From the high cost of giving birth to the price of soccer uniforms, it’s nearly inevitable that your finances will change when you become a parent. Most of all, there’s this knowledge, this pressure: Another human depends on you.
That’s where life insurance comes in. It’s important to help make sure your family is protected if something happens to you, but it can be complicated—so doing your own homework is beneficial.
And the first step to doing your own homework is to understand term vs. whole life insurance.
Term life insurance and whole life insurance are quite different, so you can’t fairly compare them apples-to-apples, but it’s important to understand some of their key attributes to help enable you to make an informed decision.
What Is Term Life Insurance?
Life insurance is an agreement between you and an insurance company. It says that if you pass away, the insurance company will pay a lump sum to the people you’ve designated as your “beneficiaries.”
It’ll do so as long as your policy payments are up to date and you’ve met certain requirements that you agreed to when you purchased the policy (for example, answering all applications questions accurately).
Term life insurance is sometimes called “pure life insurance” because the purpose of the policy is straightforward: It provides a death benefit to your beneficiaries if you were to pass away while the policy is active or “in force.”
As you might imagine, one of the most common reasons to get life insurance is to help protect dependents like children. (There are reasons why some single people might want life insurance, too.)
Typically, people have the highest need for life insurance during the first 20 years of their children’s lives. After that, their kids are likelier to be self-sufficient. As a result, 20 years is one of the most popular term lengths available.
For both term and whole life insurance policies, the death benefit is income-tax free, meaning that your beneficiaries wouldn’t owe taxes on the payout. However, there are certain circumstances where it might be included as part of your taxable estate.
What Is Whole Life Insurance?
Unlike term life policies, whole life insurance policies (also known as “permanent life insurance”) offer coverage for your entire life. In addition to paying a death benefit, whole life policies also have the ability to build cash value over time. You can borrow against or withdraw from this cash value while you’re alive.
As a result of whole life’s ability to earn interest and accumulate cash value, however, these policies tend to be more complex and more expensive than term life insurance. Certain fees and expenses associated with whole life policies will reduce the cash value, which can, in turn, affect the benefit amounts.
Key Differences Between Term and Whole Life Insurance
|Term Life Insurance||Whole Life Insurance|
|Cost||Tends to be more affordable||Tends to be more expensive, sometimes as much as four times the cost|
|Purpose||To provide a death benefit to the people you choose, upon your death||To provide a death benefit to the people you choose, upon your death; whole life also has a component to build cash value|
|Duration||Covers you for a specific length of time, most often 10-, 15-, 20- or 30-year terms; if you want coverage beyond that, you’ll need to renew your policy (at a higher rate) or get a new policy||Covers you for your whole life, most often ending either upon your passing or when you turn age 121|
|Assuming the Claim Is Approved, Is the Death Benefit Amount Guaranteed?||Yes, as long as your policy payments are up to date and you don’t meet certain exclusions||Yes, as long as your policy payments are up to date and you don’t have any outstanding policy loans (any outstanding loan is deducted from the death benefit)|
|Cash Value Accumulation||None||As you pay into your policy, you accumulate cash value at a predetermined, fixed rate, which can be borrowed against or withdrawn (doing so could be taxable and will reduce|
|How Does Your Age at Purchase Affect the Cost?||Buying a new policy generally becomes more expensive as you age||Buying a new policy generally becomes more expensive as you age|
|If You Stop Paying Your Premiums . . .||Your policy will lapse, meaning it’ll be canceled||Your cash value will first be used to pay your premiums, and once that runs out your policy will lapse, meaning it’ll be canceled|
|This is not intended to be a comprehensive comparison between term and whole life insurance, but to give a general idea of the differences in certain policy features.|
Why Some People Choose Whole Life Insurance
Meanwhile, some people pick whole life insurance to make sure they leave behind an inheritance or money for their beneficiary or beneficiaries. With term life insurance, the death benefit would only be paid if they died during a certain time frame. With whole life insurance, it doesn’t matter when they pass away.
Another reason you might choose whole life insurance is if you want to provide money for your survivors to pay estate taxes. These taxes are levied on large estates worth over a certain amount ($11.18 million, in 2018).
Whole life insurance could potentially help avoid forcing your heirs to sell off parts of the estate, like heirlooms or real estate, to cover the tax bill. Anyone who is considering a whole life policy for this reason should consult a tax professional before making any decisions.
Whole life insurance might also make sense if you have lifelong dependents, like a child with special needs, as you could fund a special needs trust through a life insurance payout. (Of course, you’ll want to talk to a lawyer and/or a financial advisor before creating a trust.)
If you have a high-risk medical condition, it’s possible you’d only be able to qualify for a “guaranteed issue” policy, which doesn’t require a medical exam. These are often a subset of whole life insurance. They tend to be more expensive, while offering a lesser death benefit.
Why Some People Choose Term Life Insurance
Term life insurance may make sense for people who only need to replace their income during a certain time period, like specific years during which they’re supporting their kids or paying off a mortgage.
It may also make sense for people who are looking for the most affordable coverage available. It also may make sense for people who’re interested in whole life insurance but can’t afford it currently. (Many times, all or part of a term life policy can be converted to a whole life policy down the road.)
Ideally, you’d spend the term of your insurance getting out of debt, paying down your mortgage and investing a portion of your income. If so, you could have enough savings and no mortgage by the time your term life insurance policy expires.
That could mean you might be fine as you are, without needing additional coverage.
Although term life insurance doesn’t build up cash value that can be borrowed against, an alternative approach may be to get a term policy and then invest the difference in premiums that would’ve gone to a whole life insurance policy.
