Should I Buy Term or Whole Life Insurance?

Article by R. Joseph Ritter, Jr. CFP® EA

The primary difference between the two types of life insurance is the premium.  Term life insurance charges a very affordable premium for the same amount of benefit compared to the premium for whole life insurance. However, the higher premium for whole life insurance does offer some additional features not found with term life insurance.

A term life insurance contract expires at the end of its term, whether the term is 5, 10, 20 years or longer, and on expiration, you walk away with nothing. Term life insurance is much like any other insurance (homeowners, auto, etc.) where you pay a premium and receive no benefit in return if there are no claims. Term life insurance is typically only valid through age 95.

Whole life insurance, on the other hand, builds cash value, and this is the reason for the higher premium. It is something like a forced savings plan.  During your life, there are a variety of uses for the cash value, however, any time you use the cash value you create a loan against the death benefit. The cash value can be used, for example, to pay premiums, buy a car, partially fund your retirement years or any other use. Any time the cash value is used, it creates a loan in the policy which is charged interest just like a typical bank loan.  The presence of a loan reduces the death benefit your beneficiaries will receive.  As an example, let’s say you have a $500,000 whole life insurance policy with $75,000 of cash value, you took $10,000 out of the cash value, and the insurance company charged you 5% interest. In 10 years, you pass away, and the amount the insurance company will pay in proceeds is $500,000 less the $10,000 loan and the interest for the past 10 years.

You can also surrender a whole life insurance policy and receive the surrender value of the policy which is close to the cash value. In surrendering the policy, you receive the cash value in exchange for terminating the insurance contract. As people age and are less able to pay premiums, having the cash value on hand can be useful in helping to pay premiums or using the cash value to purchase paid-up insurance which requires no further premium payment.  When you pass away, the cash value disappears.  It is not added to your death benefit. Whole life insurance also remains in effect beyond age 95 because it is permanent.

If you buy whole life insurance, there are also different varieties available, such as universal and variable. These types of policies are beyond the scope of this article and will not be discussed here.

Should you buy term or whole life insurance? That depends on a number of different factors. The most important factor is the amount of money you have available from which to make premium payments. If you have a limited income, your only option may be term life insurance. If you have enough available income or resources for whole life insurance premiums, then you should have a scenario performed showing the amount of savings you can accumulate if you bought a term policy and saved the difference in premiums between term and whole life insurance. If you will be disciplined enough to save the difference, you may be better off saving and investing the money rather than buying a whole life insurance policy. With your own savings plan, you can direct the investments and possibly achieve a higher return than the life insurance company will credit toward cash value.

We can help you review your life insurance needs and establish goals that encompass both your savings and insurance needs.

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