Term Life Insurance Vs Whole Life Insurance: A Complete Buyer's Guide

by Miranda Marquit

Grandpa with grandson

One of the biggest decisions you'll make when choosing life insurance is between term life insurance and whole life insurance. Each of these policy types has its advantages - and disadvantages - depending on your age, health, financial situation and what you hope to accomplish with your life insurance policy. If you're trying to decide between term life insurance and whole life insurance, here are some things to keep in mind:

The Main Differences Between Term Life and Whole Life

Before you get started, it helps to understand the main differences between term life insurance and whole life insurance:

  1. Term life insurance only covers your death, paying out only the face value of your policy. You pay a set premium for a certain number of years, usually ranging from five to 30. Your coverage lasts for that set period of time. At the end of the period, if you haven't died, you do not receive anything for the premiums you have paid in (unless you have a rare term policy that offers a partial premium refund). You might be able to renew your policy at a higher rate.
  2. Whole life insurance lasts until you die, with the same premium throughout your life. There is an investment component with whole life insurance, which means that you can build cash value for your policy. You can borrow against the cash value of your policy, or turn in your policy for a cash payment. The cash value is highly unlikely to match the face value of your policy. Depending on the policy terms, your survivors might receive the amount of "savings" from your cash policy in addition to the death benefit.

Due to the nature of these different life insurance policies, there are also variances in price. A term life insurance policy is usually much less expensive. You can get greater coverage for a lower price with term insurance. Because all you get is the death benefit, and due to the fact that you are unlikely to get any refund on the premiums paid, term life insurance policies are usually very inexpensive.

Because a whole life insurance policy covers you for your entire life, the uncertainty means that you will usually pay a higher premium. Additionally, with whole life insurance, you are putting in money for investment purposes. Your premium payment includes an extra payment that is invested by the insurance company. The money grows tax-deferred, meaning you don't have to pay on your earnings until you draw on the cash value built up by your policy. Some whole life policies offer a guaranteed minimum rate of return (usually fairly low), and you benefit if market conditions result in increased earnings.

Which Should You Buy? Term Life or Whole Life?

Once you know the basic differences between term life insurance and whole life insurance, it's time to consider which type is likely to provide you with the greatest benefit. You will need to consider whether or not you think that it's worth it to pay more for whole life insurance, and whether or not you believe that you could do better for yourself buying term life insurance and managing your own investments.

Term life insurance is usually considered the best choice for most people with growing families. It's inexpensive enough for many primary breadwinners to purchase, and it's possible to get a large amount of coverage for a low price. If you want life insurance as a way to protect your family's income in the event of your death, then term life insurance is a good choice. It offers a great dollar for dollar value, and you can get a term length that will cover you until your dependents are grown.

Whole life insurance can work for those who are interested in diversifying their assets with the help of a low-risk investment. There are different types of whole life policies, including variable life and universal life, that offer different investment options and opportunities. Policies that are equity indexed, with a guaranteed minimum return, can provide you with the opportunity for higher earnings if the market does well. However, it is important to consider, too, that earnings can be eroded by higher fees and commissions paid to managers. You will need to consider the internal rate of return, which requires that you consider your "real" return after all the costs of the policy are subtracted. Some years, you might not even beat inflation.

Whole life insurance is usually best for those who have some extra money to spend each month, and who are interested in building some value in a cash account. However, to see real value build up, you need to be prepared to hold your policy for at least 20 years. You need to be in it for the long haul. Additionally, it is important to consider that a whole life insurance policy is unlikely to be able to fund your retirement. You might be able to borrow against your cash value to get you out of a pinch, or you might be able to cash it in for some money, but you probably won't see an amount large enough to live off. Many experts agree that if you decide to get a whole life policy, you should make other investments as well; diversify your assets.

The Bottom Line

Whether you choose whole life insurance or term life insurance should be a decision made based on your financial needs. Some people decide to purchase a term life policy large enough to protect a family, and then purchase a smaller whole life policy that will protect a life partner after the children have grown, or provide an extra cushion in retirement. Carefully consider your financial and retirement goals, and your current situation, and perhaps consult a financial professional. Then get

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Peter December 22nd, 2010
This should be an easy choice. If you're young and have young kids, buy term; I usually calculate $250k/child - take away $10k per year (i.e. 8 yr old child - $170K) + mortgage & misc debt. The reason I do this is to set aside $50K for college and $10k/year for other expenses. 20 year is a good term, 30 year is better if you're thinking of having more kids in the future. If you're older (35+) and your spouse won't be able to continue the current style of living without your income, then opt for the whole life insurance. However, you must do the math to see if it makes sense. If you're under 45, chances are the difference of premium on term vs. whole life can be huge. Most of the time it makes more sense to purchase term and invest the difference (or pay off debt.) Remember, life insurance should be used to cover any unnecessary burden during the most difficult times, not get rich.
Peter December 22nd, 2010
btw, whole life insurance policy charges a hefty interest rate (against your remaining cash) when you "borrow" against it (usually around 4.5 ~ 6%.) This means that your "reserve" will empty out earlier and you will have to start paying premiums again.

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