Term versus whole life insurance: It’s a debate everyone must consider before buying a life insurance policy.
A Money Talks News reader named “Richard” wrote us the following question about this decision:
“I’m 40, with two kids. I’ve been checking out life insurance lately, and one of my friends told me I’m much better off getting whole life rather than term. What’s your opinion?”
You’re right to consider life insurance, Richard. Unless you have a ton of savings or a very high-earning spouse, life insurance is a great way to protect your family in the event of your untimely death.
The term versus whole life argument has been going on for decades. Here are the pros and cons of each.
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The types of life insurance
There are two types of life insurance. There’s term, which insures your life for a certain term — like five, 10 or 20 years. Then, there’s permanent life insurance — such as “whole life” coverage — that you theoretically keep until you die.
Now, consider how people typically use insurance. They buy term insurance when they’re relatively young and have young kids. Should they die prematurely, the death benefit will take care of their family.
They maintain their coverage until age 60 or so, when the kids are grown to be on their own and the need for insurance fades. As they reach the end of the term and insurance starts getting expensive, they don’t need it anymore, so they drop it.
Note that with term insurance, the only way to get cash from the policy is to die. Like your car, home and health insurance, it’s protection. It’s not an investment.
As the name suggests, permanent insurance is a policy you intend to keep permanently. Part of your monthly premiums pay for the death benefit, and another part goes into an internal savings account.
With a permanent policy, you don’t have to die to reap some benefits because you’re building cash value. This type of insurance could be considered an investment.
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Permanent is more expensive
You’re probably thinking, “Since whole life insurance comes with an investment account, and it’s bound to pay off sooner or later, it’s a better deal, right?” Well, not necessarily, because it costs a lot more.
Here’s an example I recently read: A 30-year-old, healthy, nonsmoking woman can get a $1 million, 20-year term life insurance policy for $500 a year. But that same woman buying the same $1 million death benefit in a permanent policy might pay $10,000 a year.
It’s building some cash value, but is this the best possible use of your extra cash?
In other words, it’s an investment, but is it a great investment?
There’s a common expression among many financial advisers: “Buy term and invest the difference.” It means that instead of putting $10,000 annually into a cash-value, permanent policy, you’re better off paying $500 for a term policy that will protect your loved ones, then investing the $9,500 difference into something else, like maybe a stock mutual fund.
Why? Because permanent life insurance policies have a lot of fees and administrative expenses that often make them less efficient as an investment than other choices.
Permanent isn’t always bad
There are situations where permanent insurance makes sense. For example, if your heirs could be facing an estate tax problem, permanent insurance can help pay the taxes when you die.
However, you’ve got to be rich for that strategy to make sense: Your estate would have to be worth $11.58 million or more for federal estate taxes to apply.
Life insurance as an investment does have other benefits. For example, you don’t pay taxes on the interest or other earnings until you take them out. Also, you have the ability to borrow against a cash-value policy.
Still, most experts will say these benefits aren’t enough to offset the higher expenses that often accompany these policies.
I hope I answered your question, Richard. If you feel like you got some value from my thoughts, sign up for my free, awesome newsletter.
For more information, check out “7 Questions You Need to Ask Before You Buy Life Insurance.”
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I founded Money Talks News in 1991. I’m a CPA, and I’ve also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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