Comparing Life Insurance Policies: Term Life vs. Whole Life
Each type of insurance policy has its benefits and drawbacks
Life insurance provides important financial benefits, but navigating the landscape of its terms and implications can be tricky. You're sure to encounter different and confusing policies and phrases, such as whole life, term life, cash value, and variable life.
What to do? Whether you're in your twenties or sixties, deciding on the right type of policy should be a priority. Weighing the details of various policies can help you make a decision.
Term Life Insurance
This type of policy covers a set period of time, so you have the option of paying for coverage only when you think you might need it.
Premiums can be reasonable if you're relatively young and healthy.
These policies don't accumulate any cash value.
You might not easily or inexpensively be able to renew if your health deteriorates during the time of the term.
Whole Life Insurance
The term of this type of policy is indefinite until the date of your death.
The rate is fixed over the life of the policy, so you can "lock in" lower premiums if you purchase while you're young.
A whole life policy accumulates value over the years so you can borrow against it or take withdrawals.
Premiums for these policies tend to be more expensive.
Term Life Insurance
Term life is exactly what it sounds like—you purchase life insurance for a specific term or time period, which can be anywhere from five to 30 years. You pay premiums for the entire length of the term. When the term expires, so does the policy. If you pass away before the term ends, the policy pays a death benefit to your beneficiaries.
Cost-wise, term life is generally the most affordable type of life insurance. Premiums are based on your health and the amount of coverage you choose. The younger and healthier you are, the cheaper term coverage is likely to be.
Advantages of Term Life Insurance
Term life policies offer the flexibility to buy only the coverage you need. If you’re only concerned about life insurance while your kids are young or while you have a mortgage to pay, you can get coverage for 20 years instead of paying for a longer policy that you might not really need.
Disadvantages of Term Life Insurance
Term life policies don't accumulate cash value. If you purchase a 20-year term policy and you decide you’d like to extend your coverage after 20 years, you might have to undergo proof of insurability and you could be denied additional coverage if your health has declined. You might have to renew at a significantly higher premium.
Types of Term Life Insurance
Term life can be broken down into a few different categories:
- Level Term: Your premium and death benefit remain the same for the entire length of the term.
- Annual Renewable Term: The death benefit remains unchanged throughout the term, but the contract renews annually, usually with an increase in premium each year. Premiums might be less than in a level term policy initially, but they can become more expensive over time.
- Decreasing Term: The death benefit decreases each year while the premium remains the same. The policy ends when the death benefit reaches zero.
As the name implies, whole life is meant to cover you for your whole, entire life. It has a cash-value component. The premium and death benefit are fixed in most cases, so the younger you are when you purchase coverage, the lower your premiums are likely to be.
Whole life is often marketed to parents as an investment for their young children, on the premise that they can lock in coverage while they're young, making it more affordable once they become adults.
Advantages of Whole Life Insurance
There are no surprises with whole life. You have a guaranteed premium, interest rate, and death benefit for the entire life of the policy. The cash value grows tax-deferred and typically allows for withdrawals and loans against the policy.
Disadvantages of Whole Life
Whole life is generally more expensive than term policies. This is largely due to the added guarantees. The policy is less flexible—changing your death benefit or premiums isn't an option. Interest earned on the cash-value account can be less than you could get elsewhere.
Other Types of Life Insurance Policies
Universal life insurance is a type of permanent insurance that covers you for your entire lifetime with a cash-value component. Instead of just selecting a specific term and putting 100 percent of your premium toward the policy in this case, part of your premium will actually go into a cash account within the policy. This cash account earns interest and accumulates value tax-deferred.
Universal life insurance offers more flexibility than term life. Because it has a cash component, you can temporarily stop making premium payments in a cash emergency as long as the cash value can cover the cost of the insurance. You might also be able to increase or decrease the death benefit over time, and you can usually take tax-free loans against the cash value in the policy.
But universal life tends to be more expensive than term life. While some of that added cost goes into the account, building cash value, the rates you'll earn on that money might not be as high as what you'd get from investing in stocks or mutual funds.
Variable Universal Life Insurance
Variable life insurance is very similar to universal life, but with one major difference. You aren’t earning a specific rate of interest in a cash-value fund, but you can invest this portion in a variety of different investments like mutual funds. You'll have more control and get potentially higher returns from your cash value.
You’re still guaranteed the minimum death benefit as long as you keep up with the minimum premium. You also have flexibility to invest the cash-value portion in a variety of investment vehicles. You can take advantage of significant tax-deferred earnings on those investments if you make wise investment decisions.
But you could put your policy in jeopardy if the market turns south and you've put the money into possibly risky investments. A significant drop in account value could force you to pay additional premiums just to keep your policy in force. In addition, the expenses associated with the investments can be significantly higher with a variable universal life than you would pay elsewhere.
What's right for you might not reflect what's right for someone else. Taking the time to learn what each type of policy offers can ensure that you choose a policy that’s best suited to your long-term needs and your financial situation.