Term Life vs. Whole Life Insurance At a Glance
The most common options you’ll see when shopping for life insurance are term life and whole life. While both provide coverage if you should pass away, there are critical differences between the two. Term life insurance is a temporary policy that will cover you for a set number of years — also known as the term. Term policies also offer no monetary value other than the death payout.
Whole life insurance, on the other hand, is a permanent policy that will last as long as you are alive and provides a cash value that can be accessed while you are living.
Term policies are often sold in terms of 15-30 years. During that time, if you should pass away, the policy would pay an amount of money — known as the death benefit — to your beneficiary. However, after that term expires, the policy may end or rise in price drastically.
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Coverage For Now and Later — Finding the Right Type of Life Insurance For You
When someone passes away prematurely, it can cause financial strain to their loved ones. Life insurance is intended to provide your beneficiaries with financial security, should that happen. As of 2021, approximately 260 million Americans have some sort of life insurance.
Those without life insurance may be more at risk of leaving debt — such as medical bills, final expense costs, and mortgage expenses — behind. Whether it is a term or whole life policy, a payout from a life insurance policy could significantly lessen the financial burden for your loved ones.
Term Life vs. Whole Life Insurance
Term Life Insurance | Whole Life Insurance | |
|---|---|---|
Eligibility | Medical exam may be required to access eligibility for higher coverages; certain high-risk jobs can disqualify | Medical exam may be required to access eligibility for higher coverages; certain high-risk jobs can disqualify |
Policy Length | Typically 10-30 years | Entire life of insured |
Premiums | Initial lower cost; may increase over time | Higher cost than term; price remains the same |
Coverage Amount | Typically starts at $25,000 | Typically starts at $10,000 |
Investment | Offers no cash value | Offers a guaranteed cash value; dividends may also be paid |
Flexibility | May be converted to a permanent policy | Little to no flexibility |
Sustainability | Often not kept after initial term | Often kept for lifetime |
What is Term Life Insurance?
A term life insurance policy is a type of life insurance that typically only lasts for a set number of years. Most term policies are sold for terms between 10-30 years. After the term is up, the policy can either renew (usually at a much higher rate) or end. If the insured should pass away during the term period, the policy would payout a death benefit. However, if the insured passes away after the policy ends, there would be no payout.
Types of Term Life Insurance Policies
When looking for a term life policy, there are several different types to consider, such as level term, convertible term, decreasing term, return of premium, renewable term, and annual renewable term. It is possible that a policy can combine more than one type of term insurance. For example, a policy may be both a level and convertible term.
Level Term
A level term policy is a policy that provides a death benefit and premium that does not change during the term period. For example, if a 20-year term policy is purchased with a death benefit of $50,000 at $50 per month, the premium nor the death benefit will change during the initial 20-year period. However, the policy premium may increase after the initial term, or the death benefit may decrease.
Convertible Term
A convertible term policy refers to a term policy that allows the policy to be changed or converted from a term policy into a permanent policy. The conversion option may not last the entire term of the policy and may not be included on all term policies.
Decreasing Term
A decreasing term policy offers a death benefit that decreases over time. These policies may be used to cover an expense, such as a mortgage or loan, and that balance will decrease over time. By the end of the term, the death benefit will reach zero, and the policy will end.
Return of Premium
A return of premium term policy (ROP) is usually a level term policy that will return all of the premiums to the insured at the end of the term if the insured is still alive. For example, if a customer purchases a 20-year ROP and pays $10,000 into the policy in premiums, at the end of the 20-year term, they would be able to cancel the policy and receive their premiums back.
Renewable Term
With a renewable term policy, the policy will renew at the end of the term instead of canceling. However, the price will increase, sometimes significantly, at each renewal. For example, a policy may be a level term for the first 20-year period but then will renew at a higher price every 5 years thereafter.
Annual Renewable Term
An annual renewable term works just like a renewable term except they renew much more often. These policies renew yearly, meaning that every year the policy will stay in effect. However, the price will increase every year and may reach a premium that becomes too expensive for you to keep.
What is Whole Life Insurance?
Whole life insurance is different than term in that it is a permanent policy designed to last your entire life, given that the premiums are paid. It also offers a cash value in addition to a death benefit; the cash value grows as the premiums are paid, and you can access it during the policy period.
Types of Whole Life Insurance
When considering whole life as an option, it is important to know that there are several different types of whole life insurance from a traditional policy to a variable. While most types of whole life policies are very similar, there are some differences to consider.
