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What is the difference between term and whole life insurance?
There are two significant differences between term vs. whole life insurance: length that the policy is in effect and the cash value benefit. Term life insurance has a set limit of time for coverage while whole life insurance, which is known as permanent life insurance, remains in effect for your lifetime (as long as you pay your premiums).
The premiums you pay for term life insurance go towards the death benefit you will leave to your beneficiaries. With whole life insurance, the premiums you pay go partly towards the death benefit, and partly towards a savings account component you can access while you are alive.
Take a closer look at the features of each kind of policy:
Whole life insurance
Whole life insurance is a type of permanent insurance because it is designed to cover you from the time you purchase a policy, until you pass away. Whole life is a traditional form of life insurance that features a fixed premium rate and pays a fixed death benefit when you pass away. In addition, whole life insurance also features a cash value savings vehicle.
Here are some important things to know about whole life policies:
- Cash value: Part of your premiums are set aside in a savings account, known as cash value. You have the option to withdraw or borrow the cash value while you are still living, and use the money for any purpose. However, the cash value is usually only accessible while you are alive and will not be included in your death benefit.
- Value to beneficiary: When the insured passes away, their designated beneficiary receives the entire face value (also called the death benefit), less any outstanding loan taken from the cash value. As noted above, any remaining cash value is typically not included in the death benefit.
- Payment schedules: Most insurers give the option to pay a whole life premium monthly, quarterly, semi-annually or annually. The policy covers you as long as you continue to pay the premium in most circumstances, and your coverage lapses if you stop making payments.
- Dividends: If you buy whole life insurance from a mutual company, you might be eligible to receive dividends, based on the company’s financial performance. Reinvesting these dividends can help your cash value grow more quickly.
- Prequalification: Depending on the policy, you may be expected to answer health questions about your medical history and you may be required to take a medical exam. Whole life insurance is generally more expensive vs. term life because the policy covers you for as long as you live and includes cash value benefits.
| Policy features | Pros | Cons |
|---|---|---|
| Cash value | Borrow from or draw on the growing amount | Must be paid back or will be deducted from the death benefit |
| Payment schedule | Monthly, quarterly, semi-annual, annual | May be subject to additional fees for breaking up the payment throughout the year |
| Value to beneficiary | Face value paid to beneficiary regardless of age when you pass away (if over 18) | Any outstanding loan against the cash value could reduce the death benefit amount |
| Dividends | Could earn dividends based on company’s financial performance | Dividends are not guaranteed are only available from certain companies |
| Prequalifications | May not require a medical exam | Coverage could be expensive depending on medical history |
Term life insurance
Term life insurance can be purchased for a set period of time, such as 30 years. When the term ends, your coverage ends, unless the policy is renewable or convertible. And if it is convertible or renewable, you will likely be required to trigger those options several months before your term ends. When comparing term vs. whole life insurance, term coverage is generally less expensive. Consider the following factors that affect term life insurance.
- Terms and medical requirements: Term life insurance often pays a set face value and covers you for a specific period, typically ranging between five and 40 years. The 20-year term policy is the most common, according to the Insurance Information Institute. To get a term life policy, you may have to answer health questions or take a medical exam. Some policies feature a renewable option which allows you to renew the policy for another term on an annual basis, oftentimes without taking another medical exam, but the rate will be based on your current age and it’s likely you’ll be required to decide whether to renew well before your policy term ends.
- Age limits: Many term life policies have an age limit, usually around 80. So, if you want to renew a 20-year policy at age 65, the insurer might only offer you a 15-year term to continue coverage.
- Premiums: Term life insurance companies base your premium on your health at the time of application or renewal, your age and your life expectancy. Term life insurance is much more affordable for people at a younger age and in good health than whole life. However, a common characteristic of term policies is increasing premiums as you age.
- Decreasing term policies: A term life policy can have a level or decreasing term. A decreasing term policy decreases the death benefit over the life of the term, usually at a monthly or yearly rate. Many people choose a decreasing term policy to provide coverage for a mortgage.
