionally, whole life insurance includes a cash value component, where part of your premium contributes to the cash value, which accumulates over time. Once you have built up sufficient cash value, you can borrow against it or surrender the policy for cash.
While whole life insurance is more complex than term life insurance, it is simpler than other permanent life insurance types. “The premiums stay the same, and the cash value increases at a guaranteed fixed rate.”The death benefit is also assured, but it’s important to note that any loans or withdrawals taken from the cash value and not repaid will be deducted from the death benefit paid to your beneficiaries.
Many whole life insurance policies are “participating” policies, meaning you might receive dividends based on the company’s financial performance. These dividends can be used in various ways, including increasing your policy’s cash value.
Cons of Whole Life Insurance
One primary shortcoming of whole life insurance is its higher cost compared to term policies. On average, whole life insurance is five to fifteen times more expensive than term insurance with the same death benefit. This is because it combines insurance coverage and an investment component, which can make it challenging for some people to manage the higher premiums.
Moreover, the death benefit and cash value are linked in whole life insurance. If you borrow against your policy, the death benefit will be reduced by the amount of the loan plus any accrued interest if it’s not repaid. For instance, a $50,000 loan would reduce the death benefit by $50,000, plus any interest, if the loan remains unpaid at the time of death.
Another factor to consider is the complexity of it. Unlike term insurance, where you can simply stop payments if you no longer need or can afford the coverage, whole life policies may impose a substantial surrender charge if you choose to cancel the policy. This fee generally diminishes over time and eventually vanishes.
Cost of Term Life vs. Whole Life
Term life insurance is generally the most cost-effective option because it offers temporary coverage and does not build cash value. Conversely, whole life insurance has much higher premiums because it provides lifetime coverage and the policy grows cash value over time. Here’s a comparison of annual premiums for term and whole life insurance.
Average Term Life Insurance Rates for Nonsmokers
These are the average annual rates for a $500,000, 20-year term life insurance policy for nonsmokers in excellent health (super preferred applicants).
How to Choose Between Term and Whole Life Insurance
Term life insurance is ideal for most families, whereas whole life and other permanent coverage options can be beneficial in certain circumstances.
Choose Term Life If You:
- Need Coverage for a Specific Period: A term life policy can replace your income if you pass away while handling major financial responsibilities, such as raising children or paying off a mortgage.
- Seek Affordable Coverage: Term life insurance is the least expensive option, especially if you are young and healthy.
- Might Consider Permanent Life Insurance Later: If you cannot currently afford permanent life insurance, you can convert your term life policy to permanent coverage later. Conversion deadlines vary by policy, and not all policies offer this option.
- Do Not Want to Accumulate Cash Value: Opting for a cheaper term life policy allows you to save the difference and possibly invest it elsewhere.
Choose Whole Life If You:
- Afford Higher Premiums: This type of life insurance requires a lifelong commitment, so it’s important to ensure you can comfortably manage the premiums. Missing payments could cause the policy to lapse.
- Want Lifelong Coverage: Whole life insurance provides a death benefit that pays out regardless of when you die. Naming beneficiaries ensures the payout goes directly to them, bypassing your estate.
- Have Lifelong Dependents: For example, a child with disabilities. Life insurance can provide funds for a trust to support your child after your passing. Consult with an attorney and financial advisor to establish a trust.
- Desire Guaranteed Cash Value Growth: Whole life policies build cash value at a guaranteed rate set by the insurer.
Alternatives to Term and Whole Life Insurance
If you require lifelong coverage but seek more flexibility than whole life insurance offers, consider other types of permanent life insurance:
- Universal Life Insurance
- Variable Life Insurance or Variable Universal Life Insurance
- Indexed Universal Life Insurance
These alternatives come with different costs and features based on the type of coverage you choose and the performance of your cash value. This can result in significant savings or unexpected expenses.
It’s always wise to discuss your specific needs with a fee-only life insurance consultant to determine your best option.
A comprehensive comparison table that covers all the key points between term and whole life insurance
| Feature | Term Life Insurance | Whole Life Insurance |
|---|---|---|
| Definition | Temporary coverage for a specific period (e.g., 10, 20, 30 years) | Permanent coverage that lasts a lifetime |
| Duration | Fixed term (e.g., 10, 20, 30 years) | Lifetime |
| Purpose | Provides coverage for a specific period, usually until a certain financial obligation is met | Provides lifelong coverage and can be used as an investment vehicle |
| Premiums | Lower premiums | Higher premiums |
| Premium Flexibility | Fixed or increasing premiums over time | Fixed premiums throughout the policy term |
| Cost Over Time | Cheaper in the short term | More expensive but accumulates cash value |
| Death Benefit | Pays a death benefit if the policyholder dies within the term | Pays a death benefit whenever the policyholder dies |
| Cash Value | No cash value | Accumulates cash value over time |
| Policy Loans | Not available | Can borrow against the cash value |
| Coverage Adjustment | Typically not adjustable | Can be adjustable with certain policy types |
| Conversion Options | Can convert to a whole life policy (with some policies) | No conversion necessary |
| Investment Element | No investment component | Includes a savings component that grows tax-deferred |
| Cash Value Growth | N/A | Grows based on dividends or interest (depending on policy) |
| Best For | Individuals needing coverage for a specific period (e.g., young families, mortgage coverage) | Individuals seeking lifelong coverage and a financial product that combines insurance with savings |
| Financial Goals | Ideal for short-term financial protection | Ideal for long-term financial planning and estate planning |
Conclusion
Choosing between whole and term life insurance depends on your needs and budget. Term life insurance is affordable and provides temporary coverage, ideal for covering short-term financial responsibilities. Though more expensive, whole life insurance offers lifelong coverage and builds cash value, making it suitable for long-term financial planning.