Traditional Whole Life
A traditional whole life insurance is the most common type of whole life insurance. This type of whole life insurance provides a death benefit, the amount paid to the beneficiary if the insured should pass away. It also builds a guaranteed cash value that you can access for any reason.
When a premium payment is paid, a portion of the payment covers the death benefit, and another portion goes into the cash value. A set interest rate is then paid on the premiums in the cash value account.
Most life insurance companies will also pay a dividend — a profit made by the insurance company that is then returned to the policyholder — to their policyholders that can help the cash value account grow. While annual dividends are not guaranteed by most companies, they are often paid by most reputable companies on a regular basis. Amongst permanent policies, a traditional whole life offers the most guarantees and stability.
Universal Life
A universal life insurance policy is another type of permanent life insurance that consumers can consider when looking for a policy. While universal life policies are not a type of whole life policy, they are a permanent policy that may perform similarly to a whole life policy.
A universal life policy has more flexibility than a whole life policy; the death benefit, premiums, and length of the policy can all be adjusted, while a traditional whole life policy cannot. A universal policy has the potential to accumulate a cash value, but it is not guaranteed.
While the policy does offer flexible premiums, if the policy becomes underfunded, it can run out prematurely, leaving you with no life insurance. A universal life policy offers a guaranteed death benefit, as long as the policy is funded correctly, and the possibility to earn a cash value.
Variable Whole Life
A variable whole life insurance works similarly to a traditional whole life policy. A variable whole life policy provides a death benefit and a cash value account. On a traditional whole life policy, the interest is paid at a set rate. However, on a variable whole life policy, the interest can vary because the cash value is invested into different accounts, often mutual funds.
The interest paid on the cash value depends on how well those accounts perform. While there is the possibility that the policyholder can earn more than on a traditional whole life, there is also the possibility that the cash value can drop. Most variable whole life policies will also offer a fixed interest option as well. If this is the case, the policyholder may be able to divide their cash value between the fixed account and the variable account.
While a variable life policy offers the possibility of the biggest return, it is also the most risky of permanent policies.
Indexed Universal Life
Like a universal life policy, an indexed universal life policy (IUL) is not a type of whole life. It is a permanent policy that will provide a death benefit and can accumulate a cash value. An indexed universal life works similarly to a universal life policy. Many features, such as premiums and death benefits, are flexible.
With an IUL policy, any funds that accumulate into the cash value account are invested into a stock market index account, such as the S&P 500. The cash value account will be linked to that stock market account. That gives the policyholder the opportunity to earn more than a set interest rate of a whole life, but they could also not earn any interest if the indexed account does not perform well.
IUL policies usually offer a guaranteed minimum interest rate and a maximum cap rate. For example, if an IUL offers a cash value account at 0-8%, the interest paid will never be less than zero, but never more than eight. If the indexed account the policy is linked to performs at 10%, the policy will only be credited the 8% maximum. If the indexed account finishes at -10%, the policy will not lose any money, but it will not gain.
Because of the caps placed on IUL policies, they are not as risky as a variable whole life policy, but not as guaranteed as a traditional whole life.
Guaranteed Issue Whole Life
A guaranteed issue whole life policy is a policy designed typically for people with medical issues that cannot acquire other life insurance. These policies usually have no to little underwriting qualifications and are guaranteed to issue, but usually aren’t available until you reach a certain age (usually 50). While these policies may be a great option for those with major medical issues, they may be much higher in premium than other permanent policies and are usually only offered at limited coverages, between $5,000 – $25,000.
Another factor to consider is that these policies often have a waiting period, usually 2-3 years, before the death benefit with be paid out. If the policyholder should pass away during the waiting period, the beneficiary would not receive the death benefit. However, some life insurance companies will pay the beneficiary any premiums that has been paid into the policy plus interest.
While a guaranteed issue policy may gain cash value and accumulate annual dividends, it is not likely that the return will be as much as a traditional whole life. These policies are designed for older people that cannot acquire another form of life insurance.
