Term Life Insurance vs. Whole Life Insurance

• Life insurance is intended to be a safety net for your family.
• Whole life insurance costs more but has more benefits.
• Term life insurance is affordable with fewer benefits.

When discussing life insurance you’ve probably heard of term life and whole life insurance. Especially when dealing with a commissioned life insurance agent, these terms can get muddled and confusing. It is important to understand what term life and whole life means as you weigh which one you need.
What is life insurance?

To understand the differences between term life and whole life insurance, we first need to know what life insurance is and why we get it. Life insurance is intended to financially protect your family in case you die. Specifically, it is a safety net so that your spouse and/or children can survive without your income in the event of your death.

Do I need life insurance?

Since the point of life insurance is to financially protect your family, you only need life insurance if you have a family to protect or other financial obligations to be covered in the event of your death. If you have no financial obligations, then life insurance may not be necessary. 

Whole Life

If you’ve decided you need life insurance then you will need to decide between whole life insurance, universal life, and term life. Whole life and universal life are similar, but not exactly the same. In this article, we will focus on the differences between whole life and term life insurance.

Pros of Whole Life

Guaranteed Death Benefit

The most important pro of whole life insurance is the death benefit. You know that, as long as you have made your payments, you will be covered with life insurance when you die. In other words, instead of being covered for a short time, you are covered until the day that you die. Another benefit to having a guaranteed death benefit is your premium rate is generally locked in for life.

Cash value

Another benefit of whole life insurance is the ability to build cash value. Cash value is how much cash is on hand in your life insurance policy to tap into. It isn’t necessarily how much you would be paid out in the event of your death, but rather money that you can access within your life insurance policy to invest and use, kind of like a retirement account. It counts as money in the bank for many financial transactions, and that is a big deal when buying a home or other large investment.

Loans

One of the biggest benefits of cash value insurance is the ability to take out a loan against it. Many insurance companies will allow you to take a loan and pay it back, plus interest, at rather reasonable rates. The biggest benefit of this loan, however, is the speed of the loan. It is much faster to get a loan from your life insurance policy, since it is technically your money, than from a bank.

Tax planning

The wealthier you get the more difficult it is to effectively do tax planning. Unlike some retirement accounts that have a cap on how much money you can put in, a cash value life insurance account has no cap. This means you can put money in and grow it tax-deferred. This would be a strategy to discuss with your accountant, not a commissioned financial advisor.

Cons of Whole Life

Policy premium

The biggest and most obvious con of a whole life insurance policy is the premium. Of any life insurance policy you can get, the policy premium for whole life is much higher. Since there is a guaranteed death benefit, the life insurance company has to factor that into their profit margins.

Front Loading your Policy

Another issue with whole life policies is that your first premium payments usually pay for the company’s expenses before increasing your cash value position. This is called front loading your policy. You might even have negative returns on your life insurance “investment” until about a decade in. So it is a long-term play.

Surrender Charges

If you cancel your policy too early, for example before the front loading of your policy is finished, you may have to pay a surrender charge. This is a certain amount of money meant to cover the costs of managing your insurance policy. In practice, it is often used to keep people in a whole life insurance policy even when it may not be what is best for them.

Outstanding loans

While it is great that you can take out a loan from your whole life insurance policy, it is important to be careful when doing so. Any outstanding loans, meaning unpaid principal and/or accrued interest, will be taken out of the death benefit payout before your beneficiaries are paid.

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Term Life

Term life insurance is an alternative to whole life insurance that has much fewer bells and whistles but also comes with its own benefits. It is an important option to consider when you are considering life insurance.

Pros of Term Life

Affordable Policy Premium

Term life is less risky than whole life insurance for insurance companies so they can offer these policies at much lower rates, usually just a few pennies per day. If you want the protection of life insurance, but don’t have the money for a permanent life insurance policy, that makes term life an ideal alternative.

Flexible

Term life policies are more flexible. You can pay them while you want insurance, and you can simply cancel at any time when you no longer want it. There are no surrender charges or questions asked.

Medical exams are not always required

Most life insurance policies require a medical exam to ensure you aren’t at high risk of dying tomorrow. This can be quite extensive and invasive, but many term life insurance policies now only require a statement that you have disclosed all illnesses and you haven’t seen your doctor about any unexplained issues recently. If you lie about this, they will find out, and your beneficiaries won’t get paid. But if you are currently healthy, this is a great way to easily get life insurance.

Cons of Term Life

No Cash Value

The money that you put into a term life policy premium is no longer your money. As such, it accumulates no cash value. That means you can’t pull money out of it and you can’t use your policy as a financial asset. It is simply meant to be a safety net in the event of your death.

Raising your rates

While your rate will never go up during the term of your insurance, once that term ends you will be required to get a new rate that will reflect your increased age and health situation. Due to age alone, this means that your premium will be much higher.

The Death Benefit is not guaranteed

With term life insurance you are not guaranteed to have a death benefit. If you outlive the term, you will get none of the money back that you put in, even if you die the day after your term ends. That means your heirs cannot count on life insurance money to cover the costs of your passing.

The Money Wrap Up

Whole life insurance and term life insurance are two very different insurance products that have very specific uses and purposes. There are pros and cons to both of them, but usually, the pros and cons are outweighed by the cost. If you can’t afford to pay for a whole life insurance policy then you can’t get one, no matter how enticing the cash value sounds.

In most instances, a life insurance policy is meant to replace your income for your beneficiaries during your working years. So generally, a term policy that covers the term of your working years will be sufficient. However, it is up to you to weigh the pros and the cons of each to decide what kind of life insurance you need.

Which type of life insurance do you think is best? Comment below.

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