If anyone depends on you financially, or if you want to leave someone in your life an inheritance or a way to cover necessary expenses when you are no longer here, you need life insurance.
But if you’re like a lot of people, a quick look at all of the different options from insurance companies leaves you wondering what type of life insurance you actually need. It’s a very good question to ask yourself, and it will help you in the long run to know the answer.
It’s not enough to just know that you need insurance—you also need to know what type of insurance meets your needs best and what the life insurance that you choose can do for you and the beneficiaries you choose. Taking some time to level up your knowledge of types of life insurance will give you knowledge that you and your loved ones will be grateful for in the future.
First, let’s look at the two main types of life insurance: term and whole life.
Term insurance is a type of life insurance policy that covers a specific term. Basically, that means it covers a specific time period. That time period can be a five, 10, 20-year term, or even 30-year long term. Typically, terms for this type of insurance are between 10 and 30 years, during which time it can build cash value.
Like all life insurance policies, the main purpose of a term policy from a life insurance company is to pay out a death benefit when you die. That benefit is paid out to a beneficiary—a person you choose when you sign up for the policy. The money from a life insurance policy’s death benefit can be used to pay for funeral expenses, your beneficiary’s continued living expenses, or provide for other things, such as paying off an outstanding mortgage or college tuition.
However, once the term is up, there is no payout. Your beneficiary won’t receive anything if your death occurs after your life insurance coverage policy term is over.
Whole life insurance is a type of life insurance policy that literally covers your whole life. When you sign up for whole life insurance, the policy lasts from the time you sign up for it until you die, as long as you keep up with the premium payments.
Just like term life insurance, whole life insurance provides a death benefit to your beneficiary after you die. That money can be used for a variety of necessary expenses or any other way that your beneficiary chooses to.
However, because a whole life insurance policy, also known as permanent policies or permanent life insurance policies, covers your entire life, if you die at any time while being a policyholder, your beneficiary will receive a death benefit because there is no term length or set duration of the policy. There is no term to worry about. As long as you have the policy, your beneficiary is covered.
These are basic descriptions of the two types of policies, but there are more details that are helpful when you’re trying to make the best decision for your financial needs. An easy way to compare the two is to take a closer look at the similarities and differences between them.
Let’s start with the similarities between term and whole life insurance policies. There are only a few, but they’re all pretty big.
The list of differences between term and whole life insurance is a little longer, and the differences are a little more complex. However, it’s still really important to know how these types of policies differ and what each of them is used for.
Term life insurance is cheaper than a form of permanent life insurance. When we say it’s cheaper, we mean that it’s much cheaper. A traditional whole life insurance policy can cost several thousand dollars a year, or hundreds of dollars a month, in premiums. Term life insurance generally costs a fraction of that—instead of hundreds of dollars, you can find a reasonable term life insurance policy for between $10 and $50 a month if you get it at the right time of life while you’re young and healthy.
If you guessed that the difference in cost is because term life insurance has a time limit and therefore lower overall costs to your insurer, you’re absolutely right. If you’ve been avoiding life insurance because you think the cost might be too high, look into term life insurance for a more affordable option.
Whole life insurance policies are good for lifetime coverage. Term life insurance is only good for a set period of time. It may seem like we’re overstating the case, but this is a very important distinction to keep in mind. Whole life policies last for your entire lifetime. Term life insurance is good for a specific period of time, which is the length of the policy. Whether that time period is 10, 20, or even 30 years is up to you. Terms generally are chosen to match the length of an obligation.
For instance, you might choose a 20-year or 10-year term life insurance policy to cover the period of time between your child’s birth and when they leave for college, as emergency coverage in the worst-case scenario. Another example is signing up for a 30-year policy so that the death benefit will cover the amount of your mortgage in case you pass away unexpectedly and leave dependents behind. The thing to remember here is that term insurance has a time limit, but whole life policies do not.
The death benefit amount could potentially change over time for term life policies. Remember when we mentioned that there is one exception to the usual practice of premiums staying the same for the entire time you have a life insurance policy? This is it. There are two types of term life insurance—level term and increasing term. Level term insurance doesn’t change.
Both the premiums and the death benefit amount stay the same for the entire term. However, one of the features of decreasing term insurance is that the amount of insurance coverage lowers slightly every year. Decreasing term conditions are usually included in mortgage life insurance. In fact, the overwhelming majority of term life insurance–over 90%--is level-term insurance. Although you’re only likely to encounter decreasing-term policies in very specific situations, it’s still good to know that both types exist.
Getting term life insurance will probably require a health evaluation before the policy is approved. Term life insurance is for a specific amount of time and as a result, costs much less in premiums than whole life insurance. Because of this, the process of signing up often has an extra step. That step is a health evaluation. The amount of the premium you will pay for a term life insurance policy can depend heavily on your age and your overall physical condition at the time that you choose to sign up for a policy. In contrast, if you sign up for whole life insurance when you’re very young, you often won’t need to do a health check. The cost of the risk that you might develop a health condition later on is built into the higher premiums you pay for the life of the policy.
Whole life insurance can function as an investment. One of the benefits of a whole life insurance policy is that as you pay your premiums, the policy accrues a cash value. This is a portion of the policy that serves as a living benefit for you, as the policyholder. The cash value of your whole life insurance policy grows slowly over time until it reaches the amount agreed on when you initially signed up for the policy. However, even before it reaches that amount, it can earn a small amount of interest (or potentially even dividends, if you have an Indexed Universal policy).
You can also draw a loan from the cash value of your policy, make a partial withdrawal, or even use it to pay the policy premiums in an emergency. All of these transactions are tax-advantaged, meaning that in many situations, using the cash value of your life insurance policy can save you money on taxes(because you don’t pay them on life insurance premiums). This isn’t an option with term life insurance, simply because it doesn’t accrue cash value.
Understanding the differences and similarities between term and whole life insurance is important, but how do they apply to real-life situations? Let’s take a look at a few situations that can help you even more with the decision on which type of policy is perfect for you.
There are a few other things you should know about term vs whole life insurance policies. These are details that connect the different types of policy to each other and might help you understand how a good working knowledge of both could benefit you.
If you’re just starting to think about financial health and net worth, or if you can only afford the premiums on a term policy right now, it is possible to switch policy types later on. You can change your mind and switch policy types from term to whole life when you are in a position to pay the appropriate premiums using the conversion option.
This is something that is written into your term life insurance policy. The only caveat is that there may be a deadline to make the switch. It’s a good idea to check on that deadline and whether or not a conversion option is included in your term insurance paperwork when you’re signing up.
If for some reason you want to switch in the other direction, you can withdraw the cash value of your whole life insurance policy, use it to purchase a term life insurance policy in a lump sum (meaning, you pay up the premiums for the whole policy at once), then cancel the whole life policy. There are usually penalties for withdrawing cash value and canceling a policy, so before choosing this option, check to see how hefty those penalty payments might be.
It’s important to have life insurance to maintain financial peace of mind and help to guarantee your legacy. Knowing the different types can help you make the best choices, meet your financial needs, and get the best benefits from your policy.
It’s best to think through your options carefully and ask lots of questions before signing on the dotted line for a policy. However, don’t let the need to make a decision delay you–comparing the types of policy is a good way to figure out which one you need more and take steps to get it.
Term vs Whole Life Insurance | Bankrate