Taking out a life insurance policy is a great way to protect your family’s financial future. A policy can also be a useful financial planning tool. But life insurance is a notoriously tricky subject to tackle.
One of the hardest challenges is deciding whether term life or whole life insurance is a better fit for you.
Not sure what separates term life from whole life in the first place? You’re not alone. Insurance industry jargon can be thick, but we’re here to clear up the picture and make sure you have all the information you need to make the best decision for you and your family.
Life Insurance = Financial Protection for Your Family
Families have all sorts of expenses: mortgage payments, utility bills, school tuition, credit card payments and car loan payments, to name a few. If something were to happen and your household unexpectedly lost your income or your spouse’s income, your surviving family might have a difficult time meeting those costs. Funeral expenses and other final arrangements could further stress your family’s financial stability.
That’s where life insurance comes in. Essentially, a policy acts as a financial safety net for your family by providing a death benefit. Most forms of natural death are covered by life insurance, but many exceptions exist, so be sure to do your research. Death attributable to suicide, motor accidents while intoxicated and high-risk activity are often explicitly not covered by term or whole life policies.
If you die while covered by your life insurance policy, your family receives a payout, either a lump sum or in installments. This is money that’s often tax-free and can be used to meet things like funeral costs, financial obligations and other personal expenses. You get coverage in exchange for paying a monthly premium, which is often decided by your age, health status and the amount of coverage you purchase.
Don’t know how much to buy? A good rule of thumb is to multiply your yearly income by 10-15, and that’s the number you should target. Companies may have different minimum and maximum amounts of coverage, but you can generally find a customized policy that meets your coverage needs.
In addition to the base death benefit, you can enhance your coverage through optional riders. These are additions or modifications that can be made to your policy—whether term or whole life—often for a fee. Riders can do things like:
- Add coverage for disability or deaths not commonly covered in base policies, like those due to public transportation accidents.
- Waive future premiums if you cannot earn an income.
- Accelerate your death benefit to pay for medical bills your family incurs while you’re still alive.
Other riders may offer access to membership perks. For a fee, you might be able to get discounts on goods and services, such as financial planning or health and wellness clubs.
One final note before we get into the differences between term and life: We’re just covering individual insurance here. Group insurance is another avenue for getting life insurance, wherein one policy covers a group of people. But that’s a complex story for a different day.
Term Life Policies Are Flexible
The “term” in “term life” refers to the period of time during which your life insurance policy is active. Often, term life policies are available for 10, 20, 25 or 30 years. If you die during the term covered, your family will be paid a death benefit and not be charged any future premiums, as your policy is no longer active. So, if you were to die in year 10 of a 30-year policy, your family would not be on the hook for paying for the other 20 years.
Typically, your insurance cannot be canceled as long as you pay your premium. Of course, if you don’t make payments, your coverage will lapse, which typically will end your policy. If you want to exit a policy you can cancel during an introductory period. Generally speaking, nonpayment of premiums will not affect your credit score, as your insurance provider is not a creditor. Given that, making payments on your life policy won’t raise your credit score either.
The major downside of term life is that your coverage ceases once the term expires. Ultimately, once your term expires, you need to reassess your options for renewing, buying new coverage or upgrading. If you were to die a month after your term expires, and you haven’t taken out a new policy, your family won’t be covered. That’s why some people opt for another term policy to cover changing needs. Others may choose to convert their term life into a permanent life policy or go without coverage because the same financial obligations—e.g., mortgage payments and college costs—no longer exist. This might be the case in your retirement.
The Pros and Cons of Term Life
Even though term life insurance lasts for a predetermined length of time, there are still advantages to taking out such a policy:
- Comparably lower cost: Term life is usually the more affordable type of life insurance, making it the easiest way to get budget-friendly protection for your family. A woman who’s 34 years old can buy $1 million in coverage through a 10-year term life policy for less than $50 a month, according to U.S. News and World Report. A man who’s 42 can purchase $1 million in coverage through a 30-year term for just over $126 a month.
- Good choice for mid-term financial planning: Lots of families take out a term life policy to coincide with major financial responsibilities or until their children are financially independent. For example, if you have 20 years left on your mortgage, a term policy of the same length could provide extra financial protection for your family.
- Upgrade if you want to: If you take out a term life policy, you’ll likely also get the option to convert to a permanent form of life insurance once the term ends if your needs change. Just remember to weigh your options, as your rates will increase the older you get. Buying another term life policy at 50 years old may not represent the same value as a whole life policy at 30.
