Life insurance is essential to secure the financial needs of your loved ones in your absence. It allows your family to cope with the loss of income caused by your demise and meet their short term and long term expenses.
Life insurance can be classified into two types: term life and whole life. In this article, we take a detailed look at term vs whole life insurance, how they differ from each other, what their advantages and disadvantages are, and which one is the right choice for you.
Features of Term Life Insurance
A term life policy is designed to cover you for a specific period of time, after which it expires. The policy term could be anywhere from 5 to 30 years, depending on the type of policy you choose.
This is the most important component of a term life policy. Death benefit refers to the amount of money your beneficiary will receive in the event of your death.
Premium is the amount you pay on a monthly or yearly basis to keep your policy active. The amount of premium you pay depends on a wide range of factors including your age, health status, occupation, the amount of coverage you choose, and the duration of the policy.
Types of Term Policies
There are three main types of term life policies – level term, declining term, and annual renewable term.
Level Term Policy
In this type of policy, the premium remains the same for the entire duration of the policy. You have to pay the exact same amount every month or every year, as long as the policy stays active.
Declining Term Policy
In this type of policy, the premium stays the same, but the death benefit gradually declines throughout the policy term. The most common example of a declining term policy is a mortgage life policy, which is tied to your mortgage.
The death benefit is proportionate to the outstanding balance on your mortgage and decreases steadily as you keep making the mortgage payments. Once you pay off the mortgage, the policy also expires. In the event of your death, the death benefit paid out is sufficient to pay off the remaining balance on your mortgage.
Annual Renewable Term Policy
This type of policy covers you only for a period of one year. At the end of the year, the policy expires and has to be renewed again.
As you keep renewing the policy year after year, the premiums increase gradually. This type of policy is only beneficial in cases where you are in need of temporary coverage for a very brief period of time.
Features of Whole Life Insurance
A whole life policy is designed to cover you throughout your life. There is no specific term period and the policy stays in effect as long as the premiums are paid regularly.
It is the amount your beneficiary stands to receive in the event of your death.
This is a unique feature which is only available in whole life policies. The insurance company allocates a portion of your premiums to a savings component known as cash value. It continues to accrue interest for the entire duration of the policy. The rate of interest is determined by the insurance company.
This is a feature available only in certain types of whole life policies. These policies are structured in a way that you are not only a policyholder, but also an investor or stockholder in the insurance company. So, the company shares its profits with all the policyholders by paying dividends.
For whole life policies, the premium usually remains the same throughout the policy’s duration. As is the case with term life policies, the amount of premium you pay depends on a range of factors like age, health condition, occupation, lifestyle, and coverage amount.
Now, let us take a look at the major differences between these two types of insurance.
Difference Between Term and Whole Life Insurance
This is the most obvious difference between a term policy and a whole life policy. Term insurance is meant to cover you for a limited period of time. Whole life insurance, on the other hand, has no such limitations and provides you with lifelong coverage.
Term insurance has a death benefit component, which is paid out to your designated beneficiary after your demise. Apart from this, it does not provide any other financial benefits.
Whole life insurance, on the contrary, not only has a death benefit, but also includes a cash value component, which keeps growing throughout the policy’s term. Some whole life policies also offer dividends on a yearly basis.
Term life policies typically have a much lower premium than whole life policies. Since term policies are only meant for a specific period of time and do not have any cash value, they are significantly cheaper than other types of policies.
Now, let us take a look at the advantages and disadvantages of term life insurance and whole life insurance.
Advantages of Term Life Insurance
- It is very cheap. In fact, if you are young and healthy, a pure term policy is the cheapest option available for you.
- It gives you the option of choosing the policy term. If you only need coverage for a specific period of time or to protect a specific financial obligation like mortgage, you can choose a term policy with an appropriate term length. This way, you do not pay for coverage that you do not need.
- It provides substantial life cover at very affordable rates. If you are young, you can easily choose a policy whose death benefit is sufficient to take care of your family’s short-term as well as long-term needs.
- It can be converted into whole life insurance. This way, you can enjoy extended coverage even after the initial term period ends.
- It is simple and uncomplicated. You only need to consider three factors – death benefit (is it sufficient to cover your family’s financial needs?), premium (is it affordable?), and term period (how many years do you need the coverage for?).
Disadvantages of Term Life Insurance
- It provides limited coverage. If you buy a 30-year term policy when you are 25, it will expire when you turn 55, at which point you need to renew the policy. You might find it difficult to qualify for a new policy due to your age and health status.
- It can be expensive if you are older and have health problems that could affect your mortality rate. Whether you apply for a new policy or renew an expired policy, you are likely to pay a much higher rate compared to a younger person.
- Unlike whole life insurance, it does not provide any living benefits. The death benefit is the only financial benefit your family stands to receive in the event of your death.
Advantages of Whole Life Insurance
- It provides you with permanent, lifelong coverage. Once you are insured, you stay insured for the rest of your life, as long as you pay the premiums. There is no hassle of extending or renewing the policy at any stage.
- Apart from a guaranteed death benefit, it also provides living benefits in the form of cash value. Once the cash value has built up, you can withdraw it or get a loan to take care of your financial needs. You can use the money to pay the premiums, buy more coverage, pay your bills, or for any other purpose.
