Whole or Term Life Insurance? The Definitive Guide

According to the American Council of Life Insurers (ACLI), in 2014, 63.7% of all individual policies sold in the U.S. were whole life, compared to just 36.3% of policies being some type of term life insurance coverage. Thus, we should expect that whole life insurance is the way to go, right?

"It's very easy for trusted companies to mislead naive customers, and life insurance companies are trusted." - Nobel Laureate, Daniel Kahneman

Yet this article is going to prove that term life insurance is better in almost every situation. The return on investment (ROI), internal rate of return (IRR) and total dollars accumulated are better than whole life insurance regardless of when you die, and during each and every time period you can think of. If you live to your life expectancy, you will have accumulated nearly 19 times more money choosing term over whole life!  

Despite this evidence, emotions play a significant role in insurance sales, which is why you are likely to purchase the wrong type of life insurance even after hearing what was stated above. Fancy illustrations and confusing jargon will blur your mind and raise questions about whether or not you are doing what is best for your family. Since you can’t trust the insurance companies, the purpose of this article is to equip you with concrete evidence that will give you the confidence you need to make and stick with the right decision on life insurance. Before we go any further, it’s important to define the role of life insurance. Life insurance should be used to replace economic losses, prevent estate taxes, and to a much smaller extent, protect your assets from creditors. Life insurance is not an investment and it should not be used as one. Keep your investments and your life insurance separate. Combining them makes money for the insurance company, not for you. (For related reading, see: Is Life Insurance a Smart Investment?)

The rest of this article will tell you what type of insurance to buy and when, and then it will provide a full mathematical analysis proving why a term policy is better for your net worth.

When Should I Purchase Whole Life Insurance?

Only if you need to prevent or pay for estate taxes (In 2017, your assets need to exceed $5.49 million if single, $10.98 million if married). Otherwise, always avoid whole or universal life insurance. Yes, always. There are a lot of “special” situations that insurance salesmen will attempt to use to justify the purchase of permanent insurance, but it’s simply best to avoid it entirely unless your assets are above the estate tax level. If you are above the age of 60 and you want a high death benefit to be passed on to your family, you are basically creating a bet with the insurance company on when you will die. The odds are not in your favor to win this bet, thus mathematically, it isn’t wise.

When Should I Purchase Term Life Insurance?

In just about every other case, as it’s always the insurance to buy when you are protecting against economic loss. Once your assets reach a level where you can absorb an economic loss without insurance, you no longer need the insurance. As a rule of thumb, purchase 10-15 times your annual income, and cover yourself until age 60 or so. (For related reading, see: Whole or Term Life Insurance: Which Is Better?)

When Should I Purchase Life Insurance for My Kids?

Unless your child is earning a very high income or has a very high net worth on his or her own, never. You don't need life insurance for your children as they do not have a positive economic value and the odds of them dying before the age of 24 is .002%, or 1 in 500. It’s often discussed that children could have an uninsurable disease that would prevent them from getting their own life insurance later on in life. Mathematically speaking, there is an even smaller chance than .002% of that happening, so it’s not wise to insure that kind of risk. (By comparison, you have a one in three chance of having a disability of 90 days or longer while you are working, which is why disability insurance is important to have.)

Mathematical Comparison of Whole and Term Life Insurance

Now, onto the mathematical analysis that supports the preceding claims.

To keep things as simple as possible, we will compare level premium whole life and term life insurance. We could run this kind of analysis with all different types of permanent life insurance and the results would be different, but the end result would always be the same, which is that term is better for your overall net worth.

We are going to purchase insurance as 30-year-old you, one day after your birthday (The same thing can be done for any age, the numbers just change, but again, the end result is the same.).

  • Whole life: Cost is $8,800 per year for your entire life, $1 million death benefit
  • Term life for 30 years: Cost is $750  per year until age 60, $1 million death benefit

Each year, you will pay the $8,800  whole life premium and you will pay the $750 term life premium. You will then invest the cost difference between whole life and term life ($8,050 per year). We will not use any riders on the whole life insurance and all of the numbers will be adjusted for costs, inflation and taxes, giving you your real return. This is extremely important, as inflation and costs are a powerful force working against any insurance contract. We could add riders to the whole life policy to protect against inflation (also adding cost), and the numbers would change, but the end result, with term being better, would still be the same. So we will opt for simplicity here instead. 

We will look at what happens if you die early at age 40, early at age 60, after your term expires at age 61, and if you live to your full life expectancy at age 82. Spoiler alert: Term is better in every situation according to ROI, IRR, and ending dollar value.

The math is clear, term life insurance is the right choice, and it’s a great choice to protect against economic loss. Now, go step confidently into your future.

(For more from this author, see: Use Insurance to Protect Your Assets From Creditors.)