Two of the most common types of life insurance are term and whole life. Life insurance benefits your loved ones when the inevitable happens. While it can be tough to think about your own death, choosing the right term or whole life insurance policy can protect your household and allow you to leave a legacy to those you care about the most.
Whole life is a form of permanent life insurance that lasts as long as you live (assuming you pay the policy’s premiums). It also includes a cash value account—a type of savings account that grows tax-free over time and that you can withdraw from or borrow against while you are alive.
Term life insurance, on the other hand, lasts only for a certain number of years (the term) and does not accrue any cash value. If you’re not sure where to buy these policies, you can select either a term or a whole life insurance policy from one of the best life insurance companies.
What is term life insurance?
Term life insurance provides a death benefit that pays the beneficiaries of the policyholder throughout a specified period of time. Once the term expires, the policyholder can either renew it for another term, possibly convert the policy to permanent coverage, or allow the term life insurance policy to lapse.
When you buy a term life insurance policy, the insurance company determines the premium based on the policy’s value (the payout amount) and such factors as your age, gender, and health. Other considerations affecting rates include the company’s business expenses, how much it earns from its investments, and mortality rates for each age.
In some cases, a medical exam may be required. The insurance company may also inquire about your driving record, current medications, smoking status, occupation, hobbies, family history, and similar information.
If you die during the policy term, the insurer will pay the policy’s face value to your beneficiaries. This cash benefit — which is not typically taxable — may be used by beneficiaries to settle your healthcare and funeral costs, consumer debt, mortgage debt, and other expenses. However, beneficiaries are not required to use the insurance proceeds to settle the deceased’s debts.
If the policy expires before your death or you live beyond the policy term, there is no payout. You may be able to renew a term policy at expiration, but the premiums will be recalculated based on your age at the time of renewal.
Types of term life insurance
There are several types of term life insurance. The best option will depend on your individual circumstances. Generally, most companies offer terms ranging from 10 to 30 years, although a few offer 35- and 40-year terms.
Level-premium insurance has a fixed monthly payment for the life of the policy. Most term life insurance has a level premium, and it’s the type we’ve been referring to in most of this article. As we mentioned before, this type of policy generally provides coverage for a period ranging from 10 to 30 years. The death benefit is also fixed.
Because actuaries must account for the increasing costs of insurance over the life of the policy’s effectiveness, the level premium is comparatively higher than yearly renewable term life insurance.
Yearly Renewable Term (YRT) Policy
Yearly renewable term (YRT) policies are one-year policies that can be renewed each year without providing evidence of insurability.
The premiums rise from year to year as the insured person ages. Thus, the premiums can become prohibitively expensive as the policyholder ages. But they may be a good option for someone who needs temporary insurance.
Decreasing term policy
These policies have a death benefit that declines each year according to a predetermined schedule. The policyholder pays a fixed-level premium for the duration of the policy.
Decreasing term policies are often used in concert with a mortgage, with the policyholder matching the payout of the insurance to the declining principal of the home loan.
Benefits and drawbacks of Term Life Insurance
- More affordable than whole life insurance.
- Premiums stay the same during the level term period.
- Guaranteed death benefit amount.
- A good choice if you need life insurance specifically to cover your income-earning years.
- Can be a good fit if you primarily want to cover specific financial concerns that have a timeline, such as a mortgage.
- You can often convert term life to a permanent policy.
- Many life insurance riders are available that can add extra coverage or features to your policy.
- If you still need life insurance after the level term period, renewal rates can be unaffordable.
- No cash value that you can tap into while you’re alive.
What is whole life insurance?
Whole life insurance guarantees payment of a death benefit to beneficiaries in exchange for level, regularly-due premium payments. The policy includes a savings portion, called the “cash value,” alongside the death benefit. In the savings component, interest may accumulate on a tax-deferred basis. Growing cash value is an essential component of whole life insurance.
To build cash value, a policyholder can often remit payments greater than the scheduled premium to purchase extra coverage (known as paid-up additions or PUA). Policy dividends can also be reinvested into the cash value and earn interest. Over time, the dividends and interest earned on the policy’s cash value will provide a positive return to investors, growing larger than the total amount of premiums paid into the policy.
