Life insurance shoppers often grapple with a big choice at the start of their decision-making process: Should I buy term life or whole life insurance?
The answer should be based on the reasons you need life insurance:
- Look at term life insurance if your life insurance need has a definite end, such as the years until you retire.
- Consider whole life insurance for longer-term financial planning goals, such as estate planning or funding a trust.
If you’re worried about finances that have a finite length, you can typically solve that with term life insurance. For example, if you want life insurance to cover the years of a mortgage or children’s college years, term life is the better choice. There’s no reason to spend money on insurance that you won’t need later in life.
Consider term life insurance if you:
- Want life insurance to cover a specific financial concern that has an end point.
- Are looking for the cheapest form of life insurance and you don’t need coverage indefinitely.
But if your need for life insurance stretches indefinitely, it’s time to look at the lifelong coverage provided by permanent life insurance policies. Whole life insurance is one form of permanent life insurance. Universal life insurance, which can also provide lifelong coverage, offers a much cheaper alternative to whole life.
Consider permanent life insurance if you:
- Wish to leave an inheritance with life insurance.
- Want to fund a trust with life insurance, such as a trust for children.
- Need funds for your family to cover funeral expenses and you won’t have savings for it.
- Want to build cash value within a life insurance policy.
- Want to provide money so beneficiaries can pay estate taxes. This will apply only in cases where you’re leaving a very large estate. The estate tax exemption in 2020 is $11.58 million for an individual or $23.16 million for a couple.
Both term life insurance and whole life insurance offer guarantees: Premiums won’t change and the death benefit amount paid to beneficiaries doesn’t change.
The main differences are in coverage length and cash value. Term life insurance offers no cash value and it’s possible you could outlive the policy. Whole life insurance provides cash value and lifelong coverage, albeit at a relatively steep price.
Summary: Term Life vs. Whole Life Insurance
|Term life||Whole life|
|Premiums stay the same||✔||✔|
|The payout (death benefit) is guaranteed and won’t change||✔||✔|
|Purchase by length of coverage, such as 5 to 30 years||✔|
|Cheapest form of life insurance||✔|
|Will last your entire life, with no specific expiration date||✔|
|Builds cash value||✔|
Comparing Term Life vs. Whole Life Insurance
The most common forms of both term life and whole life have level premiums. That means your premium payments won’t change over time and you’ll know exactly how much you owe. Life insurance companies generally offer payment plan choices such as monthly, quarterly, semi-annually and annually.
If lifelong bills for whole life insurance aren’t appealing, there are some policies that offer shorter payment schedules with larger payments, such as single-premium whole life insurance, or policies with payments for a certain number of years, such as 10 years. This allows you to have more budget flexibility later in life.
Whole life and term life policies have payouts, called death benefits, that are guaranteed and don’t change. A death benefit is generally paid tax-free to your beneficiaries.
The main difference here is that if you outlive a term life policy there’s no payout. After the period of level premiums ends you can usually renew a term life policy at a higher cost. But if you don’t renew, the policy terminates and coverage ends. Whole life insurance provides a payout no matter when you pass away, as long as you’ve paid the premiums.
Term life insurance builds no cash value. Whole life policies contain a cash value account that builds cover time at a fixed interest rate. This guaranteed cash value growth is one of the reasons whole life insurance is considerably more expensive than term life.
Cash value is meant to be used by the policyholder. You can take a loan against it and pay for anything you want. If you die without paying it back, the outstanding amount is deducted from the death benefit.
When you pass away, any cash value remaining usually reverts to the insurance company. Your beneficiaries receive the face value of the policy minus any amount that was taken out of cash value and not paid back.
If you’re looking for lifelong coverage without the high cost that a whole life insurance policy demands, consider guaranteed universal life insurance.
Source: Forbes / Featured image by senivpetro – freepik