Term vs. whole life insurance

Buying life insurance seems daunting. But most people can start shopping by making one key decision:

Do you need term life insurance or whole life insurance?

Both types have their benefits and drawbacks that determine how long you’re protected and how much you pay for your policy. In order to decide between term or whole, it’s important to know how they’re different and what makes them right (or wrong) for your financial scenario. The important things to know are:

• What is term life insurance?
• Pros and cons of term life
• What is whole life insurance?
• Pros and cons of whole life
• The differences between term vs. whole life
• Questions to ask about term and whole life
• How term and whole life are similar

What is term life insurance?

Term life insurance is “pure” life insurance; the policyholder pays premiums and, if they die while the policy is in effect, their beneficiary (or beneficiaries) receives the death benefit.

It’s very straightforward, and that’s a selling point for people who don’t want to complicate their life insurance options. Dying isn’t something most people want to think about, and term life lets people have protection without needing to dwell on it.

Another selling point for term life is the price. Because it’s stripped-down life insurance, without additional fees or maintenance, it’s much more affordable than whole life. Since life insurance is something you need to pay for over the course of decades, affordability is a huge consideration. You can more easily buy the coverage you need at a price point you’re comfortable with than with other types of insurance.

What’s the key definition when it comes to term life?

The term itself.

That’s how long the policy is active, because term life policies automatically expire after a set number of years. This is by design, but as we’ll see below, it’s unique compared to other forms of (permanent) life insurance. It makes term life a good policy for anyone who expects to build wealth over time and won’t need the financial safety net life insurance provides later in life.

However, the term limit also means coverage is limited. If you still need that financial safety net when you’re in your 60s or 70s, you’ll need to shop for a new policy (which may be prohibitively expensive) or convert your term life policy to whole life to continue coverage – a feature typically offered by most carriers for free.

Term life insurance pros & cons

Pros

• Term life is straightforward and policies are easy to understand, so you don’t have to worry about hidden fees, exclusions or risks.
• Term is typically the most affordable type of life insurance.
• You can cancel a term policy before it expires without losing any value.

Cons

• When the policy expires, so will your coverage. If you still want insurance, you’ll need to shop for a new policy or convert your policy into a form of permanent life insurance.

What is whole life insurance?

Whole life insurance is a type of permanent life insurance, which stays in effect for as long as you pay the premiums. (So potentially your whole life.) This means you never have to worry about uninsurability or losing your safety net as you get older.

Besides whole, other types of permanent life insurance include variable, universal and variable universal.

Whole life is more complicated than term overall, but one definition you need to know is the cash value. When you pay your premium on a permanent policy it’s split between the death benefit and the cash value — essentially an investment product coupled with the insurance policy.

How exactly the cash value works depends on the type of policy. For example, in a variable life policy, the cash value acts like a mutual fund, but, with whole life, it’s more similar to a simple savings account. Over the life of the policy, the death benefit shrinks and the cash value component grows until the policy consists entirely of the cash value. You can do many things with the cash value, including taking out a loan, drawing from it for retirement or funding the policy.

You might be wondering:

Why not just have separate insurance and investment vehicles?

That’s the approach most people take, and term life is the right choice for 80-90% of shoppers. But whole life is the better option for some people. If you have your insurance and investment bundled together, it works as a forced savings vehicle so you don’t have to worry about both.

The cash value also works well for people who have complicated financial situations. It’s often used to cover the estate tax, for instance, so your full inheritance goes to your beneficiaries.

But all of this comes at a price – literally. As mentioned, whole life insurance is much more expensive than term, sometimes as much as 4x the cost. So many people don’t buy enough coverage or end up dropping the policy a few years in because they can’t afford it.

Whole life insurance pros & cons

Pros

• Whole life doesn’t expire, so you can keep it for as long as necessary.
• It is sometimes useful as part of a highly customized personal finance or estate planning strategy, thanks to the cash value component.
• It works as a forced savings vehicle.

Cons

• Whole life is far more expensive than term — sometimes up to 4x the cost.
• Because of the cost, people often buy less coverage than they need or surrender the policy early.
• The interest rate you'll receive on the cash value is likely less than you’d get if you invested it in other ways.
• Whole life is more complicated than term life. The surrender value of the policy changes with time, which is something to pay attention to when accessing the cash value.

