Whole vs. Term Life Insurance

Term life insurance is a better choice for most people, but the lingo around insurance can be confusing. Whatever you choose, make sure to keep your investments and insurance separate. Use insurance to protect your assets, and use investments to grow your savings.

Where did you first hear about life insurance? Maybe it was on one of those commercials offering coverage for “only pennies a day” or something you could opt into at your first job. When you are young and single, and maybe not making much money, you likely do not think about life insurance. But as you get older, have people who depend on you, and advance your career, life insurance can be a vital resource to provide financial protection for your loved ones. With that in mind, it is a good idea to become familiar with the intricacies of life insurance and its many options. This article gives an overview of how to distinguish the various types of life insurance and other factors to consider.

What is whole life insurance?

Whole life insurance is a type of insurance that continually provides coverage so long as the policy holder continues to make premium payments. A whole life policy guarantees for your payout to not decrease and that your premium payments will not increase. When the whole life insurance policy does not expire, it is known as permanent life insurance, since it covers your entire life.

You also receive an investment component that is known as a “cash value.” With it, you get a guarantee on a certain level of return on the cash that you invest. Part of your payments go into the cash value account to build cash value. It works like a 401(k) or an IRA because it is a tax-free investment account. If you withdraw money from it early, you have to pay a tax penalty, but if you take out less than the cash value of your payments, you do not have to pay a penalty. A whole life policy will also have a “guaranteed” rate of return that is one or two percent for the cash value component, which creates a “guaranteed cash value.”

People often use whole life insurance to fund a trust if they have beneficiaries that will need long-term care. Policy holders also use it to pay off estate taxes so their heirs or descendants will not have to pay them out of their inheritance. Finally, sometimes business partners will each take out policies on each other to allow the purchase of the deceased partner’s business shares. Beyond these reasons, because of the high price of whole life insurance, it is generally recommended for only people in the highest tax bracket.

What about universal life insurance?

While you’ll usually be deciding between whole vs term life insurance, there is also universal life insurance. This type of life insurance is relatively similar to whole life insurance, but it is a bit more flexible. You can adjust your life insurance premiums to expand or retract your coverage. This can be beneficial because there are times where you may have trouble making ends meet, but you still want some coverage, so you may want to decrease your premiums. Alternatively, as your income increases over time, you might want to increase your coverage, since you will need more for income replacement.

Given the flexibility of coverage, the interest rates are also subject to change. With whole life insurance, the interest rate is fixed. This is important to note, because a flexible interest rate will often cause the rates to greatly increase, which could force you to cancel the insurance at some point.

Criticism of whole life insurance

While there are clear uses for whole life insurance, if you put in a search engine “should I get whole life insurance,” you will find several articles criticizing whole life insurance. Many are particularly critical of professionals, such as doctors or attorneys, purchasing whole life insurance because it is not the best use of their money. As noted above, the highest earners can have clear benefits from whole life, but only a handful of law firm partners will reach the point where they are permanently in the top tax bracket and have enough assets to get the benefits of whole life insurance.

The vast majority of attorneys should not pay whole life insurance costs. Most are better off putting the high premium payments that they would make towards whole life insurance towards various investments that will have a higher payout.

What is term life insurance?

Term life insurance provides coverage for a set period of time. This can either be a particular number of years or until you’ve reached a certain age. Often the idea is that term life insurance is just something you have when you are working, since the main idea behind life insurance is that it is income replacement, especially for families. Once you are retired, your children likely will not depend on you for a safety net, and your main income will come through retirement benefits that your spouse will likely have some access to even if you die.

There are two main types of term life insurance:

  • Level term: This term life insurance policy will pay out the same during the coverage period regardless of when the holder dies. So if you die after one year of having the policy in a freak accident, or die due to relative old age 29 years into the policy, your beneficiaries will get the same amount.
  • Decreasing term: This term life insurance policy will pay out less and less over the period of the coverage at a consistent rate. So the amount paid out in the event of your death one year into the policy versus 25 years in will be drastically different.

Whole life insurance vs term life insurance?