- Convertible and return-of-premium term policies: Some term life policies are convertible, allowing you to convert them to a permanent policy after a certain period without taking another medical exam. A policy with a return-of-premium feature pays back a portion of the money you paid after the term ends, but this privilege comes with much higher premiums.
| Policy features | Pros | Cons |
|---|---|---|
| Terms and medical requirements | Terms typically range from five to 40 years and usually involve medical questions, but possibly a medical exam may be skippable | Optional renewable term feature can be expensive, health history may require a medical exam |
| Age limits | Depends on company — usually cannot purchase after age 80 | Seniors may not qualify for term and renewable options may be limited |
| Premiums | Typically much cheaper than whole life for same death benefit | Health concerns could lead to higher premiums |
| Decreasing term policies | Provides coverage for a mortgage | Premiums similar to term with decreasing death benefit |
| Convertible and return-of-premium term policies | Able to convert term to whole life or get a portion of premium returned after term expires | Whole life is more expensive and uses current age when converting, return-of-premium is provided at higher costs |
Term vs. whole life insurance
Whole life and term life policies have one major thing in common — they both pay a death benefit when you pass away. So, for example, if you have a $100,000 term life policy and you pass away during the term, your beneficiary will receive $100,000.
Likewise, if you purchase a $100,000 whole life policy and continue to pay the premium until you die, that policy will pay $100,000. With both term life and whole life, the death benefit is typically distributed tax-free and can be used for any purpose.
| Why choose term life insurance | Why choose whole life insurance |
|---|---|
| Usually has cheaper premiums | Cash value and potential for dividends |
| Good health history could waive medical exam | Good health history could waive medical exam |
| Can typically purchase much higher death benefit amounts | Option to take a loan against the cash value |
| Flexible choice of terms | Life-long coverage |
Age
Whole and term life policies also approach an applicant’s age in a similar way. With both types of life insurance, you will pay a lower premium if you purchase a policy while you are relatively young. If you wait until you are in your 60s, you will pay a much higher rate or may not qualify due to a medical condition.
Duration
When comparing term versus whole life insurance, the two types of policies have a few significant differences. Term life only covers you for the length of the term, while whole life continues to cover you until the end of life under most circumstances. However, some term life policies can be continued after the term ends, if the policy is convertible or renewable, as long as you meet your policy’s deadlines for conversion or renewal.
Prequalification
The process of prequalifying for a term life or whole life insurance policy depends on a few factors, including the insurance company’s underwriting process, your overall health and the amount of coverage you want.
For either term life or whole life, you will need to submit some information about yourself in order for the insurance carrier to determine if you qualify. This might be an in-depth health questionnaire with information about your age, health history, family medical history, surgeries, and hobbies, an in-person medical exam or a phone interview with an agent from the life insurance company.
Some life insurance companies make the prequalification process even easier, requiring just a few simple questions about your age, gender and overall health. However, keep in mind that term life and whole life policies that don’t require a medical exam are typically more expensive. If you are in relatively good health and can pass a medical exam, you will probably find that your premium will be much less expensive.
Savings benefits
The savings account feature of a whole life policy sets it apart from term life coverage. Whole life policies build cash value, whereas term life insurance does not. Some term life insurance policies include a return-of-premium rider, which allows you to recoup a portion of the premiums you paid, but not all policies have this feature.
Which is better: Term or whole life insurance?
Choosing between term life vs. whole life will depend on your goals and needs. Here are some things to consider when deciding which type of life insurance is right for you.
Planning for your future
It’s important to choose a life insurance policy that aligns with your future financial needs and goals. To determine how much life insurance you need, you might want to use a tool such as a life insurance calculator to get a ballpark figure and consider consulting with a certified financial planner before you purchase the policy to ensure you are purchasing the right policy for you.
Growth opportunity
If you are looking for a policy where your money will grow, a whole life insurance policy might be the best option. Most whole life insurance policies have cash value, which grows at a fixed interest rate, and can be withdrawn while you are still living. You can also find whole life policies that can potentially earn annual dividends, possibly increasing your cash value even more. Keep in mind that most cash value accounts will not be included in your death benefit.
There are several other types of permanent life insurance that can grow your money, as well. Universal life policies work like whole life policies, but funds deposited into the cash value account earn money based on a money market interest rate. After your universal life policy matures, you can also alter the premium payments using your cash value.
Variable life insurance policies also provide permanent coverage, while offering even more flexibility by enabling you to invest the savings portion of your policy in bonds, money market mutual funds or stocks. However, variable life policies can pose a greater risk because you could decrease your cash value and death benefit if your investment underperforms.
Life stages
The best type of life insurance for you will also depend on your current stage of life. For instance, if you are young and want a low-cost policy, term life insurance might be a good choice. If you choose a flexible policy, like variable life, and invest well, you could see significant earnings by the time you retire.
And, you can use term life policies for added protection during critical periods of your life. For instance, if you just sent your daughter off to college, you could buy a five-year term policy to cover the cost of her education in case you pass away before she graduates.