Term vs. Whole Life Insurance: Eligibility
Term Life | Whole Life | |
|---|---|---|
Eligibility | No exam may be needed for lower coverages and shorter terms. Medical and lifestyle questions may be asked to determine eligibility. For higher coverages and longer terms, an exam and medical and lifestyle questions may be needed to determine eligibility. | For a guaranteed issue policy, no medical underwriting may be needed as long as the insured meets the age requirement. For lower coverages, no exam may be needed; medical and lifestyles questions may be asked to determine eligibility. For higher coverages, an exam and lifestyle questions may be needed to determine eligibility. |
When it comes to applying for a life insurance policy, a consumer may consider what will be required of them to attain the policy, and if they will be eligible to purchase a certain type of policy. Life insurance, in general, may be denied to an individual who is in bad health, has a high-risk job, or does not meet the company’s criteria.
Certain policy types may have more strenuous guidelines than others. It is important to note that each company may have different guidelines and can vary immensely.
Term vs. Whole Life Insurance: Policy Length
Term Life | Whole Life | |
|---|---|---|
Policy Length | Designed for a specific number of years; typically, 10-30 years | Designed for lifetime coverage |
When choosing between a term or whole life policy, you need to consider how long you want the policy to stay in force.
Term vs. Whole Life Insurance: Premiums
Term Life | Whole Life | |
|---|---|---|
Premiums | Generally lower premiums than whole life; premiums cover death benefit only and cost to the insurer | Generally higher premiums than term life; premiums cover death benefit, costs to the insure and accumulate in a cash value account |
When looking for a life insurance policy, one of the most common concerns are premiums, or how much you will have to pay each month to keep the policy intact. While cost is a main factor, it is important to know why some policies have higher premiums than others.
Term vs. Whole Life Insurance: Coverage Amount
Term Life | Whole Life | |
|---|---|---|
Coverage Amount | Typically starts at $25,000; a company may have a limit for — for example, up to 25 times your salary | Typically starts at $5,000; no legal limit but a company may have a limit for coverage — for example, a reasonable amount to match an insured’s income and assets |
When choosing a life insurance policy, it is important to know how much coverage is needed. Some life insurance policies may be needed to only cover a specific debt, such as a mortgage. While other policies may be needed to cover not only debt, but also end of life expenses, childcare, etc.
It is possible to combine policies to meet needs. For example, if an individual needs $500,000 in coverage, but cannot afford a whole life policy for the full amount, it is possible to split it into two or more polices, such as a term for $400,000 and a whole life for $100,000. The coverage limits of a policy can vary from company to company.
Term vs. Whole Life Insurance: Investment
Term Life | Whole Life | |
|---|---|---|
Investment | No return on premiums | Guaranteed return on premiums with set interest rate, possible dividends, and loan availability |
One main difference between whole life insurance and term insurance is the return on premiums. While term life offers little to no return on premiums, whole life will offer a guaranteed cash value as well as a possible dividend. You can access the cash value of your whole life policy at any time for any reason. The cash value can be used for unexpected debt, emergencies, or any reason you choose.
You can also choose to take a loan from the policy. What this means is that you can take a portion of the cash value, usually up to 90%, in the form of a loan. Although this amount does not have to be paid back, it will acquire interest, which can increase the amount of the loan over a period of time. If the insured passes away with an outstanding loan on their policy, the loan amount is deducted from the death benefit.
Term vs. Whole Life Insurance: Flexibility
Term Life | Whole Life | |
|---|---|---|
Flexibility | Some flexibility with conversion options and renewability | Little to no flexibility |
Some consumers may look for a policy that offers flexibility over time. While a universal life policy offers the most flexibility, it is possible to get some flexibility in other types of life insurance. For example, while a term policy does have a set price and death benefit, some types of term policies will allow the policy holder to convert all or a portion of coverage over to a permanent plan.
This allows policy holders the ability to purchase a larger term policy now with the plan to convert it into a smaller whole life policy down the road.However, whole life policies offer little to no flexibility. They are purchased at a set coverage for a set price.
Term vs. Whole Life Insurance: Sustainability
Term Life | Whole Life | |
|---|---|---|
Sustainability | May be difficult to sustain long term; lower initial premiums but may raise drastically overtime | May be more easily sustained long term; offers the same premium for the lifetime of the insured |
While it is important to consider the circumstances of your life today, such as budget and coverage needs, it’s good to keep the long-term goal in mind. While term may be a more affordable option now, it may become unsustainable long-term due to increasing premiums. It’s also possible that term policy may expire before you pass away – leaving you with no life insurance.
Advantages
Term Life
Term life may not be the best choice for everyone, but it does have some key advantages.
- Affordable premiums: Premiums on term policies are typically much lower than whole life policies for the same amount of coverage. This is attractive to those who may need a larger amount of coverage on a tighter budget.