What is the difference between term & whole life insurance policies?

When you’re deciding between term vs. whole life insurance, it’s important to know which features each policy has that you may or may not need. Use this comparison chart for a more in-depth look at the difference between term, whole and other types of permanent life insurance.

*All permanent policies can be surrendered for their current cash value after a certain number of years, at which point the insurer pays the accumulated cash value minus any loans and fees.

Duration

Term life insurance lasts for a set number of years decided on when you purchase the policy. Terms are between 1-30 years and usually come in increments of 5 years (depending on the carrier). This is ideal for most people: After 30 years, many people have fewer financial obligations. Their mortgage is paid off. Their kids don’t live at home anymore, and they can self-insure with savings. They won’t keep paying for a policy they don’t need.

On the other hand, whole life insurance (and all types of permanent life insurance) lasts for as long it’s paid. The benefit is indefinite coverage: If you find yourself 30 years into the policy and realize you still need coverage, you don’t have to worry about the policy expiring.

If you have a term life insurance policy you aren’t ready to give up, most policies come with a default term conversion rider that turns the term policy into a whole policy without you needing to go through the underwriting process again.

Guaranteed death benefit

No matter what type of life insurance you choose, the life insurance company cannot alter the death benefit. The death benefit is usually untaxed, so your beneficiaries don’t have to worry about receiving less due to taxes.

It’s important to note if you take out a loan on your whole life insurance policy and die while the loan is out, the death benefit may be used to pay back the outstanding amount, meaning your beneficiaries won’t get the full amount.

Cash value

Term life insurance doesn’t have a cash value. This makes it easy to understand but means you don’t get any additional perks.

Whole life insurance has a cash value, and it’s relatively safe compared to other types of permanent life insurance. Whole life insurance offers a guaranteed cash value, meaning it has a minimum growth rate. Other types of permanent life insurance can lose value over time depending on the wider market. However, whole life insurance is a conservative investment option and means you can likely find better returns with different investment vehicles.

Premiums

Whole life insurance premiums are level — they stay the same no matter how long you have the policy.

Term life insurance can come in two forms that affect cost — guaranteed level and annual renewable. Guaranteed level term life insurance keeps premiums the same for the entire policy term, but renewable annual term life insurance must be renewed periodically, each time raising the premiums. Renewable annual policies are best for short coverage periods because premiums typically start low compared to guaranteed level premiums, but get higher later on.

Term vs. whole life insurance questions

Now that you know some of the variables to consider when deciding between term or whole life insurance, you should ask yourself which apply to you. A licensed life insurance expert or financial planner can help you figure out the answers. Some of the questions you should ask yourself include:

• How much can I afford to pay each month for life insurance?
• What are my assets, debts and estate value?
• What investments do I have in place?
• Do I expect to self-insure in the future?
• What are my goals for my life insurance?
• What do I want to leave behind for my loved ones?

By asking these questions, and knowing how term and whole life address each of them, you can make the right choice for yourself and your family.

Common term & whole life insurance definitions

There are differences between term and whole life insurance, but some concepts are the same across types. No matter what type of insurance you choose, here are some basic definitions you need to know.

• Policyholder — The owner of the life insurance policy.
• Premium — The money a policyholder pays, monthly or annually, to keep a life insurance policy active. If it’s not paid, the policy lapses.
• Death Benefit — A (usually tax-free) lump sum of money paid out upon the death of the policyholder.
• Beneficiary — The person(s) or institution that receives the death benefit.
• Rider — A contractual modification to a policy to customize certain provisions.
• Underwriting — The process by which an insurance company looks at an applicant’s financial and health history to set the final premium rate.

Learn the definitions to more common life insurance phrases.

No matter what kind of life insurance you buy, make sure to shop around and compare quotes for the best rate. Everyone is different and each life insurers has its own methods for assessing applicants, so you may get a much cheaper rate with one insurer than another. Not sure how much life insurance you need? Our handy calculator can help you figure it out in 10 minutes or less.