Life insurance is an agreement between an insurer and a policyholder, designed to support the policyholder’s loved ones should they pass away. The policyholder agrees to pay a monthly premium and, in exchange, the life insurance company agrees to award a large sum of money (called the “death benefit”) to their loved ones in the event of their death.
Life insurance contracts come in two major categories: term life insurance and permanent life insurance (often called “whole life insurance”).
The specific components of these two products can get a bit murky—and to make it even more confusing, there are subcategories of each type of insurance—but the biggest policy differences are in pricing and term length. Term life insurance is relatively cheap and lasts for a limited amount of time, whereas permanent life insurance is more expensive but is not limited by a term length.
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Before you decide which product is right for you, let’s go into more detail about both products.
Term Life Insurance: An Overview
When people talk generically about “life insurance”, they’re usually talking about term life insurance. Term life insurance lasts for a set period of time, with term lengths lasting anywhere from 10 to 30 years. If a policyholder dies while the term is still active, the policyholder’s chosen benefactors receive the death benefit. If the policyholder ages out of the contract or stops paying premiums, their coverage ends.
Insurers take on less risk with term life insurance, as most policyholders are expected to outlive their term length. Lower risk for an insurer means lower premium payments for a policyholder: a win-win situation for both parties.
Term life insurance is designed to maximize benefit for everyone. If you think of your coverage needs visually, they’d probably look like a bell curve. You need a lot of coverage in middle adulthood (when your dependents are young and debts are high, the “peak” of the bell curve), but not as much at the beginning or end of adulthood (when dependents become financially stable, the “troughs” of the curve). The great thing about term life insurance is that, by the time you outlive your term, you probably don’t need the financial safety net anymore.
Types of Term Life Insurance
There are a few different term life insurance plans available:
- Decreasing term: The death benefit lowers over the length of the contract, meaning the premiums get cheaper as time passes.
- Convertible term: Term life insurance that can be converted into permanent life insurance at the end of the term.
- Renewable term: Term life insurance that’s priced at a set date, with pricing renegotiated (usually at a higher price point) at the renewal period.
Permanent (Whole) Life Insurance: An Overview
Permanent life insurance is a bit more complicated than term life insurance. With permanent life insurance, your coverage never ends: if you always pay your premiums on time, your beneficiaries are guaranteed to receive the death benefit at the time of your passing.
Insurers take on more risk with permanent life insurance. Due to the high probability that the insurer will have to pay out the death benefit, premium payments tend to be much higher than for term life insurance.
People turn to permanent life insurance for two common reasons: 1) they want to leave an inheritance to their heirs that is tax-free or 2) they want to add to a trust fund for their life-long dependent (such as a child with a disability).
Others might turn to permanent life insurance for the investing component, the main feature of whole life insurance.
Whole Life Insurance
The most popular type of permanent life insurance is called “whole life insurance.” In addition to the death benefit, whole life insurance has a cash value component. As a policyholder pays into their premiums every month, some of that dollar amount is set aside into an investment pool that has a cash value.
Over time, policyholders can make use of these funds. They can take out funds for personal use, borrow against funds for large purchases, or even use funds to pay off upcoming premiums.
Cash value funds are typically “use it or lose it”: beneficiaries receive a death benefit on the death of the policyholder but not any of the cash value.
Types of Permanent Life Insurance
There are several different kinds of permanent life insurance, all iterations of whole life insurance:
- Whole life: Permanent life insurance with a cash-value component.
- Universal life: Whole life insurance with a cash-value component that gains interest.
- Indexed universal: Whole life insurance with a cash-value component that earns at a fixed rate of return.
- Variable universal: Whole life insurance in which the cash-value component is invested in a separate account.
Term vs Whole Life Insurance: Policy Summary
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|Chance of investment dividends||X|
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Pros and Cons
Term and whole life insurance both have their benefits and drawbacks. To help illustrate which insurance is right for you, check out our pros and cons of both:
Term Life Insurance
- Premium prices are usually much lower than for whole life insurance.
- If timed correctly, the contract term typically ends when a policyholder’s dependents become financially independent, making coverage unnecessary.
- Term life insurance policies can often be transferred into a permanent life insurance policy, if desired.
- Coverage may end before the death of the policyholder, leaving beneficiaries with no death benefit.
- Term life insurance does not have or accumulate cash or investment value.
Permanent Life Insurance
- Coverage lasts for a policyholder’s entire life, meaning a death benefit payout is practically guaranteed.
- Coverage supports a cash-value component that can be used for investments, savings, or borrowing.
- The death benefit is typically tax-free, making permanent life insurance ideal for passing on an inheritance or supporting a trust fund.
- Premiums are expensive, often 12x more expensive per month than term life insurance.
- Policyholders without life-long dependents or heirs may not require coverage in late adulthood.
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Once you’ve decided whether term or permanent life insurance is best for your financial goals, the next step is to compare quotes. For accurate pricing, we recommend you get quotes from multiple insurers. Once you’re armed with a series of quotes, you can compare prices, coverage term lengths, and other policy details to see which insurer is offering the best deal for you and your family.