- Certain whole life policies also offer dividends on an annual basis. These dividends are tax deferred and could be an extra source of income for you.
- It can be used for estate planning purposes. If your policy has a large death benefit or built up a substantial cash value, your family could use it to pay estate taxes and other outstanding bills.
Disadvantages of Whole Life Insurance
- It is much more expensive than term life insurance. If you live paycheck to paycheck and have very little disposable income, you might not be able to afford the premiums.
- The money you withdraw or borrow from the cash value component of your policy needs to be paid back. While the interest rates on loans against cash value are very low, it is still a loan and you need to pay it back within your lifetime. If you do not, the outstanding amount will be deducted from the death benefit.
- If you do not repay the loan, the interest keeps accruing. If the total amount you owe the insurance company (original loan amount and interest payments) exceeds the accumulated cash value, your policy could lapse.
Now, let us compare the average cost of a term policy and a whole life policy.
Average Cost of Term Insurance
Given below is the average cost of a $100,000 term policy for a healthy man at the age of 30, 40, and 50.
|Age||Policy Term||Monthly Premium|
Given below is the average cost of a $100,000 term policy for a healthy woman at the age of 30, 40, and 50.
|Age||Policy Term||Monthly Premium|
Average Cost of Whole Life Insurance
Given below is the average cost of a whole life policy for a healthy man at the age of 30, 40, and 50.
|Age||Death Benefit||Monthly Premium|
Given below is the average cost of a whole life policy for a healthy woman at the age of 30, 40, and 50.
|Age||Death Benefit||Monthly Premium|
As you can see, the difference in cost between an average term policy and whole life policy is significant to say the least.
If you are 30 years of age, you can buy a 30-year, $100,000 term policy at $12 a month. For a whole life policy with the same amount of coverage, you have to pay $89 a month. So, by choosing the term policy, you could save $77 every month.
Converting a Term Policy into a Whole Life Policy
One of the best parts about a term policy, as mentioned above, is that it can be converted into a whole life policy. Now, there are many reasons why you might need to do so.
- If your term policy expires when you are in your 50’s, you might want to convert it into a whole life policy to build up some cash value, which you can utilize in your post-retirement years.
- If you have a lifelong dependent (spouse who does not work or a special needs child), a whole life policy can secure their financial needs even after you are gone.
- If you have a large estate, your heirs have to pay a considerable sum of money towards estate taxes after your death. A whole life policy, in such cases, can be used to pay estate taxes.
- If you develop a health condition in your 50’s or 60’s, which affects your insurability, it might be difficult for you to qualify for a new term policy. In such cases, converting the existing term policy into a whole life policy is the best idea, since it does not involve any medical exams or approval process.
Most insurance companies these days allow you to convert a term policy into a whole life one. All you have to do is inform the insurer that you would like to convert your policy into a permanent one. The conversion process is quite simple, as you only need to fill out a form or two.
It should be noted that most insurers have an upper limit in terms of the age at which you can convert a term policy into a whole life policy. So, if you want to convert your policy, you should do so during the conversion period, while you are still eligible.
Which is Better Term or Whole Life Insurance?
If you have to choose between term insurance and whole life insurance, term is the better choice for you.
A term policy provides you with a substantial amount of coverage at extremely low rates. Also, you have the option of converting it into a whole life policy when you are older.
So, instead of buying whole life insurance and spending a lot of money on premiums, you can buy term insurance at a fraction of the cost and invest the rest of the money in index funds. It is one of the best ways to build a significant retirement corpus.
What do the experts have to say about the term vs. whole life debate? Let us find out.
Dave Ramsey’s Advice on Term vs Whole
Dave Ramsey says that the return on investment from whole life policies is meager and is not enough to build a sufficient retirement corpus.
So, he recommends buying a term policy whose coverage amount is equivalent to 10 to 12 times your annual income. He also says that the duration of your term policy should be long enough to cover you until your children become independent and start living on their own.
Suze Orman’s Advice on Term vs Whole
Suze Orman says that whole life insurance is too expensive and the returns you get from the cash value component are not sufficient to justify the premium payments you have to make throughout your life.
Therefore, she recommends buying a term policy and investing the difference (the money you would have paid if you had bought a whole life policy) to get much better returns.
Clark Howard’s Advice on Term vs Whole
Clark Howard too concurs with Dave Ramsey and Suze Orman and recommends going the BTID route – Buy Term and Invest the Difference. He says you should consider two factors while buying a term policy.
Death Benefit – It should be at least 10 times your annual income.
Policy Term – It should be chosen based on the age of your dependents. For instance, if your children are 5 and 7 years old respectively, a 20-year policy should suffice for you, since by the time the policy expires, your children would be living on their own.
What Does NoExam.Com Recommend?
At noexam.com, we offer life insurance advice keeping in mind the long-term interests and benefits of our readers. Based on that, we recommend term life insurance. It is cheaper, provides you with adequate coverage, and can be converted into a permanent policy if needed.
The best way to plan for your future is to buy a term policy with adequate coverage and save and invest regularly. This way, you will be able to pay off your debts and build up a retirement corpus before your policy expires.
The bottom line – when it comes to term life vs. whole life insurance, term life is the better option in almost all cases.
Term vs Whole Life Insurance by Jonathan Holloway