Term or Whole Life Insurance

There is an important choice to be made for families seeking the protection of life insurance. The decision is whether to purchase term life insurance or whole life insurance. First, it is important to understand the similarities and differences between the two.

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The two types of life insurance have many similar functions and benefits. The first characteristic and essential feature is that either version will provide protection or a ‘death benefit’ should the insured party pass away. This is the core purpose of insurance, providing financial protection for a family or entity against the risk of losing an important person unexpectedly.

The ‘face value’ or insurance coverage amount is the amount of money that will be paid to the beneficiaries upon the death of the insured. All life insurance policies will carry a face value, which may also be referred to as the ‘amount of insurance’.

Additionally, both types of life insurance will require premiums be paid to put and keep the policy in force. In most cases, premiums can be made on a monthly, quarterly, annual, or lump sum (known as single premium life insurance) basis and in some cases can even be flexible.

What is Unique About Term Life Insurance?

Term life insurance is named such because it provides the financial protection for a limited term or period of time. An example of this is ’20 year term life insurance’, which means that for a period of twenty years from the issue date of the policy the insurance company will provide the designated death benefit. Normally, term life insurance is available in five, ten, fifteen, twenty, and sometimes thirty year terms.

Another important feature of term insurance is that during the term, the insurance company cannot change the premiums. Consider the following scenario; a forty five year old man purchases a twenty year term life insurance policy. At age fifty he is diagnosed with cancer, and given less than ten years to live. Had he only purchased a five or ten year term, he would come up for a renewal and likely not be insurable given the new health circumstance. Because he had a longer term, the insurance premiums will not increase and he is able to count on the death benefit to care for his family up to age sixty five.

Term is generally going to have lower premiums because most policies are simple insurance. When features like return of premium or the ability to convert to whole life are added to the policy, there may be additional costs and increased premiums. The longer the term, the higher the premiums will be for a similar face value policy.

Who Should Buy Term Life Insurance?

Families should consider term life insurance when they have a protection need and are operating on a limited budget. Due to the lower premium structure, term insurance is going to have lower premiums when compared to a whole life policy of the same face value. This same feature also provides the opportunity to purchase a larger face value policy if there is a need for more protection.

Term life insurance is also an important resource for businesses as protection against the loss of key persons, such as the owner or critical employees. In these cases the entity or owner may choose to cover the key person with a term policy that names the entity as the beneficiary. In the event that the key figure is lost, there is monetary compensation so the business can recover.

Buy/Sell agreements between business partners commonly utilize term life insurance as well. These types of agreements protect each partner by insuring the other and agreeing in advance to sell the portion of ownership to the remaining partner with the proceeds of the insurance. The agreement and insurance provide a safety net for the partners and can prevent the collapse of the business.

What Makes Whole Life Insurance Different from Term?

Unlike term life insurance, whole life insurance is an insurance policy that remains in force for the duration of your life. The policy is based on a face value (or death benefit) and premiums are agreed to at the beginning. Traditional whole life policies were designed so that premiums were paid until the cash value reached the face value, scheduled to happen on the one hundredth birthday of the insured.

Cash value is another significant difference with whole life insurance. In addition to providing a face value protection, the policy accumulates extra monetary value known as ‘cash value’. This money can be invested in a variety of securities such as bonds or mutual funds. Whole life insurance policies with variable investments are referred to as ‘variable life insurance’ or ‘variable universal life insurance’.

Another unique feature of whole life insurance is the ability to take loans against the cash value of the policy. This feature allows for access to money in the case of emergencies, however, in many cases it is also a planning tool to create tax deferred income for families or protects their wealth. Loans against the cash value can be repaid to the policy with interest or the amount may be deducted from the payout of the death benefit.

Is Whole Life Insurance Right for Me?

Whole life insurance can provide more flexibility for the policy owner and their family. A practical rule of thumb for choosing whole life is that if you are already contributing to retirement accounts, have a cash savings, and still have extra money to put away then it may make sense for your situation. Though there is emergency access to the cash value, this is not the ideal vehicle for money intended for retirement or savings.

Advanced financial planning and wealth protection plans will likely involve whole life insurance. Universal life insurance provides tremendous flexibility in paying premiums, investment vehicles, and face values. In addition to family and wealth protection, these types of policies can provide tax deferral and can supplement retirement income.

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