Term vs whole life insurance

If you’re looking for a new life insurance policy, there’s a good chance you’ve considered options for both whole and term life insurance policies. But what exactly is the difference between whole life and term life insurance? While both provide financial death benefits when the policyholder passes away, there are a couple of important factors that separate these policy types. Below, we’ve compared the differences between term life and whole life and included some pointers to help you figure out what type of life insurance is right for you and your family.

What is the difference between term and whole life insurance?

When comparing the differences between term and whole life insurance, consider the length of policy, the cash value and the cost.

• Length of policy: Term life insurance provides coverage for a specified period, such as 10, 20 or 30 years. In contrast, whole life insurance, a type of permanent insurance, offers lifelong coverage, typically until the policyholder reaches age 95 to 121, provided premiums are paid as required.
• Cash value benefit: Term life insurance premiums are applied entirely towards the death benefit, with no cash value component. Whole life insurance, however, includes a cash value feature. This means a portion of your premiums builds up a cash value that you can access during your lifetime through policy loans.
• Cost: Generally, whole life insurance is significantly more expensive than term life insurance. In fact, it can be 10 to 15 times more costly for the same face amount of coverage. This higher cost reflects the lifetime coverage and cash value benefit that whole life policies offer.

Let’s take a closer look at the features, advantages and disadvantages of each policy type and explore the differences between term and whole life insurance in more detail.

Whole life insurance

Whole life insurance is designed to provide coverage for your entire lifetime as long as you keep up with the premiums. Unlike term life insurance, which is for a limited time period, whole life insurance is a type of permanent insurance that combines a consistent premium with a guaranteed death benefit.

Here’s a closer look at what you should know about whole life insurance:

• Cash value: Part of your premium payments contributes to a cash value component. This amount grows over time and can be accessed through policy loans. However, keep in mind that loans accrue interest, and any outstanding loan balances will reduce the death benefit your beneficiaries receive.
• Value to beneficiary: When you pass away, your beneficiaries receive the full death benefit amount minus any outstanding loans against the cash value. The cash value itself is not included in the death benefit since it is a reserve on the policy. It’s an additional feature available during the lifetime of your policy.
• Payment schedules: Whole life insurance offers different payment options. You can typically choose to pay your premiums monthly, quarterly, semi-annually or annually. Additionally, there are limited-pay and single-pay options available:
• Limited-pay: You pay premiums for a set number of years (e.g., 10, 15 or 20 years) instead of for your entire life. This can help your cash value accumulate faster.
• Single-pay: You make one large payment upfront, which covers the cost of the policy for your lifetime. This option also accelerates the growth of the cash value.
• Dividends: If you have a participating policy from a mutual insurance company, you may receive dividends based on the company’s performance. You can use these dividends in various ways: reinvest them to boost your cash value, use them to purchase additional insurance coverage or take them as a cash payment.

Term life insurance

Term life insurance offers coverage for a specific period, typically between 10 to 30 years. Some insurers, such as Protective and Banner, even offer terms up to 35 or 40 years. Once the term ends, the coverage expires unless you have options to renew or convert the policy. Here’s what you need to know about term life insurance:

• Terms: Term life insurance policies are available for various lengths, from short-term options like 10 years to longer terms such as 30 years. Some carriers offer even longer terms. The most common term is 20 years, which provides substantial coverage for a significant period.
• Renewability: Many term policies come with a renewability feature, allowing you to extend your coverage for additional terms. If your policy doesn’t renew automatically, you will need to activate this option several months before the current term ends.
• Convertibility: Some term life policies offer a convertibility feature, which allows you to switch to a permanent life insurance policy without undergoing a new medical exam. This option can be beneficial if you wish to maintain coverage beyond the term without additional health evaluations.
• Return of premium: A return-of-premium policy feature refunds a portion of the premiums you paid if you outlive the term. While this can provide added value, it generally results in higher premiums compared to standard term policies.
• Premiums: Term life insurance companies base your premium on a few factors, including your age, lifestyle and health at the time of application. Your premium stays the same for the entire term. However, premiums can increase when you renew the policy because the cost is based on your age at the time of renewal.
• Level vs. decreasing term: With a level term policy, you pay a consistent premium and maintain the same death benefit throughout the term. This is the most common type of term life insurance. A decreasing term policy, on the other hand, features a death benefit that decreases over time, often used to align with reducing financial obligations like a mortgage.

