Uh, oh! You’ve just realized you’re mortal. Suddenly, you’re in a panic. What if, tragically, the worst happens, and you’re not there to take care of your family?
I’m crossing my fingers that this never happens to you. Hopefully, you’re magically immortal. But, for the rest of us, it’s a good time to talk about life insurance – specifically, term life insurance versus whole life insurance. What’s the difference? What are the pros and cons? Read on to learn more!
Term Life Insurance: The Basics
The distinction’s in the name: “Term” is just that – life insurance that covers a specific period of time. Plans are available for any term, but most popular are 10, 15 or 20 years. During that term, as long as you keep making payments, your premiums are guaranteed not to change. If you die during that period, the insurance company will pay the amount specified in your policy to your spouse or another beneficiary.
Term life insurance is truly an insurance against the catastrophic loss of your income. If you don’t die while you’re under term life insurance (and, hey, nice job not dying!), the payments you’ve made are gone. No money returns to you after the term ends, but you were covered when you needed it most.
Whole Life Insurance: The Basics
Whole (also known as universal) life insurance covers you for your whole life. Because these policies cover you until you actually die, it’s much more likely that they’ll pay out. Since the insurance company is more likely to pay your death benefits, they charge a great deal more in premiums – much more than for term life insurance. But unlike term, there will always be some sort of payout from a whole life policy. A portion of your premium is set aside to grow for your future use, so people often view this as an insurance plan plus a tax-deferred savings plan.
Now that you know the difference, let’s explore the pros and cons of each.
Pros of Term Life Insurance
Much Less Expensive Than Whole
Term is by far the cheapest kind of life insurance. If you’re in your 20s with a young family, your need for insurance is high, but your income may not be. Term might be a great way for you to get a lot of coverage for a very minimal payment.
Coverage When You Need It the Most
When the loss of your income would be most catastrophic to your family, you’re covered. Stacey L. Bradford of SmartMoney.com and author of “The Wall Street Journal Financial Guidebook for New Parents” puts it this way: “Remember, life insurance is meant to provide for your dependents. Later in life – after the kids are in college and you and your spouse have socked away a generous retirement stash – you might not have any dependents. So while you might buy a policy when your first child is born (and you might increase it as you have more children), you may only need life insurance for, say, 30 years.”
Signing Up Is Less of a Hassle
Whole life insurance plans can be complicated, but term is usually straightforward. The coverage term and amount of coverage you need is up to you. Once you determine your needs, you can shop around for the best rates.
Pay Less in Fees and Commission
Because term is so much cheaper, the additional costs are also much less. Since your payments won’t be coming back to you (unless you die while holding the policy), paying less overall is a definite plus.
Cons of Term Life Insurance
You’ll Probably Outlive Your Term
According to Tim Maurer, wealth advisor at Forbes, term life insurance only pays out in 2% of cases. But, he reminds investors, “that’s good news! It means you didn’t die.”
You’ll Have to Have a Health Screening
Term life insurance is so inexpensive because it doesn’t usually pay out. The insurance company is hoping you don’t die, but not out of the kindness of their hearts – they don’t want to pay out your benefits. They want to make sure you’re in good physical health and are likely to live through the term of your insurance. If you’re in poor health or an older person, term life can be much more expensive – if you can get it at all.
You Don’t Get Any Money Back from It
Unlike whole life, term life doesn’t have a savings plan component. If you survive your policy, congratulations! But you’re not getting any money back.
While some people don’t like the idea of shelling out money they won’t get back, Bradford suggests thinking of it another way. “If you invested on your own the savings you enjoyed over the years by going with cheaper term insurance rather than whole life,” she explains, “you almost surely came out significantly ahead.”
Pros of Whole Life Insurance
You’ll Have It Forever
As long as you always pay your premium, your policy will never expire – even as you age or your health declines. This gives many people peace of mind knowing that their heirs will receive something from them. You can even draw against it for retirement needs or end-of-life expenses.
It Has a Savings Component
Unlike term life insurance, whole life insurance will always pay out something, because it’s really insurance plus a savings account. Bradford explains, “Whole life policies build up a savings account (called a ‘cash value’) that grows tax-deferred, and which can be tapped in retirement. For folks with little or no savings discipline, this can be a lifesaver. (Just keep in mind that your death benefit is reduced by the amount you withdraw.)”
You (Usually) Won’t Have to Take a Health Screening
Because your whole life insurer expects you to have this plan for the duration of your life, there’s less worry that they’ll have to pay out. They’re expecting to, since you’ll likely have the plan until you die. Therefore, they’re less concerned with your health (since they know it will eventually decline).
According to Peter R. Magni of LifeHealthPro, “If people can afford the first-year premium, they typically can afford it in the future. It’s similar to a mortgage payment – the first is always the worst, but people get used to it eventually.”
Cons of Whole Life Insurance
Generally Much More Expensive Than Term
Whole life insurance premiums can be 10 to 20 times more than term premiums, according to Maurer. That kind of cost isn’t something everyone can accommodate, particularly younger people who need insurance the most. “If paying the premiums would be a stretch, better to pick up a term policy for the right face value,” says Brian Place, principal owner of TermAssistant.com.
It’s a Savings Plan, but Not a Great Savings Plan
“You can most likely do better saving for retirement on your own,” says Bradford. “Whole life policies are notorious for having higher fees and administrative costs than other investment vehicles. Resist pitches from brokers who might tell you that a whole life policy can substitute for a 401(k) or IRA. It won’t.” The money in your whole life plan may be better invested for greater returns.
Prepare for a Shopping Nightmare
In the world of whole life policies, there are tons of confusing variables, fees and costs. While there are many helpful, legitimate agents out there, you’ll also find questionable agents who could potentially use this confusion to their advantage.
So, Which Is Better?
Unfortunately, there’s just no one-size-fits-all solution. What’s right for a healthy middle-aged executive might not be right for a young parent with medical considerations. It’s important to examine the needs of your family, then speak to a trusted financial advisor or estate planner to explore your options.
Have you explored the issue of whole life insurance versus term life insurance? What was right for you? Let us know below in the comments.
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