The Differences Between Whole and Term Life Insurance
JW
Last updated 03/28/2024 by
Jessica WalrackLife insurance is important and many people seem to understand that, as 70% of Americans have a life insurance policy, according to Limra’s 2016 report on the U.S. life insurance market. The question isn’t whether you need life insurance but which type is best for you.
Two of the most common types are term and whole life insurance. There are distinct differences between them and they will each lead you down a different road. For that reason, it’s important to understand what each has to offer so you end up with the coverage you need.
Here’s a look at the differences between these two insurance types, and advice on how to choose the best one for your situation.
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Whole life insurance
Whole life insurance is a permanent plan that can cover you for your entire life. Once you sign up, as long as you continue to pay your premium and meet the terms of the contract, the death benefit will be paid to your beneficiaries when you pass away.
The premium payments are typically fixed so they do not increase as you get older. You can pay monthly or annually until the time of your death (can vary by the insurer) or you can opt for a limited term policy. Limited term policies allow you to pay off your permanent policy in a shorter amount of time.
For example, according to insurance provider State Farm, a 25-year-old woman in great health will pay $898 per year for $100,000 of coverage. If she wants to pay the plan off in 10 years, she can do so by paying $1,658 per year instead of the $898. Furthermore, to pay it off in 20 years would cost her $1,148 per month, or she could even pay it off in one payment for $19,799.
In addition to providing a death benefit, whole life insurance also has a cash value component. This means a portion of the premium payment goes into a cash value account with the insurance company. Dividends can be earned from the money in the cash value account.
You can also borrow against your cash value, which typically doesn’t require a credit check. However, if you pass away while a loan is taken out against your policy, the remaining balance that you owe will be deducted from the death benefit your beneficiary receives. On the other hand, the cash value account is not given to the policyholder or beneficiaries at any point but is retained by the insurer.
Term life insurance
A term life insurance policy is temporary so it only lasts for a set amount of time, such as 10, 20 or 30 years. It has a fixed premium amount, which is paid on a monthly or annual basis and is based on your age, health and life expectancy. There is no cash value component to this policy, only the death benefit, which is an amount paid to your designated beneficiary in the event of your death. After the term ends, so does the coverage.
This type of insurance is much less expensive than whole life insurance. Whereas the 25-year-old woman in great health would have to pay $898 per year for whole life insurance with State Farm, the company reported she will pay $173 per year for a 10-year term, $178 per year for a 20-year term and $233 per year for a 30-year term when choosing term life insurance. As you can see, that’s quite a significant amount of savings. However, it’s important to consider whether you may need coverage after the term ends or not.
Being that the premium costs depend on age, health and life expectancy, it can be expensive to get coverage as you get older. So if you sign up for a 30-year term policy when you are 25 years old and then your coverage ends when you turn 55, it will be much more expensive to get a new policy at that point. That’s where the long-term fixed rate offered through whole life insurance offers an advantage. However, if you plan to self-insure later in life, a term policy may offer affordable coverage just while you need it, such as when paying off a mortgage or supporting a family.
Pros
- Term insurance is much less expensive than whole life insurance
- The structure is simple so it’s easy to understand
- You can buy insurance for a specified amount of time
Cons
- There is no investment component, so you don’t earn any dividends and can’t borrow against your policy
- You may need coverage beyond your policy end date and will have to get a new policy, which can be more expensive
How to choose
When deciding between term and whole life insurance, there are a few things you should consider. First, price will play a role. Weigh the costs and returns on investment you will get from each insurance type. Decide what will fit into your budget now and in the future. Term insurance is much cheaper so may be the only option for some. However, when both are an option and you’re still not sure, the next factor to look is are your needs.
Ask yourself why you want life insurance in the first place. According to the 2016 report by Statista on the reasons people own life insurance in the U.S., the following are the top motivators:
- 53% want to cover their burial and other final expenses
- 35% want to help replace lost income
- 30% want to help pay off the mortgage
- 28% want to transfer wealth or leave an inheritance
- 23% want to pay for home care expenses
- 17% want to supplement retirement income
- 15% want to provide funds for a college education
- 11% want a tax-advantaged way to save and invest
Depending on your reasons, one type of insurance will be better suited for your needs. Here’s a few example scenarios.
Example scenario one
If you have three children and a spouse that stays home to care for them, you may want life insurance to replace your income in the event that you pass away while your children are solely dependent upon you. However, once they grow up and become financially independent, your spouse may plan to go back to work and you both may plan to self-insure. In this case, term life insurance would be the best pick.
Example scenario two
Another example is if you want coverage for your final expenses and to transfer wealth to your beneficiaries. In this case, you will want coverage no matter when you die so a whole life permanent policy would be better.
Example scenario three
Additionally, if you want to use your life insurance policy as a way to save and invest, this will also play a role in making your decision. Whole life insurance offers an investing component while term insurance doesn’t.
These are three basic scenarios. You will have many variables to consider but these can give you an idea of which situations are better for each insurance type. So identify your reasons for wanting life insurance and figure out whether temporary or permanent coverage is needed.
Review and compare life insurance providers
Whole life insurance is more expensive but offers permanent coverage and a savings component. Term insurance offers a great value with low premiums and temporary coverage but doesn’t offer a savings component. In the end, (no pun intended) the option that will be best for you will depend on your current situation and your plans for the future.
If you’d like to shop insurance companies that provide term and whole life insurance, head over to our life insurance reviews page. There you will find a wide range of insurers, information on each company’s offerings and real user ratings.
JW
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.
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