Riders

In life insurance, riders are optional benefits that you can add to your policy to tailor it to your specific needs and circumstances. These add-ons enhance your coverage by providing additional features or benefits beyond the standard policy terms. Riders can be especially useful for addressing particular concerns or situations that your base policy doesn’t cover.

Some riders come at no extra cost, while others may require an additional premium. It’s important to weigh the cost of these riders against the benefits they provide to ensure they fit within your budget and meet your needs.

Here are some common types of life insurance riders:

• Accelerated death benefit rider: This rider lets you access part of your death benefit if you’re diagnosed with a terminal illness. It’s often included at no additional cost, helping you manage expenses during a difficult time. Keep in mind that using this benefit will reduce the amount available to your beneficiaries.
• Long-term care rider: This rider helps cover costs if you need long-term care services, such as nursing home or home care. It’s useful for managing expenses related to extended care and can be included with some policies. Using this benefit will reduce the amount available to your beneficiaries. Note that it’s typically available only with permanent life insurance, not term policies.
• Accidental death rider: This rider provides an additional payout if your death results from an accident. It can help provide extra financial support in such tragic circumstances, though not all types of accidents may be covered. Note: Without this rider, a life insurance policy will still pay out if death is the result of an accident. With this rider, the payout is increased.
• Waiver of premium rider: If you become disabled and cannot work, this rider allows you to stop paying premiums without losing coverage. It typically covers you until you can return to work or reach retirement age.
• Guaranteed insurability rider: This rider allows you to buy additional coverage without undergoing a medical exam, even if your health declines. It provides flexibility to adjust your coverage as your needs change over time.
• Return of premium rider: With this rider, if you outlive your term policy, you may receive a portion of the premiums paid back. While this rider can be more expensive, it offers a financial return if you don’t make a claim during the policy term.
• Family income benefit rider: This rider provides ongoing income to your family after your death, supplementing the lump sum of the death benefit. It’s beneficial for ensuring that your loved ones have financial support over time.
• Child term rider: This rider provides coverage for your children and pays a benefit if they pass away before a specified age. It can also convert into a permanent policy for them later in life.
• Term conversion rider: This rider allows you to convert your term policy into a permanent policy without a medical exam. It offers flexibility to switch to a permanent policy as your needs evolve.
• Chronic illness rider: This rider provides access to a portion of your death benefit if you are diagnosed with a chronic illness. It can help cover medical and long-term care costs; using this benefit will reduce the amount available to your beneficiaries.
• Disability rider: This rider pays a monthly income if you become disabled. The coverage amount and duration vary by policy and can help support you financially if you can’t work.

Keep in mind that the availability of these riders can vary depending on the insurer and the type of coverage you have.

Term vs. whole life insurance

When exploring what the difference is between term and whole life insurance, it’s important to first grasp both their similarities and differences. Both types of policies provide a death benefit to your beneficiaries, but they do so in distinct ways. In the section below, we’ll explore how these two types of life insurance compare, highlighting their key similarities and differences to help you determine which might be the better fit for your needs.

Death benefits

When it comes to life insurance, one key feature of both term and whole life policies is the death benefit they provide. This benefit is the amount of money that will be paid to your beneficiaries upon your passing.

