What is Term Life vs. Whole Life Insurance?

Life insurance is like a security blanket...

As long as you take care of the blanket (pay your insurance bill), it will pay a benefit to your descendants when you pass away. Term life insurance is like a less expensive security blanket that will wear out on a set date, while whole life insurance is like a more expensive security blanket that lasts for the rest of your life.

Term life insurance is life insurance that protects a person for a set period. Once that period ends, the life insurance policy no longer offers protection, and the insured no longer pays insurance premiums.

Term life insurance works by protecting an insured person’s life for the duration of the insurance plan. If the person passes away during the term of the insurance plan, the insurer will pay out the death benefit to the named beneficiary.

When purchasing a term life insurance plan, the insured can choose from a variety of terms. For example, the insured may opt for a term of five, 10, or 20 years. The insured also selects the amount of coverage to purchase. The monthly premium for term life insurance varies with many factors, including the insured’s age, the term, health, and the amount of coverage purchased.

Typically, people buying life insurance have to show proof of insurability. This can involve visits to the doctors and sending medical records to the insurance company. Providing this information allows the insurer to account for the risk of offering insurance. Some people, such as those with terminal diseases, may be uninsurable.

The need to prove insurability can be an issue when someone’s term life insurance policy expires. If their health deteriorated over the policy’s term, they might have to pay much higher premiums if they purchase a new plan.

One type of term life insurance is Annual Renewable Term (ART) insurance. With ART life insurance, the insured purchases one year of term life insurance, with the opportunity to renew it each year for a set number of years. For example, you can purchase an ART policy that gives you the option to renew the plan annually for up to 10 years. After that, you would need to buy a new plan and prove insurability. With each annual renewal, the premium increases slightly.

ART policies reduce the risk of losing the ability to renew your insurance due to changes in health at the cost of slightly higher premiums.

Level term life insurance is more common than annual renewable term insurance. These plans offer a set premium and death benefit for a set period. Popular terms include 10, 15, 20, and 30 years. The cost of the level term life insurance policies remains the same throughout the term of the policy. The death benefit also remains the same. Typically, plans with longer durations have higher premiums.

Some level term life insurance policies include the option to renew the plan at the end of the term for some additional years. The renewal option may not be guaranteed and could be revoked if the insured’s health declines. The renewal can also include an increase in premiums.

Many level term life insurance policies also include the option to convert it to a whole life insurance policy.

Whole life insurance is insurance that lasts for the entire life of the insured. It does not expire after a set period. Because whole life insurance lasts for a lifetime, the insured will likely need to make premium payments for their entire life to keep the policy active.

Whole life insurance also has some features that make it similar to an investment. Whole life insurance can build cash value over time, which is unlike term life insurance policies.

Like most term life insurance policies, when you purchase whole life insurance, you’ll provide proof of insurability and choose a death benefit amount. You don’t need to select a term because whole life insurance policies never expire. The premium for a whole life insurance policy varies with several factors, including the death benefit that you select.

Once the policy goes into effect, the insured must make scheduled premium payments. The premiums generally remain the same for the entire life of the insured. Over time, the life insurance policy will accrue cash value. The insured can borrow money against the value of their plan or cash their policy out to access its value.

If you make the required premium payments, the death benefit is guaranteed. But, it may be reduced if the insured borrowed from their policy’s value and has not yet paid the money back with interest.

Some whole life insurance policies pay annual dividends on top of the cash value that they build. The insured can choose to take the cash to spend, leave the value in the policy, use the dividends to reduce their premiums, or buy additional insurance coverage. The options will vary with the specifics of the policy, and even plans that include dividends do not guarantee that dividends will be paid every year.

Traditional whole life insurance is the simplest. The insured pays the monthly premiums in exchange for a guaranteed death benefit. The policy also guarantees a minimum rate of return for the cash value of the plan.