The cash value offers a living benefit to the policyholder, meaning the policyholder can access it while the insured is still alive. To access cash reserves, the policyholder requests a withdrawal of funds or a loan. Withdrawals are tax-free up to the value of the total premiums paid.
Interest is charged on policy loans with rates varying per insurer, but the rates are generally lower than you’d get with a personal loan or home equity loan.
However, withdrawals and unpaid loans also reduce the cash value of the policy. Depending on the policy type and the size of its remaining cash value, a withdrawal could chip away at the death benefit or even wipe it out entirely.
Whole life insurance cash value
A cash-value life insurance policy is similar to a retirement savings account, in that it allows investments to accumulate tax-deferred interest.
Part of each premium payment goes toward the policy’s cash value, which can be withdrawn or borrowed against later in life. The cash value of a life insurance policy grows quickly when the insured is young. But because more of the premium is needed to cover the cost of insurance as the insured ages, the cash value grows more slowly as they get older, due to the higher risks associated with age.
The insured can access their policy’s cash value by borrowing against it the cash value, or by withdrawing money in a partial cash surrender. Surrenders will reduce the final death benefit of your policy.
You can also use the cash value to cover your monthly premium payments instead of paying out of pocket. Or you can surrender the whole policy to receive the entire available cash value (minus any surrender fees). However, the policy will be terminated and the death benefit is no longer be available to your beneficiaries.
Whole life death benefit
The dollar amount of the death benefit is typically specified in the policy contract. But it can be changed in some instances.
Some policies are eligible for dividend payments, and the policyholder may elect to use the dividends to buy paid-up additions to the policy, which will increase the amount paid at the time of death.
Death proceeds are non-taxable to the beneficiary.
The death benefit can also be affected by certain policy provisions or events. As mentioned before, unpaid policy loans (including accrued interest) reduce the death benefit dollar for dollar.
Alternatively, many insurers offer voluntary riders—for a fee—that secure or guarantee coverage, including the stated death benefit. Two of the most common such riders are the accidental death benefit and waiver of premium riders, which protect the death benefit if the insured becomes disabled or critically or terminally ill and is unable to remit premiums due.
Beneficiaries may also have decisions to make about how the death benefit is paid. The default option is to receive a lump-sum payment. But some policies also allow beneficiaries to choose to get the death benefit in installments or to convert it to an annuity. An annuity may pay out for a set amount of time until the death benefit is exhausted, or it could pay out for the life of the beneficiary.
The death benefit continues to earn interest until it is paid, and that interest may be taxable.
Benefits and drawbacks of whole life insurance
- Fixed premiums help you budget.
- Builds cash value at a regular rate.
- Guaranteed death benefit.
- Life insurance riders, including living benefits, offer extra coverage and features.
- Much more expensive than term life insurance.
- The death benefit will be reduced if you withdraw from the cash value or don’t repay loans you took against the cash value.
Comparing term and whole life insurance
It’s impossible to make a direct cost comparison of term life vs. whole life insurance because the policy features are so different. If you’re looking for a long stretch of coverage with term life, look at 30-year policies. Banner Life (part of Legal & General America) and Protective Life offer 40-year term life, which is currently the longest level term available.
Whether you decide to buy term or whole life insurance, your life insurance quotes will be affected by:
- Your age and gender.
- Amount of coverage.
- Your current and past health.
- Your family’s health history (parents and siblings).
- Your prescription drug history.
- Other factors such as driving record.
|Age of buyer||Gender||Term life: Monthly cost of $500,000 policy||Whole life: Monthly cost of $500,000 policy|
|Source: Forbes Advisor research. Rates are based on non-smoking buyers who are in excellent health. Term life insurance averages are for 20-year term life. It averaged the cheapest quotes found online.|
Both level-term life and whole life have fixed premiums. That means your premium payments won’t change. Life insurance companies generally offer payment plan choices, such as monthly, quarterly, semi-annually and annually.
If lifelong bills for whole life insurance aren’t appealing, some policies offer shorter payment schedules with larger payments, such as single premium life insurance, or policies with payments for a certain number of years, such as 10 years. This allows you to have more budget flexibility later in life.
Whole life and term life policies have a payout called the death benefit. The death benefit is guaranteed with both types of policies. A death benefit is paid tax-free to the life insurance beneficiaries you have listed.
