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Term vs whole life insurance

Term life insurance guarantees a payout if the policyholder dies within a set term, typically 10-30 years. Whole life insurance guarantees a payout no matter when the policyholder dies, and its premiums are therefore more expensive. Term is the best choice for most people, while whole is the right fit in relatively rare circumstances.

Before you start shopping for life insurance, it helps to already know your answer to providers’ #1 question: Do you want term or whole life insurance?

Both term and whole life insurance provide your beneficiaries with a payout if you pass away, but they differ in many respects. The right fit for you depends on your financial goals, budget for premiums, beneficiaries’ financial and medical needs, and other questions only you can answer.Here’s what you need to know and ask before deciding which is right for you.

What Is the Difference Between Whole Life and Term Life Insurance?

If you keep up with your premium payments, both term life and whole life insurance guarantee your survivors will get a death benefit — a cash payout they’ll receive if you die during your coverage period.

The three biggest differences between term life insurance and whole life insurance are:

  • Expense. Term life insurance is much cheaper than whole life insurance in just about every situation.
  • Coverage length. Term life insurance covers you for a temporary “term” or time period. The coverage length for whole life insurance is right in the name; it lasts your whole life.
  • Payouts. Term life insurance provides a cash payout only in the event of a policyholder’s death. Whole life insurance policies grow extra cash value and may pay dividends in addition to the death benefit.
  Term life Whole life
Permanent coverage X
Death benefit
Additional cash value X
Possible dividends X
Low premiums X

What Is Term Life Insurance?

Term life insurance is simpler than whole life insurance, and is in some ways comparable to car or home insurance. It covers the unexpected — in this case, your premature demise. But it’s not a long-term investment.

  • If you die during your term, your beneficiaries can make a claim. But if you outlive the policy, the coverage ends and no payout will be made.
  • Premiums are based on many factors, including age, overall health, and term length.
  • The premium usually won’t change for the life of the term. Once your term ends, however, your premiums will increase if you want to take out a new policy (since you’ll be older).
  • New policies tend to be fairly cheap for healthy people under 50, then get progressively more expensive.
  • All policies require applicants to submit some health information, and many insurers (though not all) require a medical exam.

Term life insurance policies are particularly popular among mortgagers and parents of young children, because the death of a policyholder could result in a substantial loss of income that would jeopardize mortgage payments, child-rearing expenses, or funds for college. The policy’s death benefit is a form of financial security against that lost income.

A policyholder who no longer has these financial concerns, e.g. they’ve paid off their mortgage or saved up enough for their children’s college tuition, might have no need to renew their term life insurance policy once it expires.

Read more: Buying Life Insurance Young Saves Money

Variations on Term Life Insurance

  • Return-of-premium term policies give back some of your premiums at the end of the term. These policies are generally more expensive.
  • Convertible policies can be turned into whole life policies at the end of the term. These can also cost more than average term policies.
  • Decreasing term policies decrease the death benefit (and the premium) gradually over the course of the term. These policies are helpful for covering time-bound obligations like a mortgage.

Pros & Cons of Term Life Insurance

Pros

  • Good for those who only need coverage for a certain period of time.
  • The premiums are affordable.
  • You can cancel with no penalty after purchase.
  • Payouts to beneficiaries typically aren’t taxed.

Cons

  • Does not cover permanent insurance needs.
  • You have to reapply for coverage every time your term ends, likely with another medical exam.
  • Policy renewals come with pricier premiums.

What Is Whole Life Insurance?

Whole life insurance is the most common type of permanent life insurance. Aside from the guaranteed death benefit, a portion of each paid premium accumulates into an additional cash value, which is available for you to borrow against or cash out during your lifetime. Some other notable features of whole life insurance include:

  • Some policies also pay annual cash dividends as your investment grows.
  • The cash value reverts to your insurance company when you die — it doesn’t automatically pass to beneficiaries.
  • You can surrender a whole life policy if your financial circumstances change or you have buyer’s remorse. You’ll get back the policy’s cash surrender value, but you may be charged fees.
  • Premiums are charged monthly, quarterly, semi-annually, or annually. You can usually pick your payment schedule.

Due to their cash value and length of coverage, whole life insurance premiums are significantly more expensive than term life insurance premiums. Premium quotes can be ten times or higher than what you’re quoted for term life, for policies that otherwise have the same death benefit.

Read more: Is Whole Life Insurance a Good Investment?

How Can You Use Cash Value?