• Term life insurance death benefit: With term life insurance, the death benefit is paid if you pass away during the specified term of the policy. For example, if you have a 20-year term policy with a $100,000 death benefit and you pass away within those 20 years, your beneficiaries will receive the full $100,000. The amount is typically paid out tax-free and can be used by your beneficiaries however they see fit.
• Whole life insurance death benefit: With whole life insurance, coverage doesn’t expire until age 95 to 121, depending on the policy. This essentially provides lifelong coverage and a guaranteed death benefit payout. Like term insurance, the death benefit from a whole life policy is typically also tax-free and can be used for any purpose by your beneficiaries.

It’s important to remember that if there are outstanding loans against the policy or if any benefits were accelerated (such as through a chronic illness rider or long-term care rider), these amounts will be deducted from the death benefit before it is paid out. This ensures that any financial advances or loans taken from the policy are accounted for in the final payout.

Age

Whole and term life policies also approach an applicant’s age in a similar way. With both types of life insurance, you will pay a lower premium if you purchase a policy while you are relatively young. If you wait until you are in your 60s, you will pay a much higher rate. It’s also possible that you may not qualify due to a specific risk factor, such as a medical condition.

For those seeking coverage later in life, it is possible to find life insurance into your 70s and even 80s. However, most insurers cap coverage at a maximum age of 85. This means that while you can secure insurance in your later years, the availability and terms of coverage might be limited compared to younger applicants.

Duration

When comparing term versus whole life insurance, the two types of policies have a few significant differences. Term life only covers you for the length of the term, while whole life continues to cover you until the end of life under most circumstances. However, some term life policies can be continued after the term ends if the policy is convertible or renewable, as long as you meet your policy’s deadlines for conversion or renewal.

Prequalification

Most applicants undergo a thorough underwriting process to be approved for a life insurance policy. This typically involves a health questionnaire, a review of prescription and medical records and sometimes a medical exam. In addition to health-related information, insurers may also assess non-health-related factors such as driving records and background checks.

With advancements in technology, many insurers now offer accelerated underwriting options. These streamlined processes use data analytics and other tools to expedite approval, often reducing or eliminating the need for a medical exam for some applicants.

For those whose health conditions limit their options, guaranteed issue whole life insurance can be an alternative. However, this type of policy often comes with high premiums and low coverage amounts. Additionally, guaranteed issue policies usually include a graded death benefit, where the full death benefit may not be available until the policy has been in force for a certain period, typically two years. There are also age qualifications, as these policies are typically available only to individuals within specific age ranges.

Cash value feature

A key advantage of whole life insurance is its cash value feature, which differentiates it from term life insurance. As you pay your premiums, a portion of the money accumulates — referred to as the cash value. This cash value can be used in several beneficial ways, such as:

• Collateral for a loan: You can borrow against the cash value of your policy, using it as collateral. The interest rates on these policy loans are often more favorable than traditional bank loans, though it’s important to understand that interest will accrue on the borrowed amount.
• Automatic premium loans: If you miss a premium payment, you can use the cash value to cover the premium, ensuring your policy remains in force.
• Supplemental retirement income: The cash value can be accessed to provide additional income during retirement, though loans will reduce the death benefit if not paid back and will accrue interest.

While the cash value feature offers these advantages, it’s often advised to view it primarily as an insurance component rather than an investment. When compared to other investment options, such as equities, bonds or mutual funds, the returns on the cash value feature of whole life insurance are often lower. Additionally, whole life policies include a cost to cover the insurance along with higher fees, which can diminish the overall returns. Insurance policies also have surrender charge periods up to 16 years which makes them illiquid.

If you decide you no longer need the policy, you can cancel it and receive the cash surrender value. This value represents the amount available to you after deducting any outstanding loans and surrender charges.

Which is better: term or whole life insurance?

Choosing between term life vs. whole life will depend on your goals and needs. Here are some things to consider when deciding which type of life insurance is right for you.

