08 May Whole Life vs Term Life
Why Buy Whole Life Insurance Over Term Life Insurance?
Term and whole life insurance, two of the oldest forms of life insurance, are now among the most common. Insurance providers have sought to make it more difficult to attract a wider spectrum of consumers. Shopping for life insurance may not be as entertaining as watching the latest crime drama. However, they all share one thing in common – the more you dig, the more complicated it becomes. So, let’s get down to basics. What is the difference between term and whole life insurance, and which is best for you?
These are the main aspects that set these insurance staples apart.
- Term life insurance is considered “pure” insurance, while whole life insurance has a cash benefit feature that you can use over your lifetime.
- Term life insurance only covers you for a certain period of years, but whole life insurance protects you for the rest of your life as long as you pay your premiums on time.
- Whole life insurance premium could be out of reach for budget-conscious customers because rates can be five to fifteen times higher than term life plans for the same death benefit.
Whole life insurance will provide you with lifetime benefits as well as additional assistance after retirement. Term life insurance offers coverage over a shorter period of time, but it is less costly and more quick to receive. Your relatives can use the benefit amount from this form of insurance to fund funeral costs, mortgage payments, college fees, and other expenses after your passing.
Although the death benefits of whole life and term life insurance is similar, there are major variations between these two common forms of life insurance. Term life insurance is the most affordable and easiest to grasp. It protects you for a set amount of time. Set periods can range between 10, 20, or 30 years.
Whole life insurance is more complicated and typically costs more than term life insurance, but it does have some additional advantages. Whole life insurance is the most well-known and basic form of permanent life insurance, and it protects you before you die and your family after you die. It also contains a cash-value portfolio from which you can transfer funds later in life.
What is Term Life Insurance?
Term life insurance is perhaps the easiest to understand and it is an easy insurance with no frills. The only justification to purchasing a term policy is the guarantee of a death payout for your beneficiary if you die, while the policy is in place. As the name means, this type of insurance is only available for a fixed amount of time, whether it is ten, twenty, or thirty years. After said amount of time the policy then automatically expires.
Because of these two characteristics—simplicity and finite duration—term policies are also the least expensive, often by a wide margin. If what you want from a life insurance policy is the ability to cover your families in the event of your death, term is most definitely the best option. Although no two families are alike, new parents can buy insurance that only lasts long enough for their children to complete college or enter the workforce full-time and then the policy expires.
According to financial advisors, a 20-year term insurance with a $500,000 death payout can be obtained for $28.73 per month for the average 30-year-old male. Because of female higher life expectancy, the average 30-year-old woman will buy the same policy for only $23.02.
Of course, a number of variables can affect certain costs. A higher mortality payout or a longer period of coverage, for example, would almost inevitably raise the premiums. Furthermore, since most policies require a medical assessment, any health problems might increase the rates above the average cost as well.
Since term insurance expires, you may find that you have expended all that money for no reason other than peace of mind. Moreover, you cannot use the term insurance investment to create equity or save taxes. Term life insurance offers coverage over a set amount of time. It is also referred to as “pure life insurance” because it is only intended to cover your dependents in the event that you die prematurely. If you have a term policy and die during the term, the compensation is paid to the beneficiaries. Other than that, the policy is worthless.
When shopping for term life insurance, consider the following:
- Choose a term that spans the years you’ll be paying bills that affect your family and want life insurance in case you die.
- Purchase a sum that your family would need if you were no longer able to care for them. The compensation could substitute your salary and assist your family in paying for services you currently provide, such as childcare.
In an ideal world, your need for life insurance will end by the time the term life policy expires. Your children will be on their own, your mortgage will be paid off, and you will have plenty of money in reserves to act as a financial safety net.
What is Whole Life Insurance?
Whole life insurance is a form of permanent life insurance that varies from term insurance in two important respects. For one thing, it never expires as long as you manage to pay your premiums. It also offers some “cash value” in addition to the death payout, which can be used to meet additional expenses.
The bulk of whole life plans are “level premium,” which ensures you pay the same annual rate for the life of the contract. These premiums are divided into two categories. One part of the premium goes toward the insurance portion, and the other part contributes to the growth of your cash worth over time. Many providers offer a fixed interest rate (often 1% to 2% per year), but other businesses sell “participating” plans, which pay non guaranteed dividends that will raise the overall return.
Initially, the whole life premium is greater than the expense of the insurance itself. However, when you grow older, this changes and the expense becomes less than that of a standard term policy for someone your age. This is referred to as “front-loading” the policy. Later, you can borrow or subtract from your cash valuation number to pay for expenditures such as your child’s college tuition or home renovations. In that respect, it is a much more adaptable financial tool than a term life insurance policy. Loans from the insurance policy are tax-free. However, all investment proceeds from withdrawals are subject to income tax.
Sadly, the death payment and monetary worth are not entirely distinct functions. If you borrow money from your insurance and do not repay it, your death benefit will be reduced by the same amount. When you take out a $50,000 loan, for example, the beneficiaries will receive $50,000 minus the debt owed if the loan itself is outstanding.
