If you’re shopping for life insurance, there are two main types you’ll likely encounter: term life insurance and whole life insurance.
Depending on who you talk to, you’ll hear different arguments for and against both types, which can make it difficult to figure out which type of life insurance will provide the right protection for you and your family.
This guide breaks it all down so that you can make the best decision for your specific situation.
What Is the Purpose of Life Insurance?
Before getting into the debate over term versus whole life insurance, let’s take a step back and remind ourselves why life insurance is important to begin with.
While there are some rare exceptions, life insurance primarily serves one main purpose: to provide financial protection to people who are financially dependent upon you.
In other words, life insurance makes sure that there will always be money available for the people who depend on you financially, even if you’re no longer there to provide for them.
A good example of this is a couple with young children. A toddler obviously cannot support herself financially, and life insurance makes sure that there would be financial resources to care for her no matter what happens to the parents.
Other examples of financial dependents might include a spouse who would struggle to handle all the bills on his or her own, or parents who have co-signed for your student loans.
So before you start thinking about which type of life insurance you need, ask yourself the following two questions to better understand why you’re getting life insurance at all:
- Is there anyone who would struggle financially without your support? If not, you probably don’t need life insurance.
- If so, for how long will they be dependent upon you? Is it a fixed time period or is it relatively permanent?
Your answers to those questions will help you sort through the term versus whole life insurance debate with a clearer, more personal viewpoint.
The Basics of Term Life Insurance
Term life insurance is coverage that lasts for a set amount of time, typically 5-30 years. Once that period is up, the policy expires and your coverage ends.
That expiration may sound like a problem, but it’s actually similar to most other types of insurance. Things like auto insurance and homeowners insurance are typically annual policies that have to be renewed each year, and you would cancel your coverage if you no longer had a need. Similarly, term life insurance is meant to provide coverage only for as long as you actually need it.
Let’s look at the pros and cons.
The Benefits of Term Life Insurance
Term life insurance is typically the most cost-effective way to get the protection you need. In fact, it’s often 10 times less expensive than whole life insurance for the same amount of coverage, especially if you’re relatively young and healthy.
The main reason for the price difference is that term life insurance eventually expires, meaning it has a smaller chance of paying out. And again, that may look like a downside, but...
The Coverage Period Lines Up with Your Need
Most people only have a temporary need for life insurance. Your kids will eventually grow up and be self-sufficient. Your spouse can eventually rely on retirement savings and Social Security income. Your joint debt will eventually be paid off.
Term life insurance provides financial protection for the amount of time that you need it and no more. You should hope it doesn’t pay out, because that just means that you didn’t die early. Like your car insurance, it’s good to have in case of an emergency, but the best case scenario is never having to file a claim.
In addition, if for some reason your situation changes and you no longer need life insurance, you can simply cancel your term life insurance policy and be done with it. Again, it’s coverage for as long as you need it and no more.
It’s Easy to Shop Around
Term life insurance policies are fairly simple and therefore pretty generic. As long as you’re looking at insurance companies with a strong financial rating, you can largely shop on price alone.
For example, using the Term4Sale quote engine, a 34-year-old nonsmoking male in New York City with “Preferred” health status could get a $1 million 30-year term life insurance policy for as little as $939.98 per year or as much as $1,255.30 per year. And again, because term life insurance is fairly generic, you can compare those premiums with the confidence that your policy would be just as good either way.
You Can Typically Convert to Whole Life
What happens if you end up needing life insurance coverage longer than you originally thought? Since term life insurance eventually runs out, wouldn’t that be a problem?
It is a risk, but most term life insurance policies allow you to convert your policy to whole life insurance without medical underwriting as long as you do it before the policy expires. Your premium would increase significantly upon such a conversion, reflecting the increased liability the insurance company is taking on by providing permanent coverage. And if for some reason your policy did require medical underwriting at the time of conversion, there would be the risk of an even bigger premium increase if your health has declined since you originally got the policy.
Not all policies have this conversion feature, but those that do remove the risk that you wouldn’t be able to get permanent coverage later on if you need it.
The Downsides of Term Life Insurance
It's More Expensive as You Get Older
Term life insurance is typically inexpensive if you’re relatively young, but it gets more expensive as you get older, especially if you’re looking at policies with longer terms. And the reason is simply that your odds of dying increase as you age, which means the insurance company faces a bigger risk.
For example, a 54-year-old male looking for the same $1 million, 30-year term life insurance policy we mentioned above is looking at an annual premium of $5,894 to $6,780 per year.
If you’re in your 50s or above and looking for life insurance, a term policy may or may not end up being a cost-effective way to get it.
It May Not Last as Long as You Need
Life is hard to predict, and it’s certainly possible that you end up needing life insurance for longer than you originally expected. If that happens, your term life insurance policy likely won’t have a lot of flexibility that allows you to extend it, beyond converting it to whole life.
There are also some insurance needs for which permanent protection is simply better. Those are rare, but we’ll talk about them below.
The Basics of Whole Life Insurance
Whole life insurance has two primary features:
- It provides permanent coverage, meaning that it will never expire as long as you continue to pay the premiums.
