Do you have people in your life who depend on you for their well-being? Maybe a spouse, young children, or elderly parents living under your roof? If so, there’s a strong case to be made that life insurance isn’t just something that’s nice to have — it’s a necessity.
And yet, a recent study from the Financial Health Network found that a third of households with children (34%) don’t have a life insurance policy in place. Life insurance isn’t the most fun thing to think about, and it might not be appealing to pay for something you hope you’ll never have to use. But it’s a topic that needs to be addressed in your home — because protecting your family’s financial future if you were to pass away is a key part of everyone’s financial plan.
Covering the basics: What is life insurance?
Life insurance is basically a contract between you and an insurance company. They agree to make a payout, also known as a death benefit, to your loved ones if you were to pass away in exchange for regularly paid premium payments.
This insurance coverage provides individuals and families with peace of mind because it secures their loved ones’ financial stability and overall well-being if anything were to happen to the insured party. In a nutshell, it’s designed to step in to replace your income if you were to pass away unexpectedly.
Life insurance can also provide a way for your loved ones to pay off any outstanding debt at the time of your passing or fund future needs and goals, like your child’s college education.
Naturally, the next question is what type of life insurance should you get? In general, the debate swirls between two types of life insurance: term life and whole life (or permanent) insurance. As their names suggest, term life insurance offers pure life insurance coverage for a set amount of time, while whole life insurance covers you for the rest of your life.
But there are several key factors to keep in mind when you’re choosing which life insurance policy is right for your needs. Let’s talk about both types of insurance — what they are, how they work, and the key differences between the two so that you can make the best decision to protect yourself and your family.
Learn more: What is universal life insurance?
What is term life insurance?
Term life insurance is a type of policy that provides coverage for a set period of time. It’s usually sold in increments of five years, and a policy term usually lasts anywhere from 10 to 30 years. You get to decide how long of a term you want based on your and your family’s needs. The longer the term, the higher your life insurance premiums will be.
How does a term life insurance policy work?
With a level term life policy, you’ll pay fixed premiums regularly (usually on a monthly, biannual, or annual basis). In return, the insurance company agrees to pay out the death benefit to your beneficiaries if you pass away while the policy is active. Your loved ones can use this payout to cover anything from funeral costs and large medical bills to regular monthly expenses like housing, utilities, groceries, and education.
If you die during your term, the insurance company will pay out a tax-free death benefit to your beneficiaries. But if you die after the policy term expires, the insurance company doesn’t pay a dime.
Once your term life insurance policy is about to expire, you might have an opportunity to renew it for another term. But whether or not you’ll want to renew your policy depends on your age and life circumstances. If you have a level term plan, your premiums will cost more if you sign up for another term since you’ll be older and more expensive to insure. However, you could opt for a shorter term, a lower death benefit, or both, and get a lower premium as a result.
What is whole life insurance?
Whole life insurance provides permanent, lifelong life insurance coverage and also comes with a cash value savings component. Unlike term life coverage, the policy doesn’t have an expiration date and spans your entire lifetime. And as long as you continue to pay your premiums on time and in full, your designated beneficiaries will receive a guaranteed death benefit payout when you pass away.
Just like with the term life policy, the death benefit is paid out to your beneficiaries free of any income tax.
Learn more: How to file a life insurance claim
How does a whole life insurance policy work?
With most whole life policies, your premium is fixed and doesn’t change throughout the policy’s lifetime. If you signed up for a policy today and the premium is $500 per month, that’s the amount you’ll be expected to pay 10, 20, or even 50 years from now.
Let’s talk about the cash value savings component, which is what makes whole life insurance different from term life insurance and is one of the major selling points for insurance companies when they pitch whole life policies.
Sometimes referred to as a “living benefit,” a portion of your premiums goes toward building up cash savings within the policy. Some whole life insurance policies (but not all) may also offer dividends, which pay a share of the insurance company’s profits back to the policyholders who help make their company successful. These dividends can be used to grow the cash value, or they can also be taken out as direct payments.
The money in the policy grows tax-deferred, meaning it will not be taxed as long as it continues to grow in the account. But you will pay taxes on any funds you withdraw.
But here’s the catch: If you pass away, your family will receive the death benefit, but the cash value savings will most likely end up going back to the insurance company. You can either take money out of the cash value savings while you’re still alive, or you can take the money with you if you decide to cancel the policy.
If you pass away while the policy is in place, then your beneficiaries (usually your loved ones) will receive the death benefit. For example, if you have a $750,000 whole life policy, that is the amount your spouse or your children will receive when you pass away. But if you had $50,000 sitting in cash savings at the time of your passing, they probably won’t see any of it.
Term life vs. whole life insurance: Key differences at a glance
The main differences between term life and whole life insurance can be summed up in three categories: cost, the length of coverage, and the cash value. Let’s walk through each of them one by one.
Cost
Full stop, whole life insurance is much more expensive than term life policies. Since term life coverage is temporary, offers only pure life insurance, and doesn’t build cash value, its premiums are significantly lower.
How much of a difference are we talking about? On average, whole life insurance premiums can be anywhere from five to 20 times more expensive than term life insurance. That’s definitely something to keep in mind as you’re weighing your options.
Length of coverage
Term life insurance policies come with an expiration date. Once it’s over, that’s it. Whole life policies, on the other hand, are permanent. They’re meant to last as long as you continue to pay the premiums for them.