You can use a whole life policy’s cash value buildup to pay premiums, get an emergency loan, save it for retirement, or liquidate it by canceling the policy. Returns on a whole life policy may be comparable to high-yield investments after about 20 years.

It’s extremely important to note that, depending on your policy, the cash value you have built up in the account will not transfer to your beneficiaries. You can borrow against it during your life but any outstanding loans will be paid back from your death benefit.

So let’s say you decide to pay extra for whole life insurance and you’re thinking that the extra cost is building up as cash value. It’s billed as a type of investment or savings account. However, if you die, the insurance company keeps that money.

Universal and Variable Life Policies

People who want to take advantage of whole life insurance’s investment component can consider universal or variable life policies, which are variations on permanent life insurance.

Universal life insurance policies earn interest at the market rate, so your money’s working for you as well as your beneficiaries. And once you’ve held the policy for a while, you may be able to adjust your premium payments.

Variable life insurance policies let you invest a portion of your policy into stocks, bonds, or mutual funds. This is a good option if you’re already comfortable with investing and willing to assume some risk (if your investments don’t perform well, the death benefit could decrease).

Pros & Cons of Whole Life Insurance

Pros

  • Coverage doesn’t expire if you keep paying premiums.
  • Cash value growth is tax deferred.
  • Death benefits and dividends are typically tax free.
  • Premium costs don’t change even if your health declines in the future.

Cons

  • Much more expensive than term life insurance.
  • There are usually fees for canceling coverage.
  • If you take out loans from the policy and don’t pay them back, the loan amount is subtracted from the death benefit.

How Much Life Insurance Do You Need?

Singles with no dependents probably only need a small life insurance policy. $50,000 or even $25,000 may be enough. Since there is no one else who will rely on the income, it’s basically a matter of having enough insurance to pay for final expenses (death) and any lingering obligations.

Also, consider any loans that have been co-signed by another party. For example, if your parents co-signed on your student loans they will be on the hook for those in the event of your death.  So you’ll want to get life insurance that will cover the full balance.

A family with young children, on the other hand, would need coverage to support dependents for several years. In this situation, a $500,000 life insurance policy might be the absolute minimum. For example, it would provide $20,000 for final expenses, $20,000 a year in financial support for the next 15 years ($300,000), and the remaining $180,000 to be used for your children’s education.

Since it will be much more expensive to have a larger amount of life insurance coverage, a young family can save on costs by choosing term life insurance.

One simple way to determine how much coverage your family needs is to multiply your current salary (pre-tax) by the number of years your beneficiaries will rely on the death benefit. If you’re a new parent who makes $40,000 a year, and you want 20-year coverage so your child is covered until they turn 20, you could look into an $800,000 policy. If you make the same salary but you want insurance to cover a 30-year mortgage, that puts you in the $1,200,000 range.

Read more: Calculate How Much Life Insurance You’ll Need

How Long Do You Need Coverage?

Term life insurance tends to be the more cost-effective solution when you can match the term of the policy with the length of time it will take you to pay off your debt. For example, if you’re raising a family and/or trying to pay off a mortgage, you may need a large amount of coverage for a period of 20–30 years.

After the initial term expires, you can opt to:

  1. Continue coverage at a higher premium,
  2. Lower the death benefit amount and therefore the premium, or
  3. Cancel the policy completely.

As a general rule, unless you anticipate needing coverage for longer than 16 years (and you’re able to pay higher premiums the whole time), stick with term. The 16-year mark is about when a whole life insurance policy’s cash surrender value plus insurance value will catch up to your initial investment. Cancel the policy any earlier and you risk losing money.

The idea is that as time passes the gap between your needs and means will shrink. You will pay down the mortgage and your kids will grow up.  Meanwhile, you will also be saving money. Ideally, you will eventually become self-insured.  This means you have enough saved that your loved ones will be able to use your nest egg to support themselves rather than relying on insurance.

When you reach this point you no longer need life insurance.

The ‘Invest the Difference’ Approach

It is often said that the best strategy is to buy a term life rather than whole life policy, and to then invest the difference. Let’s break down what that means:

If you buy an inexpensive term life policy, you’re saving quite a bit of money each month compared to what you would have spent on a pricier whole life policy. You could then take the difference of what you would have paid for whole life insurance and invest it in an index fund.

In this scenario you will generally have more money at the end of many years than you would have accumulated from a whole life policy.

The caveat with this approach is that it only works well for those who have the discipline to actually invest the difference, rather than use the saved money for a lifestyle upgrade.