Interest-sensitive whole life insurance is like traditional whole life insurance but offers variable returns for the cash value of the policy. If rates are high, this provides the insured with more value and the flexibility to increase their death benefit. In low-rate markets, it may offer lower returns than traditional policies.

Single-premium whole life insurance is designed for people who have a large amount of money. These plans let the insured pay all of their premiums upfront. The policy allows for all premiums to be paid at once so that any periodic payment normally due would be taken from the original investment and/or any investment gains.

Term life insurance can be a beneficial option for people who want to replace their income for a set period. For example, in a household where only one person works, the breadwinner might want to purchase a term life insurance plan to offer protection to their partner and/or children if the breadwinner passes away during their working years. The assumption is that by the time the working member of the household retires, their partner won’t need the protection of an insurance payout anymore and can continue living off of savings, making the insurance unnecessary.

Term life insurance also tends to be less expensive than whole life insurance, which may make it a better option for people on a budget.

Whole life insurance can be valuable for people who want to protect their assets from taxes. Death benefits paid by whole life insurance policies are not subject to the estate tax, letting the insured use the policy as a store of value to pass on to their heirs.

People with dependents who will remain dependent indefinitely can also benefit from whole life insurance. For example, a parent of a child with special needs may want whole life insurance for its lifetime of coverage.

Whole life insurance tends to be significantly more expensive than term life insurance. The difference in price comes from the fact that term life insurance is temporary and does not accrue value over time. Whole life policies typically must charge significantly more to account for the guarantee that they will pay the death benefit and thus must accrue sufficient funds to pay a known obligation (i.e. Term insurance can expire and then there is no ongoing obligation).

Whole life insurance and term life insurance are similar products with different goals, so there isn’t a single right answer. To find an ideal policy, think about your situation and goals.

If you only need protection for a set period, such as until your kids grow up and can support themselves, term life insurance is likely a better choice.

If your goal is to pass money to your heirs and minimize taxes, whole life insurance might be the right option — though, even then it is only one option among many when it comes to estate planning and is not generally considered a good investment. As with any complex financial decision, you may wish to consult with a financial planner or accountant.

Convertibility is an option available in most term life insurance policies that offers the insured the option to convert the policy to a whole life policy. Depending on the specifics of the policy, there generally is a ten-year window where the policyholder can elect to convert it to a whole life insurance policy.

The convertibility option is useful because it lets people on tight budgets purchase term insurance. If their financial situation changes, they can then convert their plan to a whole life insurance plan to suit their needs. The other benefit is if before a term insurance policy expires their health declines, they can convert (and keep coverage) without having to pass any medical exam.

Life insurance policies pay out a death benefit when the insured passes away. Depending on the benefit paid and the premiums paid by the insured, you may or may not get the money back in the end.

With a term life insurance policy, you do not get the money back in the end if the policy expires without the insured passing away. If the insured passes away during the term, the beneficiary receives the death benefit.

Whole life insurance policies don’t expire, so they will almost always payout when the insured dies, assuming the premiums were paid on time. The cash value of whole life policies is not paid to the policies’ beneficiaries, so you will not get that money back in the end.

Life insurance costs vary with a huge variety of factors, including:

• The insured’s age
• The insured’s gender
• Whether the insured smokes or has smoked
• The insured’s general health
• The insured’s lifestyle (risky hobbies or jobs can increase premiums)
• The insured’s driving record
• The insured’s family medical history
• The term of the policy
• The amount of the death benefit

The best way to calculate your cost of life insurance is to get quotes from different providers. Each provider has its own method of determining costs, and you’ll have a better chance of getting a good deal by shopping around.

You can also work through an insurance broker to get multiple quotes.

Some of the most popular whole and term life insurance providers are:

• AIG Direct
• Ladder
• State Farm
• Nationwide
• New York Life
• MetLife

You can get whole and term life insurance from many other providers. If you already work with an insurance broker, they can help you find a good provider for life insurance. Take the time to compare multiple providers to find the policy that best meets your needs.