Planning for your future

When planning for your future, it’s important to select a life insurance policy that aligns with your financial obligations and long-term goals. Different types of policies cater to different needs:

• Short-term financial obligations: Term life insurance often fits temporary needs, such as paying off a mortgage or covering income replacement for a specific period. As mentioned, term policies provide coverage for a set period (e.g., 10, 20 or 30 years) and can help address short-term financial responsibilities without the higher premiums associated with permanent policies.
• Long-term financial goals: If your objectives include long-term planning, such as business succession planning, estate planning or providing for future generations, whole life insurance may be more suitable. Whole life policies offer lifetime coverage (maximum coverage ages of 95 to 121) and build cash value, making them a useful tool for long-term financial strategies.

To determine the right policy for you, consider using a life insurance calculator for a general estimate and consult with a life insurance professional or certified financial planner. They can help ensure that your choice aligns with your specific financial needs and goals.

Growth opportunity

Understanding the growth potential difference between term life insurance and whole life insurance is crucial when comparing them. Tony Steuer, CLU, LA, CPFFE and internationally recognized financial preparedness advocate, provides valuable insights into how these policies function and their implications for policyholders.

Steuer emphasizes, “Insurance is insurance. When a life insurance policy is purchased, the first page states that it is an insurance policy and not an investment.” This distinction is vital because the primary purpose of life insurance is to provide financial protection, not to serve as a primary investment vehicle. However, whole life insurance policies do offer a growth component through cash value accumulation, which can be beneficial if managed correctly.

Focus on traditional investments first

For young individuals or those new to financial planning, it is often recommended to prioritize traditional investment vehicles like 401(k)s and IRAs before considering life insurance for wealth growth. These options typically provide more straightforward and potentially higher returns without the complexities and additional costs associated with life insurance policies.

Cash value in whole life policies

Whole life insurance policies come with a cash value component that grows over time. Steuer notes, “While the cash value on life insurance policies generally accumulates on a tax-free basis, this tax treatment is not guaranteed.” The cash value in whole life policies typically grows at a guaranteed rate, providing a predictable return on investment. However, it’s essential to monitor these policies regularly. “Monitoring cash value policies is important. As they have many components, policies will oftentimes encounter issues such as being underfunded (requiring more premium), accumulating less cash value,” Steuer advises.

Types of cash value policies

Different types of permanent life insurance policies offer varying growth opportunities:

• Whole life policies: These policies offer guaranteed cash value growth and can pay dividends if they are participating policies. “The cash value is a reserve on the policy’s death benefit, so that’s why the death benefit is not increased by the cash value,” Steuer explains.
• Universal life policies: These offer flexible premiums and death benefits. The cash value earns interest at a rate declared by the insurance company. Steuer describes this as a “black box” since the rate is not tied to any publicly disclosed measure.
• Variable life policies: Here, the cash value is allocated to investment sub-accounts such as bond funds, stock funds and money market funds, allowing for potential growth based on market performance but also introducing higher risks.
• Equity-indexed universal life policies: These policies allocate cash value to investment sub-accounts and have a minimum interest rate cap as well as an interest rate cap and participation rate cap. Steuer explains, “With the minimum interest rate cap, the cash value won’t have a negative return even if the index has a negative return. However, the interest rate cap can be 10 to 12 percent, meaning that if there is a 20 percent return on the index, the policy owner will miss out on the higher return.”

Whole life insurance policies have a maturity age, usually between 95 and 121. Upon reaching this age, the policy terminates, and any cash value is distributed to the policy owner. Understanding these details is helpful for making informed decisions about using life insurance as a financial tool.

While whole life insurance offers growth opportunities through cash value accumulation, it should be approached with caution and primarily seen as a protective measure rather than an investment. Consulting with a financial professional can help navigate these complexities and ensure that life insurance aligns with your overall financial strategy.