For example, say you received a quote to pay approximately $20 a month for a $500,000 policy for a 20-year term. Alternately, you could pay $320 a month for a whole life policy with the same amount of coverage.
Potentially, you could sign up for the less expensive insurance and simply invest the difference of $300 per month.
Of course, those rates are just illustrative and not indicative of any specific policies. Still, opting to invest this money yourself might provide additional transparency on the fees you’re paying. Doing so could also provide the opportunity to choose investments that earn higher returns.
Term vs. Whole Life Insurance: Factors to Consider
The choice between these two types of life insurance will be very personal and depend on your own family, and financial, situation. Some factors you might want to think about include:
Your current age
How’s your health right now? (Even something like losing ten pounds could save you on the cost of life insurance.)
What are your family’s financial needs?
What kind of funeral or final arrangements do you want, and can your family afford those expenses without additional help?
How old are your kids?
Do you have a mortgage or other debts that your family might need help paying off?
What’s your retirement plan, and how much do you have saved up already?
Do you feel strongly about leaving money behind for your beneficiaries?
What kind of financial needs do you anticipate your family having in the future? This could include everything from daycare to braces to paying for college to the overall cost of raising your kids to adulthood.
How big do you estimate your estate will be when you die, and will your heirs likely face estate taxes?
Do you plan to set up a trust for any of your heirs?
Do you want to donate your assets to charity when you die? If so, do you need an extra boost to be able to afford doing so?
In some cases, because the whole life policies are more expensive, people might buy less coverage than they need in order to afford their policies. How much coverage does your family really need, and what premiums can you afford?
How do you feel, emotionally, about potentially paying for a term life insurance policy without getting that money back, if you outlive the term?
Conversely, how do you feel about potentially paying large premiums every month over a long period of time?
Getting Into the Nitty Gritty
There are additional “flavors” of both term and whole life insurance. The main differences between the policies below are about how the death benefit changes over time.
For all of these, however, the premium remains the same month after month or year after year. This will depend on how often your premiums are set to be paid. The only thing that changes is the benefit your beneficiary (or beneficiaries) would receive if you were to die.
Level: This is the most common type of term policy, in which your premium is level (meaning it doesn’t change over time), and so is your benefit. If you had a 10-year level term policy with a $1 million death benefit, you’d pay the same premium each year during that 10-year span, and if you were to pass away at any time during that period, your beneficiaries would receive $1 million.- Annually renewable term: Sometimes known as the “purest” life insurance because it’s correlated directly with your risk. With this sort of insurance, the death benefit doesn’t change over time. Your beneficiaries receive the same payout no matter when during the period you pass away, but the premium might go up each year.
When it comes to whole life insurance, most policies have a fixed premium that you pay monthly or annually. That said, there are a few other varieties within the category of whole life insurance:
Continuous premium (straight life): This is sometimes called ordinary life or continuous premium whole life. You pay the premium from the time the policy is issued until you die, or until you turn 121 (OK, sure). Generally speaking, this kind of whole life policy tends to have the lowest annual premium.
Limited pay: You only pay your premiums for a certain duration. This could be 20 years or when you hit a specific age. Because you’re only paying for a limited time, the premium will generally be higher than with continuous premium policies.
Single premium: Under this variety, you pay just one single lump sum at the time you open the policy, rather than paying monthly or annual premiums.
Converting Term to Whole Life Insurance and Other Combo Approaches
Most term life insurance policies offer the ability to renew, convert or both. Renewability means you can renew your coverage when it expires, without any additional evidence of insurability.
That doesn’t mean you’ll get to do so at the same rate as before–in fact, your rate is likely to go up since you’ll be older at the time of renewal–but it does mean you wouldn’t need to go through another health exam, even if you’ve had changes in your health situation.
A convertible provision gives you the right to convert your policy to a permanent, or whole, life insurance policy without evidence of insurability. Again, you’ll face a different premium than with your old policy, but this means you wouldn’t have to prove your health status or go through the underwriting process again.
The option to convert a term life insurance policy into a whole life insurance policy later may be a fit if you want to start out with a more affordable policy and switch your coverage as your needs and your budget change.
Some people choose to do this when their term policies are nearing expiration and it’d be expensive to renew or extend those policies because now they’re much older than when they first signed up.
Other reasons some might consider converting a term life insurance policy into a whole life insurance policy include concerns over estate taxes or setting up a trust in the last will and testament.
Some people choose to hold both a term and a whole life insurance policy. There are different reasons for this, but you might choose this path if you want relatively short-term coverage while you’re raising your kids (through a term policy) while also having the option to utilize the cash value of a whole life policy, if the need arises.
Term vs. Whole Life Insurance: Which Is Right for Me?
It’s not fair to quickly compare these two types of life insurance, because even though they both share the primary purpose of providing a death benefit, in the end, they’re very different policies. Each that will be the “right” choice for people and families with different financial situations and goals.
Even still, many times consumers are faced with a choice between the two (or can even make the decision to choose to get both types of policies).
As explained in The New York Times, the simplest solution for many people is term life insurance. That’s despite sales agents eager to push more complex policies with “large and often hidden fees, and complex riders laden with mumbo jumbo.”
If you’re comparing different types of policies, think about the financial needs of your family and which policies have features that can help meet those needs.
This material is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or investment advice or to serve as the basis for any purchasing decisions.
Fabric Insurance Agency, LLC offers a mobile experience for people on-the-go who want a easy and fast way to purchase life insurance.