I remember (a long time ago) when I was starting a family and I knew I needed life insurance. I called a friend of mine who had been in the life insurance business for about five years and asked him what he thought I should do. He replied: “do you want term or permanent insurance?” I replied: “what?”
Most adults across the country understand the need for life insurance. They know that if the worse thing happens, their loved ones are going to need some money to move on financially. Unfortunately, that’s about all they know.
Life insurance is complicated and confusing for just about everyone, especially when you’re a young adult just starting a family. I mean, they don’t teach life insurance in high school or college. At least they didn’t when I was there. If it was an “elective” which I don’t think it was, I’m sure I wouldn’t have taken it. Would you? So my reply: “what” was pretty common then and it’s pretty common now.
So, let’s start with the basics and get a handle on the difference between whole life (permanent) insurance versus term (temporary) insurance.
What is Term Life Insurance and why is it Temporary?
First, it’s called Term Life Insurance because every policy has a policy term that is selected by the applicant. The typical policy terms offered by most insurers is 10, 15, 20, 25, and 30-year term. It’s easier if you think of the word “term” meaning policy period.
When you purchase term life insurance, you are buying a death benefit (face amount) for a period of time and that’s pretty much it. If you die during the policy period, your beneficiary will receive the death benefit and if you don’t, they won’t.
Most adults use term insurance to replace their income if they die unexpectedly. Since the rates are so much cheaper than Whole Life or Universal Life insurance, the term life product is a great solution when you need a lot of life insurance for a specific period of time and don’t want to pay an arm and a leg for it.
Why do People Buy Term Life Insurance?
Certainly, everybody has their own reasons for doing what they do, but on average, most people buy term insurance to replace their income when they die so that surviving loved ones can continue with their lives without the financial burden the loss of your income will cause.
The best method to calculate the amount of the death benefit you’ll need to use a “life insurance calculator” which can easily be found on the internet. Or, if you are getting help from an independent insurance agent (and you should), he or she will be happy to calculate your needs for you. A typical family will need financial help with the following:
- Cash to pay your survivors living expenses for a number of years that you determine
- Cash to pay off the mortgage on the family home
- Cash to pay off outstanding personal debt
- Cash to pay for college expenses for children
- Cash to fund a retirement account for your spouse or partner
- Cash for final expenses like funeral and burial expenses, and unpaid medical bills
It makes good financial sense to use inexpensive term insurance to cover temporary risks (your debts). But, and this is important, you don’t have to let your term insurance expire if you don’t want to. Most term policies include a “conversion privilege” in the policy contract that allows the policyholder to convert all or a portion of the term insurance death benefit to permanent insurance. This is a big deal.
If or when you decide to convert your policy (usually at or near the end of the policy term) you can purchase permanent insurance like whole life or universal life and not have to prove insurability. This means if you have developed health issues since you purchased your term policy, it will not affect the price of your new permanent policy. Also, since your debts have likely been reduced, you probably won’t need as much coverage as you had with your term policy. This means if you are still alive at the end of your term policy period, your policy can be converted and start covering you for the rest of your life.
What is Whole Life Insurance?
Although Whole Life Insurance shares a couple of similarities with term insurance, it’s really a completely different insurance product. Here’s why.
- Whole life insurance is considered permanent life insurance and will provide coverage for a lifetime, term insurance will not (unless converted to permanent insurance).
- The premium for your whole life insurance can never be increased by the insurance company, even if you become terminally ill or have to live in a nursing home.
- Whole life insurance includes an investment component (cash value account) that accumulates cash over time and earns a guaranteed interest rate that is stated in the insurance contract. Although this cash account grows slowly, you don’t have to pay taxes on the gains because they are considered tax-deferred.
- A policyholder can access the cash account in their whole life policy for any reason using policy loans, withdrawals, or surrendering the policy for the entire cash value amount.
- If your whole life policy is considered a “participating” policy, you can earn annual dividends from the insurer which can be taken as cash, used to purchase additional insurance, or have them deposited into your cash account and earn additional interest on the dividends.
Why do People buy Whole Life Insurance?
With term insurance costing so much less than whole life, you would think everybody would want to buy term insurance, right? No. As we mentioned earlier in the article, your life insurance purchase should depend on your needs and circumstances. This means that there as many reasons to buy whole life insurance is there are to buy term insurance.
In fact, whole life insurance can do everything term insurance can do but it will always cost quite a bit more. Not true if we reverse the policies. Here are some examples when whole life insurance is a better insurance solution than term (hint, it almost always includes a need for cash value).
- Final Expenses – Since whole life insurance provides coverage for the insured’s lifetime, it is the perfect product to cover for final expenses like funeral and burial costs when you die. Plus, most insurers will allow the applicant to purchase as little as $5,000 in coverage.
- College Planning – The cash value account in a whole life policy can be a great resource to fund for a child’s college education. When the time comes, you can withdraw the cash you need via a policy loan, cash withdrawal, or surrender your policy for all of the cash value.
- Individuals who wish to use the “Become Your Own Banker” concept and need guaranteed cash value.
- Cover Estate Taxes – Whole Life insurance is a great solution for leaving money to heirs who are subject to estate and inheritance taxes. Here is when you would select a survivorship policy (2nd to die) for you and your spouse.
- Business Planning – Whole Life insurance can be a very good solution for businesses who wish to set up buy/sell agreements or key-person insurance or LIRPs on vital personnel.
Whole Life versus Term Insurance – The Basic Differences
|Feature||Term Insurance||Whole Life Insurance|
|Affordable for large face amounts||Yes||More expensive|
|Guaranteed Death Benefit||Only for the policy term||For the life of the insured|
|Builds Cash Value||No||Yes, plus interest|
|Level Premiums||Only for the guarantee period||Yes|
|Pays Dividends||No||Yes, if participating policy|
The Bottom Line
As we mentioned earlier, the insurance product you buy should depend on your needs and budget. Rather than guess if you are unsure of which product to consider, get in touch with an independent insurance professional like the ones at InsuranceQuotes2Day so you can make certain that you purchase the product that will deliver a solid solution.