While the topic of life insurance may not be the most exciting, it certainly is important. Life insurance offers peace of mind to the policyholder that, upon their death, their family (or whomever the policy’s beneficiary is) will receive a pre-agreed payout to help with final expenses, paying the mortgage, college tuition, or whatever is needed. While people have life insurance policies for different reasons, having one is especially important if you’d leave behind dependents.
Generally speaking, there are two main types of life insurance policies: term life and whole life. Term life insurance is considerably less expensive than whole life insurance, but only covers you for a limited amount of time (hence, the “term”). Both are similar in terms of death benefits, but they are significantly different in terms of costs, options, and reasons for choosing one vs the other.
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To get started, let’s do a short review of these differences between the two main types of life insurance products.
Term Life Insurance is the most common form of life insurance and provides coverage at a fixed rate, for a fixed amount of time. Term life insurance does not have an investment component. If you stop paying the premium, the insurance policy will “lapse” after the grace period. The payments for term life insurance, also called premiums, typically are much less costly than whole life insurance premiums. Some start at just $16/mo and can offer up to $1.5 million in coverage.
While people generally think of term insurance policies as the exclusive domain of life insurance, home loans and auto loans also fall into this category, as they offer insurance coverage for a set amount of time, for a set amount of money.
Whole Life Insurance– offers guaranteed coverage for the policy holder’s entire life (not just a term), or to the maturation date of the policy, provided all premiums are paid. Unlike term life insurance, whole life insurance does have an investment component, and premiums are often more expensive than term policies. More on the investment component later in this article.
Whole life insurance is also called “ordinary life,” “straight life,” and “permanent life” insurance. Sub versions are also called Traditional Whole Life Insurance, Universal Whole Life Insurance and Variable Whole Life Insurance to name a few. In order to keep the comparison between term and whole life insurance simple, we’ll instead broadly refer to them all as “Whole Life Insurance.”
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What is term life insurance?
Term life insurance is a form of life insurance that is in effect only for a set amount of time, and only offers coverage (and death benefits/payouts) during that term. The policy must remain current and premiums paid in order for payout to occur. Other than offering a payout to the policy’s beneficiary, the policy has no value.
Common durations for term life insurance are 10, 20, or 30 years, and generally speaking, the premium remains fairly consistent throughout the duration of the policy.
While there are numerous factors to consider when purchasing term life insurance, key factors to account for include selecting a term duration that’ll cover the years you’d be paying bills, etc that you want life insurance to cover, as well as considering the amount of money your framily would need to be comfortable if you were no longer there to financially provide. Consider expenses like mortgages or rent, tuition, childcare coverage, and healthcare expenses for surviving family members. Many people opt for a policy to end around the time most of these expenses will be covered- ex: once the mortgage is paid off and kids are out of school, the need for life insurance diminishes for many.
What is whole life insurance?
Whole life insurance is a form of permanent life insurance, meaning that it never expires (“term” doesn’t end), so long premium payments are maintained. In addition to the payout upon the policyholder’s death, whole life insurance also has some “cash value,” which can be borrowed against in the future.
The reason the policy can be borrowed against is because the monthly premiums are effectively split. Part of the monthly premium paid goes to the insurance component of the policy, while part goes to this separate “fund.” Many policies pay a small, guaranteed interest rate (usually around 1-2% of this policy)
While having money to borrow against may sound like a good thing, there are a few drawbacks. If you take a loan against the policy, the death benefit will decrease by that amount, unless you pay the amount back in full, plus interest. The other challenge is that you may be forced to surrender up to 10% of the cash value of the policy if you stop paying the premiums in the early years of holding the policy. This isn’t the case, however, with term policies, wherein you can simply stop paying the premium, the policy lapses, and coverage ends.
It’s also important to note that although death benefits are nearly identical for whole and term life insurance policies, the monthly payments are not. Whole life insurance policies are MUCH more expensive- five to fifteen times more- than term. So it’s not surprising that a study from the University of Pennsylvania’s Wharton School uncovered that approximately one in four whole life insurance policies lapse within the first three years.
Which policy should I choose?
While everyone has unique personal scenarios, most people opt for term life insurance policies. The fee structure is easier to understand and the lower monthly fee puts this type of coverage within reach of far more families.
There’s a company called Bestow that offers up to $1,500,000 in coverage, with rates as low as $16/mo. This kind of security is so, so important and should be within reach for most families.
However, some families may prefer whole life policies, based on circumstances. For instance, if someone had a disabled child and could afford the premiums, whole life would guarantee their child a payout for the duration of the parent’s life. Additionally, business partners may choose to take out whole life policies, so that the remaining partner could purchase the deceased partner’s stake in the business. Finally, people with significant estates ($11.7 million individually, or $23.4 million per couple) may opt for whole life policies so beneficiaries could use the payout for inheritance or estate taxes.
