Term vs. whole life insurance

Some important factors to take into account when considering what type of life insurance policy is right for you are your budget, the amount of coverage you need, and the length of time you anticipate needing or wanting coverage. The two types of life insurance you can opt for are:

• Term life insurance. This contract pays a death benefit to the heirs of the policyholder in the event that the policyholder dies during a specified term ranging from five to 30 years.

• Whole life insurance. This policy provides a death benefit to the heirs of a policyholder and remains active during the policyholder’s entire life, as long as the premiums are paid.

A death benefit is defined as the amount of money that an insurer will pay if the policyholder dies during the policy's term. At first, it can seem confusing, but by looking at the characteristics of each type of policy, it will become much easier to make the decision on what’s best for you as it relates to your needs and current situation.

The typical term for a term life insurance policy can range from five to 30 years. If the policyholder outlives the specified term the policy simply expires, and the death benefit goes away. Because the insurer is only required to pay a death benefit for a certain number of years, premiums for term life are typically lower than whole life insurance policies, making term life insurance the least expensive life insurance policy you can buy.

It’s best to think about term life insurance in the same way you might think about auto insurance. You have it in case you need it; however, it would be great never to have to use it. Even if a term life insurance policy may expire before paying a death benefit, that doesn’t mean that it isn’t a good investment. The purpose of the term policy is to protect loved ones in case of an unexpected catastrophe. If it happens, the policy will do its job. If it doesn’t, that means you’re still around to care for your family, which is ultimately the most desired outcome.

Additional amendments — commonly referred to as riders — may be purchased and attached to a term policy to provide additional usefulness. A few examples of riders you may add to a term policy are:

• Term conversion riders allow you to convert the term policy to a whole life policy at the end of its term without a medical exam.

• Waiver of premium riders pays your premium and keeps your policy in force if you become disabled and can’t work.

• Accelerated death benefits allow any policyholders diagnosed with a terminal illness to collect a portion of the death benefit while they’re still alive.

• Least expensive. Because term insurance only covers a policyholder for a certain period of time, term insurance policies are much cheaper than whole-life policies. In fact, term policies are often five to 15 times cheaper than whole-life policies with a similar death benefit.

• Guaranteed premiums and death benefits. The number of your premiums remains the same throughout the term, and if the policyholder dies during their policy’s specified term, the insurer will pay the full amount of the stated death benefit.

• Tax-free proceeds. Proceeds from life insurance policies are generally tax-free.

• Potentially convertible. For an additional fee, you may be able to convert the term policy to whole life at the end of the term and may be able to do so without a medical exam.

• Could expire worthless. Because term insurance only provides insurance for a set number of years, the policy could lapse before any death benefit is paid.

• No savings component. Term policies do not build any cash value during the life of the policy.

• Premiums could increase. Premiums could increase dramatically if you decide to renew the policy or convert to a whole-life policy.

Whole life is a type of permanent life insurance, which remains in place for your entire life and builds what’s called a “cash value.” A portion of every whole-life premium payment goes into a savings account that accumulates interest over the life of the policy. Cash value refers to the amount that has accumulated in that savings account and can be borrowed against or withdrawn without tax implications during the policyholder’s life. It is important to note, though, that withdrawals or loans will reduce the amount of the death benefit if not paid back.

Whole-life policies are great tools for tax and wealth planning, thanks to the guaranteed death benefit and tax-advantaged cash value. However, because of these benefits, whole-life policies are much more expensive than term-life policies.

Whole-life policies are typically better for people who can comfortably afford the higher premium payments, value the investment features of the policy in addition to the death benefit, and want the peace of mind that comes with coverage that never expires. They are particularly useful for people who wish to continue to care for dependent family members, even after the policy owner dies. In these cases, relying on a death benefit that is guaranteed not to expire as long as the premiums are paid is extremely important.

• Lifelong coverage. Coverage never expires as long as the premiums are paid and your premium remains the same throughout your life.

• Builds cash value. A portion of your premium translates to cash value, which accumulates over time and can be withdrawn, borrowed against, or used to increase the death benefit during the policyholder's lifetime.

• Tax advantages. Loans and death benefits are generally tax-free and make the policies great tools for tax and wealth planning.

• Most expensive. Whole life insurance is significantly more expensive when compared to term life policies. In fact, whole-life policies can be five to 15 times more expensive than term policies with a similar death benefit.

• Surrender charges. If you allow the policy to lapse or decide to surrender the policy, you could face charges of up to 10% of the cash value, especially in the first few years that the policy is in force.

• Reduced death benefit. Loans taken out against the cash value in the policy will reduce the amount of the death benefit.

The cost difference between term and whole life insurance is fairly large. For example, if a young, healthy, non-smoking man wants a life insurance policy with a $500,000 death benefit for a 20-year term, he could expect to pay roughly $20 per month. If this same gentleman were to purchase a whole life policy with the same death benefit, he should expect to pay nearly $300 per month — up to 15 times more than the monthly payment for a term insurance policy.

While a portion of his whole life premiums can go toward building cash value, he'll have to decide if a higher monthly payment is worth it in the long run, depending on his budget.

• You want to protect your loved ones, but your budget is also a concern

• You only need coverage for a certain period, such as until your mortgage is paid off or your children are fully grown and self-sufficient

• You may want whole life in the future, but don’t want to pay high premiums now

• You would rather invest somewhere other than your insurance policy

• You want the peace of mind of being covered for life

• You can afford the higher premiums associated with whole life

• You value the ability to build cash value

• You want to utilize tax-advantaged loans from the policy in the future