What Should You Choose: Term or Whole Life Insurance?

Who Should Buy Term Life Insurance?

For most people, we suggest basic term life insurance. It’s straightforward and inexpensive, and will leave you more money each month to max out your retirement accounts, pay down a mortgage, or work toward other financial goals.

Term life insurance is the best choice if:

  • You want insurance to cover a specific, temporary financial need.
  • Affordability is your top priority.
  • You won’t need coverage indefinitely.
  • You aren’t planning on using the policy for investment.
  • You haven’t maxed out your retirement plan contributions.

Who Should Buy Whole Life Insurance?

There are rare circumstances in which whole life insurance makes more sense. Consider whole life if you:

  • Can afford expensive premiums.
  • Have already maxed out your retirement accounts.
  • Struggle to save and invest independently.

If you go with whole life insurance, you’ll lock in a better rate at a young age than you will when you’re older. And if you don’t have an orientation toward saving money, a whole life policy can prevent you from blowing through the savings intended for your investment.

Where to Find Term or Whole Life Insurance

Reviewing a number of life insurance quotes is the best way to get a competitively-priced premium for the type of insurance and coverage levels you need. You can find a good term or whole life insurance policy by either approaching a reputable insurer directly, or working with an insurance broker, which partners with many different insurers.

» See the best life insurance companies

Ladder Life Insurance

Ladder offers addorbable term lengths between 10 and 30 years with a coverage minimum of $100,000 and a maximum of $8 million. The company is unique in that it gives you the option to “ladder” your coverage, which allows you to adjust your death benefit as your family’s financial needs evolve.

Pros:
  • Affordable term life coverage
  • Easy application
  • Option to “ladder” your coverage
Cons:
  • Only sells term life policies
  • No riders available
Get A Quote
Ladder Insurance Services, LLC (CA license # 0K22568; AR license # 3000140372) offers term life insurance policies: (i) in California, on behalf of its affiliate, Ladder Life Insurance Company, Menlo Park, CA (policy form # P-LL100CA); (ii) in New York, on behalf of Allianz Life Insurance Company of New York, New York, NY (policy form # MN-26); and (iii) Fidelity Security Life Insurance Company®, Kansas City, MO (policy form # ICC17-M-1069, M-1069 and policy # TL-146) in the District of Columbia and all states except New York and California. Only Allianz Life Insurance Company of New York is authorized to issue life insurance in the state of New York. Insurance policy prices, coverages, features, terms, benefits, exclusions, limitations and available discounts vary among these insurers and are subject to qualifications. Each insurer is solely responsible for any claims and has financial responsibility for its own products.

Term Life vs. Whole Life Insurance FAQs

What happens if you outlive your term life insurance?

Once a term life insurance policy ends, it’s done — there’s no payout unless you choose a policy that returns some of your premiums.

You’ll probably have the option to renew for another term, but you’ll pay higher premiums than you did before. If you want more coverage, it may be worth shopping around to see if another insurer offers lower premiums.

Can you switch from term life to whole life?

Yes, you can switch from one kind of life insurance policy to another.

Changing from term life to whole life is the easier option (which is one reason why term life is typically the best choice for most young people). Your term policy may have a set time period during which you can switch from term to whole life coverage (a conversion period). Conversion policies are worth considering if you have health conditions that would raise your premiums on a new life insurance plan.

Changing a whole life to a term life policy is also possible if you’ve built up cash value. Your insurer can take the accumulated cash value and use it to cover the length of the term you choose.

What happens if I cancel my life insurance?

If you bought a term life insurance policy you no longer need, terminating the policy should be as simple as stopping premium payments. You won’t get any money back, but you won’t lose any investment value either.

Before you cancel a whole life policy, ask your insurer for the cash surrender value (the cash value minus any fees the insurer charges for surrendering the policy). Otherwise, the insurer will use any remaining cash value to keep paying premiums.

Summary

If you’re primarily concerned with a time-bound financial obligation, like a mortgage or paying for your kids’ college tuition, you should probably get a term life insurance policy and call it a day. Whole life is generally a better choice only for those who don’t have the discipline to save on their own or who have already maxed out their retirement accounts and would like to diversify their investment portfolio.

If you’re on the fence, you can leave your options open by getting a convertible term policy that can be switched to a whole life policy at a later date.

About the author

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David Weliver

Founder of Money Under 30, David has over 20 years of experience as a personal finance journalist covering credit cards, banking and investing.

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