There are some drawbacks to term life:
- Coverage is temporary: The biggest downside to term life insurance is that policies are active for only so long. That means your family won’t be covered if something unexpected happens after your insurance expires.
- Rising premiums: Premiums for term life policies are often fixed, meaning they stay constant over the duration of the policy. However, some policies may be structured in a way that seems less costly upfront but feature steadily increasing premiums as your term progresses.
Young Families Often Opt for Term Life
The rate you pay for term life insurance is largely determined by your age and health. Factors outside your control may influence the rates you see, like demand for life insurance. During a pandemic, you might be paying more if you take a policy out amid an outbreak.
Most consumers seeking term life fall into younger and healthier demographics, making term life rates among the most affordable. This is because such populations present less risk than a 70-year-old with multiple chronic conditions. In the end, your rate depends on individual factors. So if you’re looking for affordable protection for your family, term life might be the best choice for you.
Term life is also a great option if you want a policy that:
- Grants you some flexibility for future planning, as you’re not locked into a lifetime policy.
- Can replace your or your spouse’s income on a temporary basis.
- Will cover your children until they are financially stable on their own.
- Is active for the same length as certain financial responsibilities—e.g., a car loan or remaining years on a mortgage.
Whole Life Insurance Offers Lifetime Coverage
Like with term life policies, whole life policies award a death benefit when you pass. This benefit is decided by the amount of coverage you purchase, but you can also add riders that accelerate your benefit or expand coverage for covered types of death.
The biggest difference between term life and whole life insurance is that the latter is a type of permanent life insurance. Your policy has no expiration date. That means you and your family benefit from a lifetime of protection without having to worry about an unexpected event occurring after your term has ended.
The Pros and Cons of Whole Life
As if a lifetime of coverage wasn’t enough of advantage, whole life insurance can also be a highly useful financial planning tool:
- Cash value: When you make a premium payment on your whole life policy, a portion of that goes toward an account that builds cash up over time. Your family gets this amount in addition to the death benefit when their claim is approved, or you can access it while living. You pay taxes only when the money is withdrawn, allowing for tax-deferred growth of cash value. You can often access it at any time, invest it, or take a loan out against it. However, be aware that anything you take out and don’t repay will eventually be subtracted from what your family receives in the end.
- Dividend payments: Many life insurance companies offer whole life policyholders the opportunity to accrue dividends through a whole life policy. This works much like how stocks make dividend payments to shareholders from corporate profits. The amount you see through a dividend payment is determined by company earnings and your provider’s target payout ratio—which is the percentage of earnings paid to policyholders. Some life insurance companies will make an annual dividend payment to whole life policyholders that adds to their cash value.
Some potential downsides to consider include:
- Higher cost: Whole life is more expensive than term life, largely because of the lifetime of coverage. This means monthly premiums that might not fit every household budget.
- Interest rates on cash value loans: If you need emergency extra money, a cash value loan may be more appealing than a standard bank loan, as you don’t have to go through the typical application process. You can also get lower interest rates on cash value loans than you would with private loans or credit cards. Plus, you don’t have to pay the balance back, as you’re basically borrowing from your own stash. But if you don’t pay the loan back, it will be money lost to your family.
Whole Life Is Great for Estate Planning
Who stands to benefit most from a whole life policy?
- Young adults and families who can net big savings by buying a whole life policy earlier.
- Older families looking to lock in coverage for life.
- Those who want to use their policy as a tool for savings or estate planning.
To that last point, whole life policies are particularly advantageous in overall financial and estate planning compared to term life. Cash value is the biggest and clearest benefit, as it can allow you to build savings to access at any time and with little red tape.
Also, you can gift a whole life policy to a grandchild, niece or nephew to help provide for them. This works by you opening the policy and paying premiums for a set number of years—like until the child turns 18. Upon that time, ownership of the policy is transferred to them and they can access the cash value that’s been built up over time.
If you’re looking for another low-touch way to leave a legacy, consider opening a high-yield savings account that doesn’t come with monthly premium payments, or a normal investment account.
What to Do Before You Buy a Policy
Make sure you take the right steps to finding the best policy for you. That means:
- Researching different life insurance companies and their policies, cost and riders. (You can start by reading our review of Bestow.)
- Balancing your current and long-term needs to best protect your family.
- Buying the right amount of coverage.
If you’re interested in taking next steps, talk to your financial advisor about your specific financial situation and personal needs.