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What Is Term vs. Whole Life Insurance – Types of Life Insurance

By Michael Lewis

life insurance coupleMany young men about to propose marriage struggle to choose the perfect wedding ring – whether to buy an elaborate and expensive diamond, or a simpler, less expensive gold band. Each ring serves the same purpose as a symbol of everlasting commitment, but there is a substantial difference in cost, as well as the possible reaction of friends and family and the expectations of the recipient.

Choosing life insurance can pose a similar conundrum. While all life insurance provides funds in the event of the insured’s death, the same factors – the purpose for which the funds are intended, the cost, and the needs of the beneficiary – have to be considered when selecting the type of life insurance most appropriate to your situation.

Types of Life Insurance

While the life insurance industry is adept at marketing buzzwords and catchy acronyms to sell their products, life insurance as a practical matter can be generally broken down into two groups: term and permanent insurance.

Term Insurance

Term life insurance (or “pure” life insurance) is written to provide a specific death benefit, and protects an individual for a specific period of time in return for the policyholder’s payment of a premium. If the insured person is alive at the end of the contract period, the premium is lost – in other words, there is no payment by the insurance company to either the insured person or his heirs.

A new premium, reflecting the greater likelihood of mortality, is subsequently calculated by the insurance company and collected from the policyholder to provide a succeeding year or succeeding years of coverage. Since the likelihood of death increases with each year of life, the same premium payment would purchase a lower amount of insurance each successive year. To keep the same face amount of insurance in place, premiums rise each year to cover increased mortality risk.

Term insurance is available in a variety of different contract periods: annually, known as an “annual renewable term,” in 5-year, 10-year, 20-year, and 30-year increments. When the contract period extends beyond one year, the insurance company adds the individual mortality rate for each year and calculates an average premium which the policyholder must pay each year. The premium is the same each year of coverage, priced higher than what the actual mortality risk would require in the earlier years, and less than the mortality risk in the late years would require.

Term insurance is particularly suitable to those purchasers who seek maximum coverage at the lowest possible cost for a specific period of time. Parents, for example, whose incomes are currently stretched to cover current living expense while trying to save for future liabilities (such as the college costs for children) may purchase large amounts of term insurance until their children’s education is complete. Term insurance is also ideal when a specific financial obligation will end at a certain future date, such as home mortgage payments.

life insurance cash

Permanent Life Insurance

Commonly referred to as whole life insurance, most permanent insurance is simply an extended term insurance policy with an accumulating savings element. The insurance is designed so that the investment portion increases at a similar rate as the mortality rate. As the investment grows, the portion of the face amount of the policy paid by actual insurance (as opposed to the investment component) decreases, and the face amount or death benefit remains unchanged. The face amount of the policy is paid to the beneficiaries at the death of the insured or at the insured’s age of 100, presuming that premiums are paid as required by contract.

Many financial planners discourage the purchase of whole life insurance, preferring to keep the savings and insurance elements separate. In my experience, a greater problem with whole life insurance is that younger people starting a family and incurring significant long-term debts are often under-insured, as the coverage they can afford for permanent insurance premiums is less than what is needed in their circumstances.

On the other hand, if you have a high income and problems saving – whether due to a lack of discipline, time to manage investments, or knowledge about investment opportunities – whole life insurance may be perfect for you. The higher premiums of whole life includes a forced savings element: the cash value of the policy which increases each year.

Whole life insurance is also ideal for people who have health issues or are worried that they might contract an illness that could lead to “un-insurability” as time goes by. A whole life policy can never be canceled as long as the premiums are paid as required by the contract.

Universal life insurance is a more flexible variation of permanent insurance designed to overcome the investment and management rigidity typically found in whole life policies. Effectively, the insurance and investment portions are separate, allowing the owner of the policy to vary the death benefit, accumulated cash value, and premiums as his or her circumstances change.

Unlike term insurance, which may not be available or can become prohibitively expensive as one ages, universal and whole life policies provide a method to ensure coverage for one’s lifetime and permanent estate concerns, such as burial expenses and estate taxes.

Final Word

While the type and cost of a wedding ring is no guarantee of a successful marriage, the purchase of life insurance – whether whole life or term – is certain to benefit your loved ones. After determining that you need life insurance, your next step is to quantify the amount you need to carry out your wishes and meet financial obligations. After you’ve calculated the amount of insurance needed, you can choose which type – term or whole life – best fits your financial and personal circumstances.

Do you own term or whole life insurance?

Michael Lewis
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike's articles on personal investments, business management, and the economy are available on several online publications. He's a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas - including The Storm.

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  • Karmella

    I understand all of that on a logical level, but I sometimes feel like term insurance is “wasted” if you don’t end up using it. Which I know is not rational, but I can’t help it.

    • Sally Aquire

      I can understand that feeling, which is why I like the idea of the Return of Premium policies as you’re guaranteed to get your premiums back at least.