Life stages

Selecting the right type of life insurance can vary depending on your life stage and evolving needs. Here’s a general guide to consider for each decade:

• 20s and 30s:
• Term life insurance: Often ideal for younger individuals who want to protect their dependents or cover debts with lower premiums. This period is typically characterized by starting a career, buying a home and starting a family, so affordability and sufficient coverage are key.
• 40s:
• Term life insurance: Continue with term life to cover financial obligations such as a mortgage or children’s education. This is also a good time to evaluate whether your policy still meets your needs or if additional coverage might be necessary.
• Whole life insurance: Start considering whole life insurance if you want lifelong coverage and a cash value component for long-term financial planning.
• 50s:
• Whole life insurance: This decade often involves planning for retirement and estate planning. Whole life insurance can be beneficial as it offers lifetime coverage and can be an essential part of your estate plan.
• Term life insurance: If you still have significant financial responsibilities, a term policy can provide additional coverage during this time.
• 60s and Beyond:
• Whole life insurance: Continue with whole life insurance for its benefits in estate planning and providing a financial legacy. It’s also useful for covering final expenses.
• Term life insurance: For those still managing debt or other obligations, a term policy can provide necessary coverage without high premiums.

Another approach to aligning insurance with different life stages is laddering policies. This strategy involves purchasing multiple term life policies with varying expiration dates. For example, you might start with a 20-year term policy when you’re younger and then add a 10-year term policy as your needs evolve, or purchase both a 30-year policy to cover the mortgage and a 15-year policy to protect your teenage child through college. This approach allows you to tailor your coverage to match changing financial obligations and reduce costs as you age.

Frequently asked questions

• What is a death benefit?

  A death benefit is the amount of money the life insurance company pays out to your chosen beneficiary when you pass away. For term life insurance, the death benefit pays out to the beneficiary if the insured person dies during the term. For whole life insurance, because it’s permanent coverage, the death benefit is not limited to a term and pays a tax-free death benefit to the beneficiary when the insured dies. It’s important to ensure that your beneficiary information is up-to-date to avoid any complications with the payout.

• What is cash value?

  Cash value is a feature of permanent life insurance policies where a portion of your premiums contributes to a savings-like component within the policy. This cash value grows at a fixed interest rate and accumulates over time. You can access the cash value while you’re alive by making withdrawals or taking out a loan against it. This can be used for various purposes, such as paying premiums, covering emergency expenses or supplementing retirement income. Note that any loans taken against the cash value accrue interest, and if not repaid, the outstanding amount is deducted from the death benefit. Unlike term life insurance, which doesn’t have a cash value component, whole life insurance provides this additional financial resource, but it’s important to remember that cash value growth might be lower compared to other true investment options like equities or bonds.

• Is whole or term life insurance more expensive?

  In general, whole life has much higher premiums than term life. However, many factors determine the cost of life insurance, including your age, health and life expectancy. Regardless of whether you choose term or whole life coverage, rates will be lower if coverage is purchased when you are younger.

• What happens if I outlive my term life insurance?

  If you outlive your term life insurance policy, the coverage expires at the end of the term, and you will no longer have insurance protection unless you have specific options. Some policies offer a conversion feature, allowing you to switch to a permanent life insurance policy without a medical exam. Alternatively, a renewable term policy can be extended, though the premiums will increase yearly with age. Be aware that renewable policies often have a maximum renewal age, which may limit how long you can extend the coverage, and the conversion period can expire. If neither conversion nor renewal options are available, you would need to purchase a new policy to continue having life insurance coverage. It’s advisable to review your policy’s terms and consider your future insurance needs well before your term ends.

• Can I buy both term and whole life?

  Yes, it is a common strategy to purchase both term and whole life insurance to address different financial needs. By combining these policies, you can secure a larger term life insurance policy to cover significant expenses, such as a mortgage and the years spent raising children. This provides robust protection during crucial financial periods. At the same time, you can obtain a smaller whole life policy to supplement the term coverage. This whole life policy offers a death benefit and builds cash value over time, which can be used for end-of-life expenses or other needs. This approach allows you to balance affordability with comprehensive coverage, ensuring that you have protection throughout various stages of your life.