While in theory you could buy both main types of life insurance, due to the costs of both, many people choose one or the other. So when deciding on term vs life, it is important to know the differences between each type of policy. They are as follows:

  • In terms of cost, term life insurance will cost less than whole life because term life’s death benefit may be decreasing every year, so it costs less for the life insurance company to make a profit and regardless it will expire at some point.
  • Term life is simpler because you generally make the premium payments, while whole life can become complicated with figuring out the cash value component, and if it is universal, the premiums can fluctuate.
  • Whole life insurance is better for building assets in the sense that many policies allow you to invest, and you are able to borrow against the policy. However, since this policy is more expensive, it can take money away from other investments you would otherwise perfect.

Interestingly, both types can be converted from one to the other. You can convert your whole life to term and vice versa.

Factors to consider for any type of life insurance

As covered above there are some key differences between the different types of insurance. These factors are significant no matter which type of insurance you choose.

  • The financial circumstances of you and your loved ones. If your loved ones will depend on you throughout your life, that could impact how large of a payout you want and the length of coverage you need.
  • Your age and health. Where you are in your life and the health risks you are subject to could affect the type of coverage you want.
  • Who your beneficiaries are. Whether you are purchasing insurance when you only have a spouse or partner—as opposed to also having children—can impact what kind of coverage you want.

Factors that impact coverage

Just as there are aspects that you will want to consider in terms of what kind of coverage you want, there are factors that will impact the premium you have to pay, your interest rates, and if you even qualify for coverage.

  • Your gender: Generally men will pay a higher premium because they have a higher chance of mortality.
  • Your age: If you buy life insurance later in life, you will generally have to pay more. This is why some people buy life insurance when they are young, even if they do not have any dependents. They can lock in lower rates for comprehensive coverage for their future family.
  • Any existing or past health issues: Like with age, if the life insurance company thinks you are at a greater risk of death, they will charge you more. Your height/weight and family history of health issues may also be factors.
  • Any issues you may have with substances: If you do drugs, smoke weed, drink often, or smoke tobacco, you will likely have higher rates. Interestingly, even if you chew tobacco or use nicotine patches, they will also count against you.
  • Various issues in your record can count against you, such as having a criminal history, a DUI, any tickets, and credit problems.
  • The insurance company will also count any dangerous hobbies you have against you.

It is important to be truthful and comprehensive on all of these factors when they ask you about them. Medical factors may be verified through a medical exam. The failure to tell the truth could void your policy.

Surrendering life insurance

Any type of life insurance will provide you with options to surrender it, but the value you can get for it will vary depending on your plan and other factors. You will typically cancel your life insurance policy because you cannot afford it, you do not need it anymore, you found a better deal elsewhere, or you want its cash value.

Whole life insurance is where you will get the greatest amount of money back. Given that the policy’s cash value is generally always increasing, and the value of the minimum death benefit never decreases, you can receive a decent amount of money. Still, this is unlikely to be as much as you would have had you invested the money.

Universal life insurance may give you a decent amount depending on when you cash it out. The later you do, the less amount of money you will get. Still if the option is cashing it out or having to pay drastically increased rates, you may financially be better off surrendering it.

You will likely get the least amount of money for term life insurance. The reason for this is that there is no cash value for term insurance, and the death benefit is continually decreasing. If you try to cash out towards the end of your coverage period, you will likely get little money for it.

No matter what type of life insurance you have, you should contact your insurance agent or  your insurance provider to check on the best way to cancel it.

Other things to consider about life insurance

Before you decide what type of life insurance you want, make sure you are educated on how to buy life insurance. You will want to go with a reputable company that is giving you a fair deal. Sometimes you can join a robust plan through your employer. When you compare plans and life insurance quotes, you are going to want to think carefully about how much you are paying, and the potential payout to maximize the financial efficiency of the plan.

If you have student loans, you might want to consider taking out a life insurance policy to ensure a loved one is not responsible for paying off the financial obligations of the loan in the event that you pass before paying it off.

Life insurance is a great way to aid your loved ones with final expenses, funeral costs, and replacing your income. You should include life insurance in your estate planning. It will help give you a peace of mind that your family is taken care of in case something bad happens to you, and making an educated decision about it will ensure you can maximize your savings.

Todd Carney is a graduate of Harvard Law School. He holds a Bachelor’s degree in Political Science and Public Communications. He has also worked in digital media in New York City and Washington D.C. The views in his pieces are his alone and do not reflect the views of his employer.

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