There are two main types of life insurance: term life and permanent life, with whole life being a popular type of permanent insurance. By navigating the nuances of whole life vs term life, you’ll be able to better decide what’s best for your loved ones’ needs.
What Is Better: Term Life or Whole Life Insurance?
The main difference between whole life and term life is that term life insurance provides temporary coverage for a specific period while whole life provides coverage for your entire life. With term insurance, a death benefit is a primary feature. But whole life policies combine both a death benefit and a savings feature.
An advantage in getting term insurance is it’s often less expensive because it doesn’t include the additional benefit of having a savings account. The downside is that at the end of the term, the policy will have no value.
The major advantage with whole life insurance is you can invest in, borrow against, or withdraw money from the policy while you’re still alive. This money comes from the cash value that the policy builds over time. The drawback is it usually takes a long time to build cash value for most policies, and can even take decades.
|Term Life||Whole Life|
|Basic type of life insurance||More complex type of life insurance|
|Maximum term policy sold is usually a 30-year plan1||No limit on the amount of years you can purchase since coverage lasts for a lifetime, as long as premiums are paid|
|Death benefit is paid to beneficiaries only if you die with an active policy—e.g. If you have a 20-year policy, a death benefit is paid if you die during those 20 years or your policy has been renewed after 20 years and is still active||Death benefit is paid regardless of when you die, as long as the policy is active|
|Cost starts out low, but may become expensive later in life—e.g. If the term ends at age 55 and you renew, it may be expensive since you’re older||Cost starts out high but may get lower over the life of the policy|
|Premiums for most plans remain the same only for the term—increases when you renew||Premiums for the most common type of plan stays the same for the life of the policy|
|Typically provides more insurance protection per dollar||Usually provides less insurance protection per dollar in the early years of the policy|
|Death benefit can stay the same, increase, or decrease depending on the type of plan||Death benefit typically remains fixed as long as the policy is in force|
Understanding Term Insurance
Although term insurance can generally fit the needs of most people, it’s important to understand why and who should get it, as well as how different term plans compare. This can help you decide how long you need insurance protection and what type of plan would be best for you and your family’s needs. Term plans can provide coverage for as little as one year or up to 30 years.1
Why Get a Term Plan?
A term plan is designed to cover short-term needs. A primary example of this is needing money that could replace your income to cover major expenses like your kids’ college education or to pay down a mortgage. Longer term plans like a 20-year or 30-year plan are usually a good fit in these situations.2
You can also get a term life policy to cover other short-term needs, such as a car loan, student loans, credit card debts, and medical bills you may leave behind. If you estimate it could take at least five years to pay off these debts, then a 5-year or 10-year policy may be enough for your beneficiary to cover these expenses.
Who Should Get Term Life Coverage?
Term coverage is most suited for young individuals and persons with growing children. Since term plans are usually much less expensive than permanent insurance, those who are just starting out in life and haven’t reached their peak income-potential can find this type of coverage the best fit for their budget.
Young singles with no dependents: you typically don’t need life insurance if no one depends on you for financial support. But you may still want to have a policy if certain situations apply. For example, if you have large sums of debt for which a family member is the cosigner, he or she would become responsible for making payments if you passed away. Also, you may need insurance to help cover your burial costs if you expect that this expense would be a financial burden for your family.
Young married couples and those with children: if you’re a newlywed without kids or are married and just starting a family, chances are you recently bought a house or will be getting one soon. This is a major expense you will be paying probably for the next 30 years. If you or your spouse were to suddenly pass away, it may be difficult to continue mortgage payments and meet daily living expenses on one income. This would be an even bigger financial burden if the breadwinner dies and the other spouse doesn’t work. If you have small children, this is also the time when you need the most income replacement from a life policy that could support your family until your children grow up. When you compare term vs permanent life insurance, a term plan allows you to get more coverage at a lower cost.
Single-parents: raising a family on your own can be challenging. Not to mention all the expenses you have to meet on just one income. According to the USDA, the average cost to raise a child to college-age is approximately $233,000.3 If you were no longer around, it would take a lot of money to replace your income until your children become adults. Considering that most single-parents are mothers and the average wage for single-mothers is $45,128, term insurance is often the best option in getting low-cost life insurance.4,5
Business owners who want to fund a buy-sell agreement: a buy-sell agreement is when business partners make a prearranged deal to buy out the interests of a deceased partner or one who has left the company. With life insurance, each partner would get a policy and name the other as the beneficiary. When one partner dies, the other would use the death benefit to buy out the deceased interests. Term insurance can be a good option for this situation because it’s less expensive and offers more flexibility in case a business needs to change the benefit amount periodically.
While there is a place for buy-sell agreements, most businesses do not have the cash flow or profit to get the amount of coverage needed for whole life insurance. Most buy-sell agreements are funded with term insurance for two reasons: cost and changing needs. A business’ financial need will likely change every few years, and it is easier to simply replace a term policy to meet the most recent need.
You can better estimate your term life coverage needs by using a life insurance calculator.
Is a Medical Test Required for Term Insurance?
A medical exam is not always necessarily required to get a term insurance policy. However this can vary based on the insurance company.
What Happens to Term Life Insurance at the End of the Term?
At the end of your term life insurance policy, you may have a few options. If you still need coverage for your family, your plan may be renewable for a while.
You may also have a term plan with a convertibility feature. This means that your term policy can be set to convert to permanent insurance when the term ends. This can be a great way to have insurance for the years you need it most, but still be able to get lifetime protection with a policy that builds cash value.
Can You Cancel Term Life Insurance Early?
