Understanding the Basics of Life Insurance: Term vs. Whole Life Policies

Life insurance offers peace of mind and helps ensure that loved ones are taken care of. Choosing the right policy is key; after all, life insurance choices may impact a family's future financial security.

An understanding of available options helps when making these important coverage decisions. One often-asked question lies in the difference between two common types of life insurance: term and whole life.

In a nutshell, it comes down to cost and length of coverage. Term life insurance usually costs less and offers coverage over a set length of time. Whole life insurance tends to cost more, but lasts for the policyholder's lifetime and accrues cash value. Each type of policy offers advantages. Let's dive deeper into the differences between term and whole life insurance policies.

What is Term Life Insurance?

Term life insurance is simple. This type of policy provides coverage over a set time period, or "term." Typical coverage terms range from five to 30 years. When that set time period ends, the policy expires. Term life insurance pays a guaranteed death benefit to beneficiaries if the policyholder passes away within the term of coverage. Benefit payouts are exempt from income tax.

Most policies have fixed premium rates that don't change, making term life insurance a straightforward option that's easy to understand and manage. And because this type of coverage is shorter, it tends to cost less. Typically, the younger the policyholder and the shorter the term, the lower the premiums.

Why Choose Term Life Insurance?

For many, term life insurance offers peace of mind at a reduced cost, thanks to lower premiums. They're straightforward and don't usually require a medical review.

Term policies can be a good choice for those who need to create a safety net for a certain time period. For instance, parents may purchase term insurance until dependents become adults, or ensure that a mortgage or loan debt can be paid if they pass away unexpectedly.

But what happens if a policyholder outlives the term? Some policies may offer a return of premiums if the policyholder doesn't pass away within the set term, or the option to convert to whole-life coverage when the term ends.

Other term life insurance policies may include premiums that increase or decrease over time. This type of policy comes with a corresponding change in guaranteed death benefit amounts.

What is Whole Life Insurance?

While term insurance offers coverage over a set period of time, whole life insurance offers coverage across the policyholder's entire lifespan. As long as premiums are kept current, whole life insurance will pay a guaranteed death benefit upon the policyholder's passing. Premiums are fixed, so they don't change throughout the policyholder's life. As a general rule, the greater the death benefit, the higher the premiums.

There's one more thing that sets whole policies apart from term: a cash value component. Over time, part of the premium payments are saved at a set interest rate, so value accrues. The cash value component allows policyholders to use whole-life policies as savings and investment tools.

Gains are tax-deferred, so no taxes are due while the cash value accrues. Plus, policyholders may borrow against the value, or cash it out. (Of course, this reduces the death benefit.)

However, whole-life policies have higher premiums. Some plans determine premium costs based in part on a mandatory medical exam.

Why Choose Whole Life Insurance?

Whole life insurance is a good choice for those who want the peace of mind of knowing that their beneficiaries are guaranteed a payment, regardless of the policyholder's lifespan.

Whole insurance policies can also act as a tax-advantaged investment vehicle, allowing policyholders to grow their savings.

Conclusion

The main differences between term and whole life insurance come down to the length of coverage and cost. Term life policies offer lower costs and simplicity. Whole life insurance policies are more complex and cost more, but offer cash savings that can grow over time.

Both coverage types help ensure future financial security for beneficiaries. In fact, 71% of those with life insurance say they'd be financially secure if a primary wage earner passed away, as compared to only 48 percent of those without coverage.

Choosing life insurance can feel overwhelming. Work with an independent insurance agent (like Leap | Carpenter | Kemps) to compare options from multiple insurers; we'll help identify the best policy at the best rate.

To help you get started, download this free guide, Why Low-Cost Insurance May Not Be the Best, to learn more about choosing the right coverage.