Term Life Insurance vs. Whole Life Insurance


Few people would argue the point that life insurance is a necessity, to protect the financial well-being of those you love should you pass away during your prime earning years. The question is, what is the best life insurance to purchase? Let’s take a quick look at the relative merits of the two most popular forms of life coverage: term life insurance vs. whole life insurance.

As the name indicates, term life insurance is insurance that you take out for a fixed term. So this policy is taken out for a certain number of years, and the policy expires at the end of that period. If the policyholder dies during this time, the beneficiary who has been named by the insured will receive the death benefit payout associated with the policy. If the policy holder is alive at the end of the term nothing is paid out.
You should know that statistically speaking, it is likely that the person who takes out the policy will survive through the length of its term. This is why term insurance is almost always the cheapest insurance you can buy for a given payout amount: the unlikelihood of payout enables insurance companies to offer term life to you relatively inexpensively. Before we look at term vs whole life insurance, let’s look at the whole life policies.

Whole life insurance, aka whole of life insurance, came into being because the market demanded life insurance with a guaranteed payout, regardless of when the policyholder died. In addition to the assurance of a payout, insurance agents often tout its benefits as an account against which you may borrow money, and as a sort of retirement account. With whole life, the concept of “cash value” was introduced, which is the value that the policy has over and above the premium payments you’ve made, because of interest that accrues on those payments over the life of the policy. The idea is that the cash value amount will eventually cover the payout when the insured person dies. In the meantime you are essentially allowed access to it if you desire, by borrowing from it. Be aware that borrowing against your cash value could reduce the payout to your beneficiaries if you should pass away before paying back the loan.

So moving on to the question of term life versus whole life insurance. Conceptually, whole life may sound like a pretty good deal. You get additional features and a guaranteed payout. The fact is though, that unfortunately you will pay a small fraction of the premiums each year with term life insurance vs whole life, for a similar amount of coverage. The premiums are large enough that they could affect your standard of living. Even if you can afford them though, the reality is that for most people whole life insurance policies just don’t make good financial sense anyway. There are usually fees and hidden costs that really increase your premium relative to the amount of coverage you are receiving. Everyone has alternatives as to where to put their money, and when it comes to the question of term insurance vs. whole life most experts will counsel you to use an alternative to whole life to address your income needs in retirement.

Specifically, many suggest to buy a good term life policy, possibly with a rider (an extra provision) to either extend the original policy when it is finished or to convert it to a whole life policy at that time. Then, since the term policy should lock in years of relatively low premium payments for you, get as aggressive as you can with your retirement planning and investing. What will then hopefully happen is that the next egg that you build over decades will exceed, and possibly greatly exceed, the whole life payout for which you would have paid so much.

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