Yes, you cancel your term life insurance policy early. Term life policies will also halt coverage if you stop making your premium payments.
Comparing Different Term Plans
Term life insurance policies have two different variations: annual renewable term and level premium term. Both offer renewal based on making payments on time, not on your current health, so you can extend your coverage without answering health questions or taking a medical exam. Both options also have a maximum issue age for enrolling in a policy, which is usually 80.6
A major difference between the two plans is that annual renewable term policies are very rare, so they’re not available from most insurance companies. This is because it provides very little life insurance protection for families. Additionally, these plans are usually offered through state insurance departments as a way for businesses to meet their life insurance needs. Level premium term insurance is what most insurers provide to individual consumers. Rates on term insurance in general has hit an all-time low, so you may do better with getting longer insurance protection with a level premium term policy.
Here’s how the two term plans compare:
|Annual Renewable Term (ART)||Level Premium Term (LPT)|
|Provides coverage for one year at a time, but is rarely offered||Provides longer terms, usually 5, 10, 15, 20, 25, or 30 years—20-year most common|
|Premium increases every year you renew||Premium stays the same for a set period of time—can be for the entire policy or only for a part of the policy|
|Premiums usually start out lower, but could cost more than LPT policies if renewed every year for a long time||Premiums may be a little higher than ART policies to start, but usually gets lower toward the end of the policy|
How to Define Whole Life Insurance
The most common type of whole life insurance is ordinary level premium whole life, often called ‘ordinary life’. Other names for this type of coverage include traditional whole life and straight life. One of the advantages of whole life insurance is that all policy types provide guaranteed cash value on a tax-deferred basis, making it an attractive option when you compare whole life vs term life insurance. Tax deferred means you don’t pay taxes for every year the cash value increases, only when you withdraw money from the policy.
In exchange for the permanent coverage and cash value features these policies provide, you agree to pay the insurance company scheduled premium payments practically for the rest of your life, which is usually up to age 100.7 But depending on the type of whole life policy, you could have a shorter term for premium payments. A life insurance calculator could help you estimate your whole life insurance coverage needs.
Why Get Whole Life Insurance?
One of the primary reasons to get whole life coverage is to leave your beneficiaries with a financial advantage. Since whole life policies build cash value, there is more opportunity to transfer wealth to your loved ones. Or if you’re big on giving back, a whole life policy can also be used to set up a charity in your name.
Who Should Get a Whole Life Policy?
Anyone who wants to can apply for a whole life insurance policy. Younger adults who would rather lock-in a less expensive premium because of their age can take advantage of this type of coverage. Those who want to build cash value to use in retirement years can also benefit from this policy. But just as how term insurance is more suitable for some, a whole life policy may also be a better fit for certain groups of people.
High income-earners: when considering whole life vs term life and who should get what, you want to remember that the higher cost means having a higher income. Although young people can earn high wages, income typically peaks the more a person advances in their career and then drops down after retirement. According to PayScale, the 40s and 50s is generally the age range when many people reach their highest incomes.8 This may make sense since term insurance is usually more suitable for younger persons, typically those in their 20s and 30s.
Those who you need more liquid assets: an asset that is liquid means it can be converted to cash fairly easy. Permanent insurance provides this benefit since you can withdraw or borrow from the cash value. People who have illiquid estates that would be subject to high estate taxes are good candidates for whole life insurance because the money from the policy could cover these costs.
Retirees who need more supplemental income: if you retired at 65 for example, and expect that your retirement savings may run out in 10 to 15 years, a whole life policy may work for you.
Comparing Whole Life Insurance Types
Besides ordinary life, there are five other basic types of whole life policies: nonparticipating, participating, limited payment, single premium, and intermediate premium. There are pros and cons for each, and not all insurance companies offer each type of policy.
Here’s what each type of whole life insurance offers:
|Ordinary Whole Life||Level premiums for the life of the policy; the insurance company puts the excess premiums paid in the early years in investment accounts to build the policy’s cash value||Higher premiums than term life plans|
|Nonparticipating Whole Life||The premium and the face amount (the value of the policy) are level for life; offers a lower out-of-pocket cost||Doesn’t pay dividends|
|Participating Whole Life||Pays dividends based on the insurance company’s excess earnings in investments; can use dividends to buy more coverage, reduce premium payments, or withdraw as cash||Dividends are not guaranteed|
|Limited Payment Whole Life||Allows you to pay premiums for a limited time, such as for 10 or 20 years||Premiums are higher since it’s spread over a shorter period of time|
|Single Premium Whole Life||Policy is fully paid up at the time of purchase; provides immediate cash and loan value||Have to pay the entire premium at once, which can be a large amount of money|
|Intermediate Premium Whole Life||Policy is issued at a current premium rate which could stay the same; premiums guaranteed not to exceed a maximum rate||Premiums can change based on the insurance company’s estimates on expense costs, mortality, and investment earnings|
Choosing between Whole Life vs Term Life Insurance
There is no one size fits all when comes to choosing between whole and term life coverage. It really comes down to your needs and budget. Here are some tips on how to decide which type of life insurance is right for you:
- Determine your priorities—is income replacement, money for your funeral expenses, or retirement savings most important at this time in your life?
- Use online life insurance calculators to estimate your needs.
- Do your research by comparing rates and policy features from different insurance companies.
To get more insight on the difference between whole and term life insurance, speak to a HealthMarkets licensed insurance agent, who can help guide you towards the life insurance policy that’s right for you. Don’t delay in getting the coverage that could help provide your loved ones with financial security.