Term vs. Whole Life Insurance Explained

Benjamin Franklin famously said, “In this world, nothing can be said to be certain, except death and taxes.” Which is why in dealing with the first, at least life insurance is such a smart investment. You can’t predict when it will happen, but you can still plan to keep your family financially protected after your death.

You have two main options when it comes to coverage: term life and whole life insurance. Both provide your beneficiaries with a lump-sum payment upon your death, but they work differently, so understanding the difference is important.

What is Term Life Insurance?

Term life insurance provides life insurance coverage for a set amount of time, known as a term. The most common terms are 10, 20, and 30 years. As long as your death occurs within your term, your beneficiaries receive a set payout to cover funeral expenses, bills, and other important costs basically replacing your income. If you’re still alive at the end of your term, your policy can be renewed or converted to extend coverage.

Generally, you pay monthly premiums to maintain the insurance policy. The premiums are often quite low. Depending on the exact nature of your policy, they often increase as you get older, however. Also, the insurance will only pay out the exact amount of the policy, known as the face value. All the premiums you pay into it won’t earn anything above the original amount of insurance you bought.

Which leads us to whole life insurance.

What Is Whole Life Insurance?

Whole life insurance, on the other hand, does build up an additional sum alongside the face value of the policy over the years. Known as the cash value, this sum can be borrowed against, or even withdrawn outright. Also, a whole life insurance policy lasts your entire lifetime; there’s no need to renew it. Once you buy it, you (or your heirs) are guaranteed a payout, which will be the policy’s face value plus any accrued cash value.

All this means that, not surprisingly, whole life is more expensive than term life. However, you only need to pay premiums until a certain age. After that age, you essentially “own” the policy.

Many people are drawn to whole life insurance as an investment strategy because the cash value grows tax-free, and in most cases, can be withdrawn tax-free, too. But keep in mind that it often takes more than a decade to build up significant cash value. You have the ability to withdraw a portion of your cash value during your lifetime, but if you don’t pay it back then that amount is deducted from the payout upon your death. Also, you have to be careful not to withdraw too much. In some cases that cash value goes to pay your premiums for the insurance; without it, the policy could lapse.

Also, insurance companies charge annual fees, which can be high compared to those of, say, mutual funds. There are often more productive and profitable ways to invest your money.

Compare Your Options

Let’s compare the real-life use of term and whole life insurance. Say a 30-year old man wants to purchase $250,000 in life insurance coverage. He’d spend about $200 a month for a term life policy, and $2,150 monthly for a whole life plan. (These numbers are ballpark averages and just to illustrate the argument. For quick quotes, try Policygenius.com.) 

If he chooses a term life insurance policy, he pays $200 a month over the next 20 years and has the peace of mind of knowing that his family receives $250,000 if he dies unexpectedly. He can also renew his policy for the same price (or a slightly increased price, depending on his age) to extend his family’s financial protection.

If he chooses a whole life policy of $250,000, he’ll pay $2,150 a month and gradually build up a cash value in the policy over 10 or 15 years. He’ll have the ability to redeem the cash value while he’s still alive, but doing so will diminish his death benefit. If he doesn’t touch it, after his death, his beneficiaries will receive $125,000, plus whatever cash value built up, which could add substantially to the overall sum.

Final Thoughts on Term vs. Whole Life Insurance

The bottom line? Term life insurance is great if you want a simple, affordable plan that provides clear-cut financial benefits to your family. Whole life insurance is a good choice if you are willing to pay more every month for the ability to maintain coverage as long as you live, and receive some return on the money you invested in the policy.

Read about micro-investing and how to get started with our complete guide: Micro-Investing: What It Is, Why It’s for You and How to Start.