The two main types of life insurance are whole life and term life insurance. Knowing the differences between whole life and term life insurance can help you determine which is best for your life insurance plan.
For some people, whole life might be the best solution. For other people that need to insure for a certain amount of time, term life insurance might make the most sense. Or, some life insurance plans might combine a little bit of whole life and term life insurance in order to make the plan more cost-effective, because term is usually cheaper than whole life.
What is life insurance?
If you have an active life insurance policy and you die, the insurance company should pay your beneficiary or beneficiaries the death benefit on your life insurance policy.
The death benefit is the amount that the beneficiary is owed according to the life insurance contract. If it’s a whole life insurance policy, that death benefit may be less any outstanding loans taken against the policy.
As long as you were honest during the application process, your named beneficiaries should receive a death benefit upon your death, as long as the cause of death is not excluded from the policy. For instance, some companies may have a two-year contestability period that would not pay a death benefit during this period if suicide was the cause of death.
What is whole life insurance?
Whole life insurance is permanent life insurance. It should be with you for the rest of your life, as long as you pay your premiums on time. Even if you were to get a disease that would make you uninsurable, your coverage is already in place – assuming you were honest during the application process. Unlike term insurance, whole life policies have cash value and you may receive dividends on these policies. You may also opt for the paid up addition option, where the dividend is used to buy a piece of life insurance that builds into the value of the policy.
The premium on a standard whole life policy is always the same for the duration of your life, assuming the policy is kept in force by making timely payments.
“The only thing that can vary is the dividend, which is based on the expense ratios and the investment portfolios that the company has,” says Marvin Feldman, CLU, ChFC, RFC, president and CEO of Life Happens.
What is term insurance?
Term insurance is temporary life insurance. It is a policy that is a contract for a set amount of time.
Unlike whole life, term insurance doesn’t have cash value. For instance, a 10-year term policy would have the same monthly payment – or annual payment if you pay it annually – every month for that 10-year period. Term is usually more cost-effective than whole life. But sometimes you get what you pay for. Once a term insurance policy ends, you may have to apply for a new policy – if an insurance need still exists. You’ll be older when the policy ends, and generally people don’t get healthier as they age, meaning your next policy will likely be more expensive.
A term policy may work best to cover a time-sensitive event. For instance, if you have a 15-year mortgage, you may want to get a term insurance policy to pay off the mortgage if one of the borrowers passed away. Or if your child is 5 years old and you want to make sure that college is paid for, a 20-year term could insure that.
Feldman says that term insurance works well for the items that need 10 to 20 years of life insurance.
“But you get beyond 20 years, the cost-benefit relationship between permanent and term really switches over to the permanent because you’ve built so much value over the years,” Feldman says. “And if you would stop the permanent at the end of the 20 years, your actual net out of pocket at the end is nominal — if anything, you may even have a profit. So, you have to look at what you’re trying to cover and for how long you want that coverage to stay in effect to determine what product is most appropriate.”
Term insurance can be the best of both worlds
Many term life insurance policies have what is called a conversion privilege. This may allow a customer to convert their term insurance policy into a whole life policy.
Feldman says very few clients understand or know about this feature. Feldman says he is currently helping a customer who bought a 10-year term policy nine years ago. He has developed some very significant heart issues and is currently uninsurable. So, Feldman is helping this customer convert since there is no medical test necessary for the conversion in this instance. And since his original policy was issued as an elite non-smoker, his whole life policy will also be at an elite non-smoker rate, even though he is uninsurable.
“So, it locks in the underwriting classification when you go through that conversion,” Feldman says. “Chances are very, very few people out there truly understand the flexibility that they have in the term.”
That’s where an insurance expert comes into play, whether that is a life insurance agent, an advisor or a company.
Feldman says if you’re buying a 5-year term policy you may have five years to convert, and if you have a 10-year term, you may have 10 years to convert. But some of the 20-year term policies he says only allow you to convert through the first 10 years.
And some companies may only allow a conversion during the first five years, if they allow a conversion, no matter how long the contract is for. So, always check with your individual life insurance company to see what its conversion policy is.
An easy way to think of whole life and term
Think of whole life as buying a home and term as renting. When you buy a home, you are building equity. And when you sell that home you may profit if it went up in value. If you walk away from a whole life insurance policy, or surrender it, you may get some cash back if a certain amount of time has passed.
Term is like paying your landlord for 10 years. If you pay your landlord rent for 10 years and tell that person that you’re moving, you don’t get any equity back. (A security deposit isn’t equity.) The same thing happens if you terminate a term policy — you paid money into the policy, but don’t get any money back.
Life insurance for babies and toddlers
Life insurance is available for infants and children. Unlike traditional whole life and term policies for adults, the death benefit usually isn’t the main focus. Items such as a guaranteed insurability option may be important to have if a child is uninsurable in the future because of disease or illness.
Feldman says he remembers one client who had a child who developed severe epilepsy and had a life insurance policy as a child. The child died from an epileptic seizure while in his apartment while away at college.
“Everybody thought, ‘(Oh) you don’t need that,’” Feldman says.
In this case, the policy paid for funeral costs and helped set up a nonprofit foundation to help people get treatment for epilepsy.
Feldman says he got policies on his children and grandchildren as soon as they were born. And he used the cash value from a policy that his father gave him to purchase his first home.
Life insurance for seniors
These policies are usually called funeral expense or final expense policies. They usually have a death benefit under $20,000 and typically are for people 50 to 80 years old. These types of whole life policies may not have medical exams, and they might not ask health questions.
The low death benefit is meant to cover expenses that a family would incur for a burial or funeral. Be aware that these policies may have a limited death benefit during the first two years.
How much life insurance do you need?
Getting the right amount of life insurance is important so that if something happens to you, your family is adequately covered. Bankrate’s life insurance calculator can help you figure out the proper amount of life insurance you should get.