What's the Difference Between Term and Whole Life Insurance?

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A Comparison between Term and Whole Life Insurance

Term and whole life insurance, two of the oldest types of life insurance, are still among the most popular. It's not that insurance firms haven't tried to make it more difficult to reach a wider audience. While shopping for life insurance isn't as entertaining as reading a spy book, both have one thing in common: the more you dive, the more complicated everything becomes.

But, to come back to basics, what is the difference between a term and a lifetime contract, and which is best for your needs? We'll go through the major elements that set these insurance staples apart.

TAKEAWAYS IMPORTANT

• Term life insurance is "pure" insurance, but whole life insurance includes a cash value component that you can access at any time throughout your life.
• Term insurance protects you for a set number of years, whereas whole life insurance protects you for the rest of your life—as long as you keep up with the premium payments.
• Whole life premiums can be five to fifteen times higher than term plans with the same death benefit, thus they may not be a viable alternative for consumers on a tight budget.

Term Life Insurance is a type of life insurance that lasts for

Term life insurance is likely the most basic to comprehend, as it is simple insurance with no frills. The guarantee of a death benefit for your beneficiary if you die while the policy is in place is the only reason to buy a term insurance. As the name implies, this bare-bones form of insurance is only valid for a set amount of time, whether it's five, twenty, or thirty years. The policy simply ends after that.

Benefits

Term plans are also the cheapest, frequently by a large amount, due to these two characteristics—simplicity and finite duration. If all you want from a life insurance coverage is to safeguard your family in the event of your death, term insurance is probably the best option. While no two families are same, new parents may obtain insurance that only lasts long enough for their children to complete college or enter the job full-time.

For $27.49 a month, a 30-year-old male can purchase a 20-year term coverage with a $500,000 death benefit. The average 30-year-old woman may obtain the same policy for just $21.75 due to her normally longer longevity.

Drawbacks

Those prices will, of course, fluctuate due to a variety of reasons. A higher death benefit or a longer period of coverage, for example, will almost likely raise rates. Furthermore, because most policies include a medical exam, any health issues could raise your rates above the average.

Because term insurance ends, you may find yourself with a large sum of money spent for no reason other than peace of mind. You also can't utilize your term insurance investment to grow wealth or save money on taxes.

Pros 

Term insurance is generally less expensive than other types of life insurance.

It's easier to grasp than "permanent" policies.

Cons 

Protection is only offered during the policy's term.

It can't be utilized to develop riches or to avoid paying taxes.

Insurance for the rest of your life

Whole life insurance is a type of permanent life insurance that differs from term insurance in two significant respects. For one thing, as long as you keep paying your premiums, it will never expire. In addition to the death benefit, it gives some "cash value," which can be used to meet future financial requirements.

Benefits

The majority of whole life policies are "level premium," which means you pay the same monthly rate throughout the policy's term. Those premiums are divided into two categories. One portion of your contribution goes toward the insurance component, while the other contributes to the growth of your cash worth over time.

Many companies offer a guaranteed interest rate (typically 1% to 2% yearly), but some also sell "participating" policies, which pay unguaranteed dividends and can boost your total return.

The cost of the whole life premium is initially higher than the cost of the insurance. However, as you become older, this changes, and the premium is less than an usual term coverage for someone your age. This is referred to as "front-loading" your insurance coverage.

You can borrow or take a withdrawal from your cash value amount, which grows tax-deferred, at a later date to pay for costs like your child's college tuition or house maintenance. It's a far more adaptable financial tool than a term policy in this regard. Loans from your insurance are tax-free, but any investment gains from withdrawals will be subject to income tax.

Drawbacks

Regrettably, the death benefit and monetary value are not entirely distinct aspects. If you take a borrowing from your policy and don't pay it back, your death benefit will be reduced by the same amount. If you take out a $50,000 loan, your beneficiaries will receive $50,000 less, plus any interest payable, if the debt is still owed.

The biggest downside of whole life insurance is that it is significantly more expensive than term insurance. Permanent policies are five to fifteen times more expensive than term insurance with the same death benefit. The relatively high cost makes it difficult for many consumers to keep up with payments.

The complexity of whole life insurance is another possible disadvantage. If you no longer need the insurance or can no longer afford it, you can simply cease making payments on a term policy.

Whole life policyholders, on the other hand, may suffer a surrender charge of up to 10% of the cash value if they opt to cancel their policy, depending on their carrier. This charge usually decreases over time until it eventually vanishes.

Pros

You can borrow money against your whole life insurance coverage for future financial requirements.

Loans, like death benefits, are tax-free in most cases.

You can fix your premiums for the rest of your life.

Cons

Whole life insurance is substantially more expensive than term life insurance.

Surrender charges may apply if you have to let the insurance lapse within the first few years.

Your death benefit will be reduced if you have any outstanding loans.

Particular Points to Consider

So, which sort of insurance is right for you and your family? If term insurance is all you can afford, the answer is simple: it's better to have any protection than none at all.

For those who can afford the significantly higher premiums associated with a whole life policy, the decision is a little difficult. Many fee-based (non-commission-earning) financial planners recommend starting with 401(k)s and individual retirement accounts (IRAs) if your objective is to save for retirement. For some people, a cash value insurance may be a better option than a fully taxable investment account after they've maxed out their contributions.

Some customers have particular financial requirements that a whole life policy can help them better handle. Parents with impaired children, for example, may wish to seek whole life insurance, which covers you for the rest of your life. As long as you pay your premiums, you may rest assured that your children will get the death benefit from your policy.

It can also be a useful tool for small business succession planning. Business partners may take out whole life insurance for each owner as part of a buy-and-sell arrangement so that the remaining partners can purchase the deceased's equity portion in the case of their death.

Final Thoughts

With its cash value component, whole life insurance surely provides more financial flexibility. Nonetheless, because permanent policies are more complicated and costly, many buyers adhere to the ancient adage, "Buy term and invest the remainder."