Life Insurance - Choosing Between Whole Life and Term Life

Life insurance comes in two basic flavors: whole life and term life. The main difference is the period covered by the insurance policy. Whole life insures a person until he or she dies—the policyholder’s whole life. Term life insures a person for a limited number of years, the term. Insurance professionals are sharply divided over the merits of the two kinds of insurance. Term life partisans say whole life is a waste of money. Whole lifers disagree, arguing that whole life offers benefits not available in term life. Who is correct? That depends on the insurance consumer’s goals, risk tolerance, and investment savvy.

Term life and whole life are similar in many ways. Both pay a death benefit when the policyholder dies while the coverage is in force. The death benefit can be small or large, depending on the goals of the insured. For example, if the life insurance consumer is concerned only about covering funeral and burial costs, then the death benefit probably would be in the $5000 to $10,000 range. If the consumer wants to ensure that his or her family will be able to maintain its lifestyle after his or her death, he or she would opt for a much larger death benefit—as much as 7-10 times his or her annual salary. This would allow the family to meet its expenses for several years after the death of the insured.

Unless the insured dies during period covered by the term life policy, the insurance company will not have to pay a death benefit. As a result, term life insurance costs much less than whole life insurance, which always pays a death benefit (unless a policy lapses due to nonpayment). Cost savings is the main benefit of term life.

Term life advocates argue that the period during which a family will need to replace a breadwinner’s lost income is limited to the years when the household includes children. Replacing a breadwinner’s income is not critical once the children have grown up and moved away. Depending on how many children are in the family and when the policy is taken out, a 20- or 30-year term policy usually will cover the critical insurance years. The assumption is that after the children are grown, a surviving spouse will be able to support himself or herself. If the spouse does not work outside the home, however, then the breadwinner might want to take out a second term policy after the first one has expired.

The problem with the latter scenario, according to whole life advocates, is that the insurance consumer might not qualify for a second policy. For example, if the insurance consumer has developed a serious and potentially deadly medical condition, such as cancer or AIDS, he or she may be uninsurable, or the price of the insurance might put it out of reach. This can never happen with whole life insurance: the coverage continues as long as the premiums are paid, no matter what medical problems the insured develops.

Whole lifers also point out that other factors can make the term-life window too small. Children may be born with or develop disabilities that make it impossible for them to live independently and leave the home. Similarly, the parents of the insured may become infirm and need to live with the family. Even a spouse may become unable to work due to disease or accident. In each of these cases, the family may need the breadwinner’s income beyond the 20- or 30-year term life period. Depending on the age and health of the breadwinner, a second term life policy can be very expensive, wiping out any cost savings realized by during the first term life policy.

Even in the best-case scenario, whole lifers argue, term life insurance has a major shortcoming: all the money spent on premiums is lost. The term life policy holder will have gained peace of mind, but that is all. If the term life consumer dies one day after the policy expires, the family will realize nothing from the 20 or 30 years worth of premiums that were paid.

Whole life insurance is different. The policy is guaranteed to pay a death benefit no matter when the insured dies. In addition, the premiums paid into a whole life policy contribute toward what is known as the policy’s cash value or surrender value. The life insurance company agrees to pay the policyholder the surrender value of the policy at any time the contract is cancelled. The policyholder can also borrow the cash value from the insurance company, or use it as collateral for a loan.

Term lifers maintain that cash value is a false promise. True, it accumulates, but at a much slower rate than almost any other form of investment. They recommend taking out the same amount of coverage in a term policy at a much lower rate, saving the difference in premiums, and investing the savings in stocks, bonds, or something else. With a good investment, the return on the savings will be much larger than the accumulated cash value of a whole life policy. 

Whole lifers admit that many investments earn more than whole life insurance, but they also point out that not all investments do. Some investments actually lose money, while whole life is guaranteed to accumulate cash value. It also takes time and discipline to make the term life insurance plan work. The consumer not only has to buy life insurance, but he or she has to calculate the savings, commit to saving that amount every month, quarter, or year, and find an appropriate investment for that amount of money. It takes effort to earn the reward. Whole life may pay less, but it is easy and convenient. Choosing between the two is a matter of the consumer’s goals, lifestyle, and personality.