Understanding these differences is crucial in selecting the right policy. For more flexibility, consider alternatives like universal, variable, or indexed universal life insurance. Consulting a fee-only life insurance consultant can help you make the best choice for your situation.
FAQs
What Happens to Term Life Insurance at the End of the Term?
When your term life insurance policy ends, your coverage typically expires. This means you will no longer be covered, and you will stop paying premiums. If you pass away after the policy ends, your beneficiaries will not receive a death benefit.
If you still require life insurance after your term expires, you can purchase a new policy. However, you should expect to pay higher rates due to your increased age and any changes in health.
In some cases, your coverage may continue if you convert your term life insurance to a permanent life insurance policy before the conversion deadline set by your insurer. This allows you to maintain coverage without needing a new medical exam or pay the typically higher rates associated with a new policy.
Why is Term Life Insurance Cheaper Than Whole Life?
Term life insurance is generally more affordable than whole life insurance because it provides temporary coverage and does not accumulate cash value. Unlike whole life , which is a form of permanent life insurance covering the individual for their entire life, term life insurance covers a fixed period and may expire without paying any benefits. This lack of a cash value component and the potential for expiration without a payout contribute to the lower cost of term life insurance than whole life insurance.
Does Term Life Insurance Build Cash Value?
No, term life insurance does not build cash value. Term policies offer no payout after the term expires and provide no value beyond the death benefit. If you’re interested in a policy accumulating value over time, you should consider permanent life insurance options.
Which is Better: Whole or Term Life Insurance?
Your ideal life insurance policy depends on your specific needs and budget. For most people, term life insurance is sufficient. However, whole life insurance might be worth considering if you have maxed out your tax-advantaged retirement accounts or have a lifelong dependent, such as a child with special needs. Understanding the differences between whole and term life insurance can help you select the policy that best suits your lifestyle and financial situation.
What Are the Main Differences Between Term and Whole Life Insurance?
Term life insurance provides temporary coverage for a specified period, such as 10, 15, or 20 years, and pays out a death benefit if the policyholder dies during that time. It is a simple and affordable option for many families, typically offering coverage for 10 to 30 years.
In contrast, whole life insurance offers lifelong coverage and includes a cash value component that accumulates interest over time. This cash value grows throughout the policy’s life, providing an additional financial benefit beyond the death benefit.
What is the Main Disadvantage of Whole Life Insurance?
While whole life insurance offers several benefits, it also has notable drawbacks. These include higher premiums than term life insurance, lack of flexibility, slower cash value growth, and potential penalties. Considering these disadvantages is important when selecting the best insurance product for your needs and lifestyle.
What Are the Two Components of Whole Life Insurance?
Whole life consists of two main components:
- Guaranteed Death Benefit: The death benefit is the amount paid to your beneficiaries upon death. It is guaranteed never to decrease, providing a stable and predictable financial benefit for your loved ones.
- Guaranteed Cash Value: This component allows the policy to accumulate cash at a guaranteed yearly rate. The cash value grows steadily and is designed to equal the policy’s face amount by a specified age, typically 100 or 121.
In addition to these components, whole life insurance often includes the potential to earn dividends if it is a participating policy. These dividends can be used in several ways, such as increasing the policy’s cash value, reducing premiums, or purchasing additional coverage. The cash value can also be accessed through loans or withdrawals, providing a financial resource that policyholders can use during their lifetime. However, it is important to repay any loans to avoid reducing the death benefit.
When should you switch from term to whole life insurance?
If your term policy allows a conversion to whole life, it might be beneficial in certain situations. Changes in goals, income, or health can make this option advantageous. Converting to whole life can help you build cash value for retirement or other expenses as you age. Additionally, you might be able to afford the higher premiums of whole life insurance over time. If you face a serious health issue, getting a new policy may be difficult, making a term-to-whole life conversion your best option for permanent coverage.
At what point does a Whole Life Insurance policy endow?
A Whole Life Insurance policy typically endows when the policyholder reaches a specific age, which is most commonly 100 or 121 years old, depending on the policy. When the policy endows, the cash value of the policy equals the death benefit. At this point, the insurance company usually pays the policyholder the cash value, and the policy terminates.
Here’s a summary of the key points regarding endowment in Whole Life Insurance:
- Endowment Age: The age at which the policy endows is usually specified in the policy, often 100 or 121 years.
- Cash Value Equals Death Benefit: Upon endowment, the accumulated cash value of the policy will equal the policy’s death benefit.
- Policy Termination: Once the policy endows, it typically terminates, and the policyholder receives the cash value.
If the policyholder is still alive at the endowment age, they will receive the full cash value, which can be used as a lump sum or in other ways depending on the policy terms.