- It includes a savings component that builds up over time and can eventually be used for a variety of purposes.
There are several types of whole life insurance that have slightly different features and serve different purposes, like universal life insurance, variable life insurance, and equity-indexed life insurance. For the purposes of this article we’ll focus on the basic whole life insurance that most people will come across, and for the most part, all of the following pros and cons would apply no matter which type you’re talking about.
The Benefits of Whole Life Insurance
It Can Handle a Permanent Need
If you have a permanent or indefinite need for life insurance, whole life insurance is the way to get it.
For example, if you have a child with special needs who will likely be dependent upon others for his or her entire life, whole life insurance may make sense. Or if you will have multiple millions of dollars to pass on to your heirs, whole life insurance can help with estate taxes and preserve your family’s wealth.
Most people don’t have these kinds of permanent needs, but if you do, then whole life insurance can be valuable.
It Can Be a Form of Forced Savings
For people who struggle to consistently save money, whole life insurance can be a way to force yourself to build long-term savings while also providing financial protection.
It may not be the most efficient savings account, as we’ll talk about below, but having some savings is better than having none, and the savings you do accumulate can be withdrawn for any reason. Taxes are also deferred while the money is inside the account, which can be a benefit for high-income earners who have already maxed out their other tax-advantaged savings accounts.
It's Can Be Structured to Meet Your Goals
If you work with a life insurance professional who really knows what they’re doing, you can specially structure a whole life insurance policy to serve specific purposes.
For example, if your main goal is permanent life insurance protection, you can structure it to minimize the savings component and make that protection as cheap as possible. If your main goal is to build savings, you can structure it to minimize other costs and front-load your contributions to grow your savings as quickly as possible.
If you can find a life insurance agent who’s willing to work with you in a fiduciary capacity, meaning they put your interests ahead of their own, you can get fairly creative and structure your whole life insurance policy to meet your specific needs.
The Downsides of Whole Life Insurance
Whole life insurance is an expensive way to get the financial protection you need. For example, remember the 34-year-old male who would pay $939.98 per year for a $1 million 30-year term life insurance policy? According to LLIS, a team of independent insurance advisers, a $1 million whole life insurance policy for the same individual would be $11,240 per year. That’s 12 times more expensive for the same amount of coverage. (Though, to be fair, for a longer coverage period.)
There are also a lot of hidden fees that add to the cost, from the sizable commission paid to the agent who sells you the policy to the management fees associated with the policy’s savings account.
Unless you truly have a permanent need for coverage, whole life insurance is probably not the most cost-effective way to get it.
Most People Don't Have a Permanent Need
The simple fact is that most people don’t have a need for permanent life insurance coverage. As your children age and your savings grow, the financial impact of your death decreases until there’s little to no risk.
It might be nice to know that whole life insurance will eventually pay out, but is that something you need? And if not, is it worth paying those big premiums over all those years instead of putting that money elsewhere?
Don’t be fooled into thinking that your insurance has to pay out for it to be valuable. If you don’t have the need for permanent coverage, you shouldn’t pay for it.
It's Not an Efficient Savings Vehicle
The savings component of whole life insurance might sound attractive, but the truth is that it’s not an especially efficient way to save money.
It takes a long time for the cash value to build up. It’s often 7-10 years just to break even, and even over long periods of time in the best of circumstances the return is likely to be low.
Not only that, but withdrawals from your account are actually loans, meaning you’re typically charged interest for the right to use your own money. Can you imagine if your savings account at the bank charged you interest each time you took money out?
Finally, unlike other savings accounts where you can simply decide to pause or decrease your contributions for a while if you hit a rough patch, your whole life insurance premiums are due like clockwork no matter what. Your policy can lapse if you fail to pay your premiums, losing you both the protection you need and the savings you’ve built up.
The truth is that unless you’ve already maxed out all your other tax-advantaged savings accounts — like your 401(k), IRAs, health savings accounts, and 529 accounts — the tax benefits of saving within a life insurance policy likely aren’t worth it. And even then you may be better off using a taxable brokerage account, depending on your specific goals and circumstances.
Which Type of Life Insurance Is Right for You?
If you’re purely looking for the financial protection that life insurance provides, and if your need is temporary, then term life insurance is likely the best option for you. It’s the cheapest way to get the protection you need, leaving more room in your budget for your other goals and obligations.
And for most people, quite honestly, that’s the end of the discussion. Most people don’t have a need for permanent coverage and will be better off putting their savings elsewhere, like regular savings accounts for short-term needs and dedicated retirement accounts for long-term investments.
But there are a few situations in which some kind of whole life insurance can make sense.
If you have a truly permanent need for life insurance, such as a child with long-term special needs, then a whole life insurance policy specially designed to provide the protection you need at the lowest cost possible may be well worth it.
And if your income is very high and you’re already maxing out all other tax-advantaged investment accounts, a whole life insurance policy can be a way to get some additional tax-deferred savings. Again, you’d ideally want it to be specially designed to minimize fees and maximize the amount that goes toward savings.
In any case, remember to focus on the reason why you’re getting life insurance in the first place and to make decisions around that need. The right type of life insurance will likely be pretty clear as long as you keep your personal goals at the forefront.
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