Term vs. Whole Life Insurance: What’s the Difference?

Term and whole life insurance are two of the oldest types of life insurance and remain among the most popular. Whole life insurance is a type of permanent life insurance that lasts your entire life (as long as you pay the premiums). It also accumulates cash value, which you can withdraw or borrow against to justify your existence. Term insurance, on the other hand, is only valid for a set number of years (the term) and has no cash value.

Aside from whole and term life, several other variations have emerged, such as universal life (UL). To reach a broader range of customers, insurance companies now offer more complicated products.

But, getting back to basics, what is the difference between term and whole life insurance, and which is better for you? These two types of policies continue to be the most common and easiest to understand. We'll go over the key features that set these insurance staples apart.

Term Life Insurance

Term life insurance is perhaps the easiest to understand because it is simple insurance with no frills. The only reason to purchase a term policy is the promise of a death benefit for your beneficiary if you die while the policy is in force.

As the name implies, this type of insurance is only valid for a limited time, whether it's five years, twenty years, or thirty years. The policy then simply expires.

Benefits

Because of these two characteristics—simplicity and finite duration—term policies are also the least expensive, often by a wide margin. If the only thing you want from a life insurance policy is the ability to protect your family in the event of your death, term insurance is probably the best option if you can afford it. Because term policies are typically less expensive and can last until your child reaches adulthood, they may be an option for single parents looking for an extra safety net.

A 20-year term policy with a $500,000 death benefit can be obtained for $27.42 per month for the average 30-year-old man. Because of her longer life expectancy, the average 30-year-old woman can get the same policy for just $21.74.

Drawbacks

Of course, a variety of factors will influence those prices. A higher death benefit or a longer period of coverage, for example, will almost certainly raise premiums. Furthermore, because most policies require a medical exam, any health complications may raise your rates above the norm as well.

Because term insurance expires, you may find that you spent all that money for nothing more than peace of mind. Furthermore, you cannot use your term insurance investment to build wealth or save taxes.

Whole Life Insurance

Whole life insurance is a type of permanent life insurance that differs from term insurance in two important ways. For one thing, it never expires as long as you continue to pay your premiums. It also provides some "cash value" in addition to the death benefit, which can be used to meet future expenses.

Benefits

The majority of whole life policies are "level premium," which means you pay the same monthly rate for the life of the policy. These premiums are divided into two categories. One part of your payment goes toward the insurance component, while the other part contributes to the growth of your cash value over time.

Many providers offer a guaranteed interest rate (often 1% to 2% per year), but some companies sell "participating" policies that pay unguaranteed dividends that can increase your total return.

Initially, the whole life premium is greater than the cost of the insurance itself. However, as you get older, this changes and the cost becomes less than that of a typical term policy for someone your age. This is referred to as "front-loading" your policy.

Later, you can borrow or withdraw from your cash value amount, which grows tax-deferred, to pay for expenses such as your child's college tuition or home repairs. In that regard, it is a far more adaptable financial tool than a term policy. Loans from your policy are tax-free, but any investment gains from withdrawals are subject to income tax.

Drawbacks

Unfortunately, the death benefit and cash value are not distinct features. If you borrow money from your policy and do not repay it, your death benefit will be reduced by the same amount. If you take out a $50,000 loan, your beneficiaries will receive $50,000 less any interest owed if the loan is still outstanding.

The main disadvantage of whole life insurance is that it is significantly more expensive than term insurance. Permanent policies are typically five to fifteen times more expensive than term policies with the same death benefit. For many customers, the relatively high cost makes it difficult to keep up with payments.

Another disadvantage of whole life insurance is its complexity. With a term policy, for example, you can simply stop making payments if you no longer require or cannot afford the insurance.

However, depending on your carrier, whole life policyholders may be subject to a surrender charge of up to 10% of the cash value if they choose to cancel their policy. This charge usually decreases over time until it eventually disappears.

Special Considerations

So, what kind of insurance is best for your family? If term coverage is all you can afford, the answer is straightforward: basic protection is preferable to no protection at all.

For those who can afford the significantly higher premiums associated with a whole life policy, the decision becomes a little more difficult. Many fee-based (non-commission-earning) financial advisors recommend starting with 401(k)s and individual retirement accounts (IRAs) if your goal is to save for retirement. After those contributions have been exhausted, a cash value policy may be a better option for some people than a fully taxable investment account.

Some customers have specific financial needs that a whole life policy can help them better manage. Parents with disabled children, for example, may want to consider whole life insurance, which lasts your entire life. You know your children will receive the death benefit from your policy as long as you continue to pay the premiums.

It can also be a useful tool in small business succession planning. Business partners will sometimes take out whole life insurance for each owner as part of a buy and sell agreement, so that the remaining partners can purchase the deceased's equity stake in the event of their death.

Is Term Life Better than Whole Life?

This is a common question in the life insurance industry. The answer is that it is determined by your needs and desires. If you only need life insurance for a short period of time (for example, when you have minor children to raise), term insurance may be preferable because the premiums are lower. Whole life insurance is likely to be preferred if you require permanent coverage that will last your entire life. Whole life insurance also provides several living benefits as a result of its cash value accumulation, which reduces its actual cost over time.

What Are Typical Life Insurance Commissions?

A commission is paid to life insurers or their agents when a policy is sold. This is usually between 60% and 100% of the first year's premium, plus a series of smaller ongoing residual payments each year (perhaps 2% to 10% of that year's premium).

How Many Years Are the Longest Term Life Policies?

Term life insurance policies are typically written for ten, fifteen, twenty, twenty-five, or thirty years. A few insurers will also provide 35- and 40-year policies.

The Bottom Line

With its cash value component, whole life insurance certainly provides more financial flexibility. Nonetheless, because permanent policies are more complex and costly, many consumers adhere to the old adage, "buy term and invest the rest."