The biggest drawback of whole life insurance is that it is much more costly than term insurance. Permanent plans are usually five to fifteen times more costly than term policies for the same death benefit. For certain buyers, the extremely high cost makes it impossible to keep up with payments. According to a June 2016 study from the University of Pennsylvania’s Wharton Campus, nearly 25% of permanent life policies expire within the first three years.
Another downside to whole life insurance is its difficulty. In a term policy, for example, you can actually avoid making contributions if you no longer require or cannot afford the insurance. However, depending on the carrier, whole life policyholders can be subject to a surrender fee of up to 10% of the cash value if they want to cancel their policy. Usually, this charge decreases over time until it gradually disappears.
Whole life insurance offers coverage for the remainder of one’s life and includes an investment portion known as the policy’s cash benefit. In a tax-deferred portfolio, the capital value increases steadily. This means you don’t have to pay taxes on the dividends when they accumulate.
As the policyholder, you have the ability to borrow money against the account or cash out the policy. However, if you do not repay insurance loans with interest, your death payout will be reduced, and if you lose the policy, you will no longer have coverage.
Although more complex than term life insurance, whole life is the most basic form of permanent life insurance. This is why:
- The premium rates remain constant for the remainder of your life.
- The death benefit is guaranteed.
- The cash value account increases at a predictable pace.
Some whole life plans often carry out taxable dividends and are a portion of the insurer’s earnings. Dividends may be taken in cash, left in your portfolio to gain interest, or used to reduce your insurance costs, repay program loans, or purchase extra coverage. That said, dividend payouts are not a guarantee and are up to the companies discretion and can stop at anytime.
Policy Features of Term Life vs. Whole Life
|Policy Characteristics||Term Life||Whole Life|
|Policy length can be chosen||✓|
|Policy coverage for life||✓|
|Premium remains stable||✓||✓|
|Low premiums rates||✓|
|Amount of payout is guaranteed||✓||✓|
|Cash value is accumulated||✓|
|Annual dividends offered||✓|
Cost Comparison of Term Life vs. Whole Life
Term life insurance is inexpensive because it is temporary and has no cash value; in most situations, the spouse will not expect a payout because you will survive the term. Whole life insurance rates are much more expensive, because the coverage is permanent and the scheme has cash value, with a fixed amount of investment gain on a percentage of the money you spend.
The table below compares the annual expenses of term life insurance and whole life insurance on a $500,000 account. The most common term period, 20 years, was used because there is no way to compare the length of term life to whole life.
|Individual Covered||Whole Life||Term Life 20-year|
|Male; age 30||$4,015||$230|
|Female; age 30||$3,560||$195|
|Male; age 40||$6,042||$340|
|Female; age 40||$5,415||$290|
|Male; age 50||$9,430||$840|
|Female; age 50||$8,440||$655|
Which One to Choose – Term Life vs. Whole Life
Term life insurance is adequate for the majority of households in need of life insurance for a set amount of time. However, whole life and other types of permanent coverage may be helpful in some circumstances.
Pick term life insurance if you:
- Only require life insurance to replace your wages for a limited time, such as when raising children or paying off a mortgage.
- Seek the most cost-effective coverage.
- You’re dreaming of getting permanent life insurance but can’t afford it. Many term life insurance plans may be converted to a permanent policy. (The date for conversion varies depending on the policy)
- Believe you can make better investments with your money. Purchasing a cheaper term life insurance policy allows you to spend the money you would have spent on a whole life policy elsewhere.
Pick whole life insurance if you:
- You choose to leave money to your children to pay death or estate taxes. Federal inheritance taxes will be levied on properties worth more than $11.7 million per person or $23.4 million per couple starting in 2021. Inheritance and estate taxes differ by jurisdiction.
- Have a lifetime dependent, such as a disabled child. Life insurance will be used to finance a trust that will provide for your child until you die. If you plan to set up a trust, you can consult with an attorney and/or a financial planner.
- Want to use your retirement fund, while still leaving an inheritance or funds for final expenses including funeral costs.
- Desire to equalize inheritances. If you want to leave a company or property to one of your children, whole life insurance will be able to cover your other children.
Choosing Your Coverage
So, which kind of insurance is better for you and your family? If term coverage is something you can afford, the solution is straightforward: basic insurance is preferable to no protection at all.
For anyone who can pay the much higher costs associated with a whole life policy, the decision becomes a bit more difficult. Most fee-based (non-commission-earning) financial planners recommend starting with 401(k)s and individual retirement accounts (IRAs) if the intention is to prepare for retirement. When such investments have been expended, a cash value scheme could be a better choice for some individuals than a completely taxed savings portfolio.
Most clients have particular financial needs that can be handled more efficiently over the course of their lives. Parents of disabled children, for example, will choose to seek whole life insurance, which covers your whole life. You know your children will receive the death payout from the insurance as long as you continue to pay the premiums.
It may also be a useful tool in small business succession planning. Company associates will also carry out whole life insurance on each owner as part of a buy and sell deal. Therefore, the surviving partners will acquire the deceased’s equity interest in the case of their death.
The Bottom Line
With its cash value component, whole life insurance definitely provides more financial stability. Nonetheless, since permanent plans are more complicated and pricey, often customers stick to the old adage “Buy term and invest the rest.”