Choosing Between Whole and Term Life Insurance

One of the most frequent questions that people who are interested in purchasing life insurance ask is what type they should purchase: whole life insurance or term life insurance. Whole life policies are still popular among some agents, but term life insurance policies are usually a more suitable alternative.

How Whole Life Insurance Works

Whole life insurance, as the name implies, is meant to cover you for your entire life. It's a type of permanent insurance. As long as you pay your premiums, the insurance can’t lapse. The problem is most people don’t need insurance to cover their entire lives. Most need life insurance for two possible reasons - to insure those that depend upon their income and/or to pay down debt. (For more, see: Understanding Different Types of Life Insurance.)

Nearly all people plan to retire at some point and once they are retired, typically the only income they earn is Social Security. Expenses tend to drop when one spouse predeceases another so replacing Social Security income is often unnecessary. In addition, most people are on track to pay off most of their debt once they retire so there is less need for life insurance in retirement. 

How Term Life Insurance Works

Because life insurance is often unneeded in retirement, the best solution for most people is term life insurance. Term life insurance is insurance that has a level premium for a specific number of years. Term insurance is “pure” insurance in that it lacks the investment component, while whole life insurance has both an insurance, or face value, and a cash value.

The cost of the insurance component itself is lower with term insurance for a few reasons. The primary reason is that the likelihood of a claim is lower with term insurance than whole life insurance. There is an investment component to a whole life policy, which is referred to as the cash value of a policy.

The cash value will grow if you continue to make premium payments. However, if you were to invest the difference in premiums between a whole life policy and a comparable term policy in a low cost diversified portfolio, over the long term the value of the portfolio would most likely exceed the cash value of the insurance policy.

Whole Life Versus Term Life

There are some instances in which the permanent insurance offered by whole life is needed. Parents who care for a disabled child or dependent often need whole life, as do business owners who might need liquidity for their business at some point. Finally, high income earners who want to minimize investment-related income and who also need insurance might find such policies useful.

However, for most people, term life insurance offers the coverage they need at the lowest cost. (For more, see: Buying a Life Insurance Policy? Read This First.)