The main difference is that coverage ends with a term life policy if you don’t renew it every year after the level term period ends. If you outlive your term life policy and don’t renew it, there is no death benefit ever paid.
Term life insurance builds no cash value while whole life policies contain a cash value account that builds over time at a fixed earnings rate. This guaranteed cash value growth in a whole life insurance policy is one of the reasons whole life is considerably more expensive than term life.
The policyholder can take money from the available cash value. You can take a loan against it and pay for anything you want. Or take out money as a withdrawal that you won’t pay back. The outstanding loan or withdrawal amount is deducted from the death benefit.
Any cash value in the policy usually reverts to the insurance company when you pass away. Your beneficiaries receive the face value of the policy minus any amount that was taken out of cash value and not paid back.
If you’re looking for lifelong coverage without the high cost that a whole life insurance policy demands, consider guaranteed universal life insurance.
Ending a policy
While you do your best to anticipate financial needs many years down the road, you might find you no longer need life insurance.
- With term life insurance, you can stop paying, which terminates the policy. Since there’s no cash value, there’s no money to walk away with.
- With whole life insurance, you may have cash value to take away if you surrender the policy.
If you don’t tell your insurer that you want to surrender your life insurance policy, the insurer will likely use any cash value in the whole life policy to continue paying the premiums on your behalf until the cash value is depleted. Instead of walking away, contact the insurer and take the surrender value, which is the cash value minus any surrender charge.
How to choose between term and whole life insurance
Whether term life insurance or whole life insurance is the best fit for you will come down to your family situation, budget, long-term goals, and other factors. Here are some considerations to help you make the right decision.
Term life insurance will benefit you if:
- You don’t want to tie up your cash flow. Term life is generally much less expensive than whole life, and it may be the better option if you want a lower premium payment.
- You want to protect family members financially. Term life is a good choice if you want to protect your spouse or dependents against large debts or expenses. This can include mortgage or child care, by a guaranteed death benefit for a set period of time. An example of a time period would be your income-earning years.
- You want the flexibility of waiting to purchase whole life insurance. Some term policies can be converted to whole life insurance at a later time. However, check the term policy to make sure it offers that option and note any conversion timeframe it may require. Keep in mind that after the policy’s term expires, you will not be able to convert it to a whole policy.
Whole life insurance will benefit you if:
- You want a policy with accruing cash value. Unlike term life insurance, whole life has a cash value that builds over time on a tax-deferred basis. The cash value can be used as a savings vehicle for retirement, or the policy can be closed out if you’re in financial need, although you’ll need to pay a surrender charge if you cancel the policy early. You can also withdraw some of the cash value from the policy or take out a loan against its equity. However, remember that you must pay back any cash value you take out for your beneficiaries to receive the policy’s full benefit.
- You want a policy to last your entire life. Whole life insurance policies will remain in effect for the duration of the insured person’s lifespan, as long as they pay premiums. This is in contrast to term life policies that end after a specified period of time.
Term and whole life insurance: Which is better?
If term coverage is all you can afford, then the answer is simple: Basic protection is better than no protection at all.
The question is a little trickier for folks who can afford the substantially higher premiums that come with a whole-life policy. If your goal is to save for retirement, then many fee-based (that is, non-commission-earning) financial advisors recommend turning to 401(k)s and individual retirement accounts (IRAs) first.
After maxing out those contributions, a cash value policy may be a better option for some people than a fully taxable investment account.
Some consumers have unique financial needs that a whole life policy can help manage more effectively. For example, parents with disabled children may want to consider whole life insurance, as it lasts your entire lifetime. As long as you keep paying the premiums, you know your kids will receive the death benefit from your policy, even when they’re adults.
Whole life can also be a valuable tool in succession planning for small businesses. As part of a buy and sell agreement, business partners will sometimes take out whole life insurance for each owner. This lets the remaining partners purchase the deceased’s equity stake in the event of their passing.
Ultimately, it all boils down to your needs. If you only need life insurance for a relatively short period of time (such as only when you have minor children to raise), term life may be better, as the premiums are more affordable.
However, if you need permanent coverage that lasts your entire life, you should choose whole life. Whole life also offers several living benefits deriving from its cash value accumulation. You can borrow against it or withdraw during your lifetime.
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