When you’re deciding what type of life insurance is right for your situation, you need to consider whether you’ll only need life insurance for a set period of time or if you need life insurance on a more permanent basis.
Cash Value
Unlike term life policies, whole life comes with a cash value component that many insurance salespeople use as a major selling point. It’s also the main reason whole life policies are more expensive than their term life counterparts.
Term life insurance simply offers the death benefit in exchange for your premiums, pure and simple. Whole life insurance markets itself as a way to have life insurance and save up for future expenses.
How much does each life insurance plan type cost?
To determine the amount of your premium, the insurance company will take a few factors into account, including your age, overall health, life expectancy, and more. If possible, it’s best to get life insurance when you’re young and healthy, since it becomes more expensive as you get older.
Both term life and whole life take the same factors into account when it comes to the price of your life insurance plan:
While whole life insurance costs more than term life insurance policies because of the cash value component, term life policies, in particular, will take the length of the term into account to determine the cost of your policy. The longer the term, the higher the premiums.
The cost difference between whole life and term life policies is substantial. Let’s say you’re a healthy, nonsmoking, 30-year-old male looking for a life insurance policy with $500,000 worth of coverage.
If you wanted a 20-year term life insurance policy, your premiums would probably be around $30 to $40 per month. What about a whole life insurance policy with the same amount of coverage? Those premiums would probably cost you between $390 and $490 per month.
Monthly Life Insurance Premiums by Age and Gender ($500,000 Coverage)
The rates above are based on Policygenius average monthly premium data for people with few health conditions who don’t smoke. Term life rates reflect a level 20-year term.
Who should choose term life insurance?
If you’re simply looking for the life insurance coverage you need — nothing more and nothing less — then term life insurance is for you. There are several reasons, but the main one is cost. Term life insurance gives you more bang for your buck. When everything is equal, it provides you with the life insurance coverage you need at a better price point.
Who should choose whole life insurance?
All that said, whole life insurance policies do have their place, and it might make sense for certain folks in certain situations. For example, a whole life policy may be the way to go in some scenarios, including the following:
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If you have children with special needs who will be dependent on you for financial stability for their entire lives
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If you or your family has a health history that includes a genetic condition or major illness that may prevent you from qualifying for term life policies
Can you convert term life to whole life? Or vice versa?
While you can’t convert a term life policy into a whole life policy, most insurance companies will allow you to convert a term life policy to a whole life policy at any point. The only time you might want to do this is if you realize that you might need life insurance on a more permanent basis due to a health condition or changing life circumstances.
If you want to get rid of your whole life policy in exchange for a term life policy, then you’ll need to cancel your whole life policy first. Just make sure your term life insurance policy is active and in place before you cancel your whole life policy, so you don’t have a gap in coverage.
Term life vs. whole life: Which is better?
For the vast majority of people, a term life policy makes the most sense because it gives you the life insurance coverage you need with lower premiums.
With a level term policy, you can get lower premiums and use the hundreds of dollars in savings (when compared to whole life premiums) to save in a high-yield savings account or invest with tax-advantaged retirement accounts like your 401(k), an individual retirement account (IRA), or with a taxable brokerage account.
A whole life policy makes sense for those with special circumstances or who want a cash value savings component. One thing to keep in mind: After fees and commissions, the average annual rate of return on the cash value of a whole life insurance policy is usually somewhere between 1% and 4%. A high-yield savings account or money market savings account offers better rates of return than that. And if you’re looking to invest for the long term, you won’t have to look too hard to find index funds or mutual funds that produce better returns than what you would get with cash value from a whole life policy.
But again, each person’s circumstances factor into whether term life or whole life is the better choice. Before you sign up for a policy, it’s always a good idea to get quotes from different insurance carriers to make sure you’re getting the best possible price and coverage available.
Term vs. whole life insurance FAQs
What is the main difference between term and whole life insurance?
The main difference between term and whole life insurance is that term life only provides pure life insurance coverage for a set amount of time, while whole life provides a cash value component along with life insurance coverage on a permanent basis (as long as premiums are paid).
Which is cheaper, term or whole life insurance?
Since term life simply offers life insurance coverage for a certain amount of time and nothing else, it is often cheaper than whole life insurance, which comes with a cash value savings component.
What happens if I outlive my term life insurance policy?
If you were to pass away after your term life insurance policy expires, then your beneficiaries would not receive a death benefit payout from the insurance company. Your loved ones only receive the death benefit if you were to die during the term when the policy is still active.
Can I have both term and whole life insurance?
Yes, you can have both a term life and a whole life insurance policy. However, having both types of insurance would be redundant in most cases. Based on your and your family’s needs and health history, it often makes more sense to choose one or the other to cover your life insurance needs.
What is “cash value” in whole life insurance?
The cash value in a whole life insurance policy is a savings component that supplements the life insurance coverage you receive. Part of your premiums go toward building this cash value, and the money grows tax-deferred within the policy. You can withdraw money from the account at any time while you’re still alive, or if you cancel the policy. If you pass away, the cash value goes back to the insurance company.
Can I get a term life insurance policy through my workplace?
Some employers offer a group term life policy, and it’s usually free, but keep in mind that the amount of coverage they provide is minimal, so you’ll likely still need to get a policy outside of work to supplement that coverage.