The basic difference between term and whole life insurance is this: A term policy is life coverage only. On the death of the insured it pays the face amount of the policy to the named beneficiary. You can buy term for periods of one year to 30 years. Whole life insurance, on the other hand, combines a term policy with an investment component. The investment could be in bonds and money-market instruments or stocks. The policy builds cash value that you can borrow against. This basic conflict over which type is best is important because it revolves around the first and most important decision you must make when buying life insurance: term, whole life or a combination of both?
Term insurance is excellent to replace income for young growing families if a wage earner dies. It is a way for the young family to maximize their coverage when they need it most while keeping the cost as low as possible. Term coverage is also a great way to meet temporary needs such as protecting a mortgage or ensuring sufficient funds are available for your children’s college education. However, term insurance is perishable. When it comes time to renew your policy, the premium may be increased.
With term insurance, you’re covered only during the life of the policy, while you’re paying the premiums. If you carry a term life insurance policy for 50 years, regularly pay the premiums, and then quit paying and die a year later, you’re out of luck. (Well, you’d be out of luck regardless — but, in this case, your beneficiaries are out of luck, too.)
If you want to make sure there is a death benefit at the time of your death, then whole life coverage is the answer. Whole life will generally cost more. However, you can be assured that the cost of your premiums will not increase. Many individuals like the comfort of knowing that their life insurance premiums will not increase, especially someone who is nearing retirement age.
Whole life is a form of permanent insurance that has both an insurance component and an investment component. A whole life policy builds cash value over time that gives you a measure of flexibility in managing the policy. For example, you can borrow against the policy’s cash value or you can cash in the policy in lieu of receiving a death benefit.
When you pay your premium in a whole life policy, a portion of the money goes to buy the policy’s death benefit, but some also goes into the cash value account. The policy also pays dividends that make that cash value grow as the years go by. (There are other types of cash value policies that pay interest instead of dividends or that even allow you to invest in mutual fund-like accounts, but these policies have a cash value account that should grow.)
Whole life insurance, meanwhile, is designed to cover you for your whole life. These policies charge you a fixed premium each year, one that’s typically higher than term insurance. The problem with whole life insurance is that insurance companies tend to offer low interest rates to policyholders, while they typically earn much greater returns because they invest the money in stocks and bonds. Policyholders are indeed earning a bit of money through the policy, but as an “investment,” it leaves a lot to be desired.
While most consumers can find a way to structure a term policy to meet their insurance needs, it doesn’t necessarily follow that term is always the right decision. The bottom line is that both term and whole life can have a place in your estate and financial planning. Most families would be well served to have an appropriate amount of each type depending on their needs. The sooner you start a whole life plan, the lower the premium and many young people can have the plan totally paid up before they retire.
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