- Flexible coverage: Term policies allows consumers to choose how long their coverage will last, allowing the policyholder to have flexibility if they only need a policy for a certain amount of time. Often, it is possible to convert the term policy to a whole life policy.
- No investment risk: While a term policy does not offer any returns on premiums, there is also no risk of losing any money due to investment. The premiums are used to cover the death benefit and not invested otherwise.
- Straightforward policy: A term policy is simple to understand. An insured will pay a specific premium for a set number of years. If they pass away during that term, their beneficiary receives a payout. There is no cash value or investment component to understand.
Whole Life
While whole life may not be the best choice for some, there are many advantages to consider.
- Lifetime coverage: Whole life policies offer coverage for your entire life. As long as the premiums are paid, the policy will stay in force.
- Level premiums: The premiums on a whole life policy will not change. This allows the insured to plan their budget and not have to worry about the premiums raising.
- Cash value: A whole life policy offers a cash value component that is an attractive feature to many consumers. This allows them to not only have a death benefit coverage, but access to a cash value should they need it.
- Tax advantages: Not only is the death benefit paid to the beneficiary tax free, but the cash value of the policy also grows tax-deferred. This means that while the policy value is growing, it is not taxed. When the policyholder accesses the cash value of the policy, only the gains are taxed. For example, if the policyholder paid in $5,000 to a policy and withdrew $8,000, only the $3,000 gain would be taxed.
Drawbacks
Term Life
Although term policies have many advantages, there are some drawbacks as well.
- Temporary coverage: A term policy will only last for a set number of years. After the term is over, the policy may end or renew at a much higher cost
- Increasing premium: Unlike a whole life policy, a term policy’s premiums may increase. While the price may be level during the initial term, policyholders may see a significant increase afterwards.
- No cash value: A term policy is not designed to provide a cash value to the insured. Rather, it simply provides a death benefit should the insured pass away during their term.
- No lifetime coverage: Although term policies may be offered at terms up to 30 years, it is not guaranteed that the policy will last the entire lifetime of the insured. It is possible that the term policy may end, leaving the insured without life insurance coverage.
Whole Life
Whole life insurance has many advantages to consider, but there are some disadvantages as well.
- Higher premiums: Compared to a term policy for the same coverage, a whole life policy may be much higher in cost.
- Less flexibility: With a whole life policy, there is no way to change the policy into another type of policy. Should you decide you want to change to a term policy, you would have to cancel the whole life and reapply for a new policy
- No guaranteed dividends: While a whole life policy offers a guaranteed set interest rate to establish a cash value, there is not guarantee that a policy will pay a dividend. Dividends often help boost the cash value of a policy and are often paid but cannot be guaranteed.
- No investment diversification: While a whole life policy does offer a return on premiums in the cash value, they are not designed as investment vehicles. They often have limited investment options and the policyholder’s control over investment decisions is minimal.
How to Get It: Term or Whole Life Insurance
After you decide what type of policy is best for you, it is time to make a purchase:
- Look at insurer details. This includes financial stability and years in business.
- Obtain quotes from several companies and compare. Look at premiums, length of term, return on premiums, and more.
- Apply for a policy. Each company’s process may be a little different, but the steps should be similar. You will need to contact the company and provide some information to fill out an application. This may vary from basic information, such as name and date of birth, to more detailed information, such as health and job details.
- Complete underwriting, if applicable. Once the application is submitted, the insurance company will then continue with the underwriting process, which may include medical questions or a medical exam. The higher amount of coverage that is applied for, the more strenuous the underwriting process can be.
- Await decision on coverage. When the underwriting process is completed, the insurance company will make a decision to either approve or deny you. It is possible that you will be approved, but at a higher rate than quoted. If approved, the policy will continue as planned. If denied, you may need to apply for a different type of policy, or may not be able to purchase life insurance altogether. If this happens, you can consider simplified issue or guaranteed issue options instead, which have more flexible acceptance criteria, though often at a higher cost.
Parting Thoughts
Whether it is a term or whole life policy, it is important you find a life insurance policy to cover your individual needs. It’s necessary to have adequate coverage in place so your loved ones are financially set in the event of your death. Although both types of policies offer a death benefit, there are many differences. Understanding the differences will help you make a well-informed decision.
A term policy may be best if having a lower premium and flexibility is most important to you. If having a set premium and lifetime coverage is most important, then a whole life policy may be better.