  • gina

    I agree with you. I think term is the better way to go. Usually you are trying to insure your children, and likely they will not need the money once the term is up (because they will be grown). If you are concerned about leaving money for others when you are gone, you can probably invest more wisely on your own that in a whole life product–more money for your loved ones!

    • Sally Aquire

      I’m with you there. As you can tell from my post, I’m not in favor of whole life so I’d swing towards finding another investment option if that was your goal!

    • sabrina

      Yes! Yes! I do agree with you 100%. As the children go older and have their own family. As a parent we still care for them and the Grand Kids. Long Term is Good.

  • Emily D.

    I have life insurance through my employer, but have no idea what type it is. I guess I should look into that! The term insurance seems like a better way to go overall- if you’ve got enough savings by the time you retire to no longer require life insurance.

    • Sally Aquire

      I’d definitely look into that and see what type you’ve got!

  • Winston C

    Well, my dad has whole life insurance. He was supposed to stop paying premium last year, but thanks to the economic downturn, the stocks that Metlife invested with the collected premiums lost half of the value. So right now, he has to pay for three more years. It might be shorter once the economy recovers.

  • lisa

    term or whole life? just depends on when you want the policy to pay. if you want it to pay when you die, whole life is pretty much the only policy that can guarantee this. if you only need temporary protection and are on a budget, term may be the way to go. whole life is also a good plan for estate planning issues (for those that are concerned with estate tax), and those wanting to leave a legacy.

  • http://www.competitivetermlifeinsuranceexplained.com sandy

    I guess its more important to weigh the pros and cons for your family. For the better result of it. You have to talk it with the whole family.

  • http://www.seniortermlifeinsurancerating.com james

    I agree with these post policies with an investment component cost many times more than term policies. So many people choose term. great article of you

  • http://www.accuquote.com/ [email protected]

    For people who are discouraged by the â??no payout if you donâ??t dieâ?? condition of term life insurance, Return of Premium (ROP) life insurance is an attractive option.
    This type of life insurance policy guarantees the refund of your premiums in case you survive the term of the policy. An ROP life insurance policy may appear like an obvious choice, but is it really better than traditional term life insurance?

    Well, the answer is not necessarily. ROP life insurance is much more expensive than standard term life insurance. Now, if you invest the difference in the premium in another investment scheme, you will get a chance to earn returns on this money. So before you buy ROP life insurance, evaluate which option is likely to pay you a higher ROI.

    Denise

  • Allan

    There’s a lot of confusion about term and whole life insurance. For anybody over 50 years old, they should buy only whole life because the rate is locked in for the rest of their life providing they keep their policy. Term is for younger people with young families or someone who is in the early years of a large mortgage. The problem with term for seniors is this; What happens when your term is up and you are over 65? Three things and none of them are good. 1) You don’t qualify because of health conditions 2) Premiums soar out of this world passing up whole life in cost in later years 3) You simply run out of options on term and must go to whole life way to late costing a fortune. If you have cancer, heart problems, strokes etc you go to a graded benefit which only pays the full face amount 2-3 yrs after the policy is issued. If you pass away before the 2-3 year wait, the beneficiary only recieves the premiums back plus interest. That is a disaster considering that a traditional funeral cost in excess of $10,000. My opinion is that I would rather pay a higher premium while I’m young to lock in the original age rather than have term for many many years and get slammed in my latter years in higher premium. Term policies issued might start out cheap but when you hit 65 it goes through the roof.

  • http://www.qualitytermlife.com/ QualityTermLife

    There can be a place for Whole Life. A commercial reason would be to insure a business partner or loan. And perhaps for people who are well-off, it can be a convenient option bequeath a charity, pay estate taxes, or leave a legacy to heirs. These folks already have their other investments in place.

    But that is not most people. The typical profile of a term life insurance owner is someone who is a family breadwinner and has minimal savings. It is critical protection. If you are in this category and aren’t insured, get insured now! (BTW, insurance through work is almost always inadequate).

    Choose Term Life Insurance for covering specific needs that will disappear with time, such as: Income replacement, Financial security for dependents, Mortgage protection, College funding, Final/burial expenses. Ideal for young families.

    You can use an online quote engine to compare term life insurance prices. There is one at at Quality Term Life where you can look at available rates from nearly a hundred companies. Great needs calculator, too, so you can estimate how much coverage you should get.

  • akbarsheikh

    In spite of knowing the difference between term and whole life, people still get to a road block when it comes to buying a life insurance policy. First thing they need to be clear is what financial purpose they are trying to fulfil.

  • Carol Xu

    Whether you buy term or whole, the age you are when you buy it has the biggest affect on your rates. So, youngsters! Go out and buy life insurance before it’s too late! Life Ant has the best rates I’ve found.. $44 premiums for a 2 million policy. Select Quote is also OK. Good luck guys!

    • Michael Lewis

      Carol,
      Thanks for writing. As you pointed out, someone looking for coverage should get quotes from several companies to be sure they are getting the best deal.

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