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Whole Life vs. Term Life Insurance: Which is the Right Policy Coverage for You?

While it’s common to think of life insurance as a single product, it actually comes in several different variations.

The two most common: whole life and term life insurance policies.

Now:

The two supply basically the same function – to provide your beneficiaries with money upon your death. But that’s largely where the similarities end.

Whole life vs. term life insurance is an ongoing debate in the financial media, on the web, and even within the insurance industry itself.

How are they the same, how are they different, and which is the best choice for you?

What is Whole Life Insurance?

Sometimes referred to as permanent life insurance, whole life insurance is a type of policy that will remain in force for the rest of your life, as long as you make your regular premium payments.

That is:

Short of failing to pay your premiums, your policy can never be canceled.

It also features another permanent benefit.

Premiums stay the same

Your premiums will remain the same on an annual basis for the life of the policy.

This is unlike term life insurance, where premiums will increase as the term ends and the policy is renewed for a new term.

Cash value

But perhaps the most significant feature of all with whole life insurance is the cash value feature.

In this way:

Whole life insurance incorporates an investment feature into a life insurance policy.

As you make your premium payments, whether that’s monthly, quarterly, or annually, they’re split between covering the cost of life insurance provision and contributing toward your cash value.

In the first few years of the policy, most of your premium will go toward administrative fees to set up a policy and compensate the insurance agent or agency that sold you the policy.

But, the longer the policy is in force, a higher percentage of your premium goes toward the cash value.

Over time, the cash value builds.

Earn interest

You’ll also earn interest on your cash value.

The interest rate may be set at a permanent rate, or more likely, come with periodic changes but include a minimum return.

That will guarantee that:

  • your cash value will not decline due to market risk, and
  • you’ll always get some return on your policy.

Perhaps best of all:

The interest earned on your cash value accumulates on a tax-deferred basis.

You can borrow against the cash value of the policy at very favorable interest rates if you need to access any of the funds.

But in yet another advantage to the cash value, once it reaches a certain level you can use the cash value to pay the premiums on your policy.

It’s possible your cash value will grow to a level that your policy will be fully paid up, and you will no longer need to make premium payments going forward.

What is Term Life Insurance?

Term life insurance is sometimes referred to as temporary life insurance.

That’s because it’s available in specific terms, generally in five-year increments, running from as few as five years to as many as 30 years.

Fixed premiums

During the term of the policy, you’ll have a fixed amount of life insurance, with a fixed premium payment.

However, when the term expires, you may need to take a new term policy, which will come with a higher monthly premium, based on your age at the time you purchase the new policy.

The big advantage of term policies over whole life is cost. A typical term life insurance policy will cost only a fraction of the premium of a whole life policy.

That will enable you to either save money on the premiums or purchase a larger amount of life insurance coverage.

Policy renewal

Many term policies come with an automatic renewability clause.

That means once your current term policy expires, you’ll automatically be able to take a new term policy without needing to reapply or qualify based on your medical condition.

A frequent renewal provision will be a 20-year term policy, automatically converting to a five-year term policy upon expiration.

The renewability provision may or may not enable you to renew your coverage in five-year increments up to a certain age.

But even though you’ll be able to extend your original policy with a new term policy, your premium will be higher at the time of renewal, based on your higher age.

No cash value or investment provision

Term life insurance is also known as pure life insurance since it has no cash value or investment provision.

You purchase your policy, it will provide you with a death benefit should you die within the term, and once the policy expires it will simply end and you will have no additional benefits.

However, it is possible to add a return of premium rider to a term policy, which will increase the premium cost of the plan.

However, when the term ends, the premiums paid will be returned to you, often reflecting a predetermined investment return on your money.

With that rider, a term policy can effectively function as a cost-free life insurance policy once the term ends.

Whole Life vs. Term Life Insurance

Whole Life Term Life
Time frame Permanent Temporary, generally 5 to 30 years
Premium level Fixed for life of the policy Fixed for the term
Cash value Yes No
Interest-bearing Yes No
Loan provision Yes No
Cost High Roughly 10% of the cost of an equivalent amount of whole life insurance
Cannot be canceled except for nonpayment Yes Yes

How to Choose

If you’re looking to buy a life insurance policy and considering a whole life policy or a term life policy, which should you choose?

Let’s look at when each policy type will be the right choice.

Whole life insurance is better if…

  • You want permanent life insurance, maybe because your family’s medical history indicates the possibility of future chronic health conditions.

  • You want to maintain level insurance premiums for the rest of your life.

  • Your track record on saving and investing money is questionable, and you like the idea of having a policy that combines both life insurance and an investment provision.

  • You don’t have a need for a large amount of life insurance, either because you have no dependents, or you have a large base of financial assets and are largely self-insured.

  • The idea of eventually having a paid-up policy, with no future premium payments, appeals to you and fits neatly within your future financial plans.

  • You want a base amount of permanent life insurance, with a plan to supplement that with term coverage for specific, but temporary needs.

  • Your financial situation enables you to afford the higher premium payments on a whole life policy, and you prefer to avoid the higher premiums that will come with term insurance especially as you move past age 50.

Term life insurance is better if…

  • Money is tight, and while you need life insurance coverage, there’s not a lot of room in your budget for the extra cost. Low-cost term insurance is the perfect solution.

  • You’re at a place in life where you have a need for a large amount of life insurance that would be prohibitively expensive with a whole life policy. You find that you can purchase a $1 million term policy for about the same cost as a $100,000 whole life policy. Since most of your need for insurance is temporary (providing for your children while they’re young), you’re okay with the policy expiring in the future.

  • You are able to purchase a 30-year term policy that will provide for your financial needs for the foreseeable future, making it almost the equivalent to a whole life policy.

  • You’re looking to supplement an employer life insurance plan with additional coverage. Term offers a low-cost way to do this.

  • You have a need for extra life insurance with a known time horizon. For example, you just purchased a home with a large mortgage, and you want a dedicated life insurance policy to pay off the loan in the event of your death. You have a 20-year mortgage and can cover your family during the entire term with a matching 20-year term life insurance policy.

  • You need to take a policy on an important business associate, like a business partner or a key employee. Since the arrangement won’t be for life, a term policy will fit better than whole life.

  • You are aware that the returns on the cash value of whole life insurance aren’t very good, and prefer to have the lowest possible premiums, so you can invest more money on your own at higher returns.

  • You’re able to purchase a term life insurance policy with an option to convert the policy to a whole life plan before the policy term expires. It gives you the best of both worlds – low premiums in the near-term, and potentially permanent life insurance in the longer term.

Final Thoughts

The reality is:

For most people, term life insurance is going to be the better choice.

The main reason is the much lower premium cost.

That means you can purchase a larger death benefit with a smaller premium. And if you prefer to invest money yourself, rather than relying on the low interest paid on the cash value of a whole life policy, term life will give you more extra cash to do that.

For example, while you might earn only 2% to 5% on the cash value of your whole life insurance, you can earn an average of 10% in an index fund based on the S&P 500.

Still another factor in favor of term insurance is this: most people have the greatest need for life insurance when they’re very young, and money is tight.

But as they get older, and build their financial resources, there’s less need for life insurance. You can take a term life insurance policy for $1 million when you’re 30, then reduce it to $500,000 – or even $250,000 – when you reach 50.

In a real way:

The whole life vs. term life insurance debate is something like trying to predict the future.

You’ll need to evaluate future financial needs, along with the likelihood of developing a serious health condition along the way.

The best approach is to make your decision based on your current financial situation, in combination with where you expect to be 20 or 30 years from now.