When choosing a life insurance policy, one of the first choices you’re likely to make is whether to choose term life insurance or whole life insurance.

Generally, term life insurance is best for someone who needs the most affordable life insurance option for a fixed length of time. But whole life insurance is a more flexible component of your financial plan. Whole life insurance not only lasts for your lifetime, it also has a cash value component that can help provide a source of liquidity if you need it in the future.

It’s also possible to have both term life insurance and whole life insurance at the same time.

What is term life insurance?

Term life insurance is a type of life insurance policy that pays a death benefit if the insured person dies during a specified term. If the policyholder is still alive at the end of the term, no death benefit will be paid out.

Term life insurance policies also have no cash value component, so policyholders don’t get any value from a term life insurance policy beyond the death benefit.

Benefits of term life insurance

Affordability

Because term life insurance covers a fixed term and might not need to pay out a death benefit, premiums are lower than they would be for a whole life policy with the same size death benefit. This also means that with term life insurance, the same premium would buy a larger death benefit than it would with a whole life policy.

Flexibility

You can choose the time period you want to cover, for example, a 10- or 20-year term, or until a certain age, such as 85. Shorter terms have lower premiums. You may want to consider a shorter term if you’re only looking for coverage for a short time — for example, if your youngest child will graduate college in less than 10 years and your spouse works, you may feel that you only need to insure the loss of your income at your death if it happened in the next 10 years.

Longer durations of coverage, such as to age 85, generally have the most affordable premiums in the early years but do get higher as you age.

Standardization

Term life policies usually share some basic features: length of term, renewability and the ability to convert to whole life insurance. This makes it easier to compare different term life insurance policies to find the one that best meets your needs and budget.

Limitations of term life insurance

Coverage will end

Term life insurance only lasts as long as the term you selected.

Circumstances change, and the term that seemed sufficient when you first got coverage may not meet your new needs. Maybe you realized your children will need financial support for longer than you anticipated, or your spouse has stopped working unexpectedly.

If you discover that the loss of your income would cause hardship for a longer time than you expected, you may need a new term life policy or a whole life policy. Since you'll be older when you apply for the new policy, your rates will be higher, or you may have a new health condition that makes you unable to get a new policy at all.

No cash value

Term life insurance does not include a cash value component like whole life insurance does. Cash value can provide a source of liquidity over time that you can access during your lifetime, and which is guaranteed to never go down in value.

How term lengths work

Term life insurance policies are typically offered in 5-year increments; the shortest term could be as short as 5 years, while longer policies can go up to 30 years. Not all companies offer all term lengths. To choose the right term length for you, consider the following factors:

Amount of coverage needed

Consider all of the financial obligations you would want covered if you died during your policy's term. These can include your children's educations, support for a nonworking spouse, mortgage payments, or other unpaid debt.

Length of time you'll have dependents

If you have children that you plan to support until they are financially independent, you'll have to estimate when that will be. For some it may be until college graduation, and for others it may take longer.

If you have a spouse or aging relatives you support, you’ll likely want to consider a longer term or whole life insurance. Even with a working spouse, you may still need to replace your income in order for your family to maintain the level of financial security they are used to.

Future sources of funds

How much retirement planning have you and your spouse done? The fewer sources of retirement income you have, the more coverage you may need to support the other if one of you passes away.

Converting term to whole life insurance

When you buy a term life policy, it may include the option to convert to whole life insurance. This option lets term policyholders enjoy the benefits of a whole life policy without undergoing a new medical exam.

It's best to convert as soon as you can, because there may be time limits for when certain conversion benefits are available.

Second, premiums will likely be based on your age at the time that you convert, so the sooner you do convert, the more permanent death benefit you will be able to acquire for a given premium amount.

Finally, the sooner you convert, the longer your cash value has to grow. Like all things that involve compound interest, the longer the time horizon, the better the appreciation.

What is whole life insurance?

Whole life insurance is a type of insurance policy that lasts for your entire lifetime, paying a death benefit to your beneficiaries when you die, and providing a cash value component that you can access for any reason. Some whole life insurance policies also pay dividends that can be used to increase the value of your policy or taken as a distribution.

Benefits of whole life insurance

Lifetime coverage

Whole life insurance lasts for your full lifetime. As long as you pay your premiums, your beneficiaries will receive a death benefit, no matter when you die.

Cash value

Whole life insurance policies include a component known as cash value that can be used a source of liquidity as it grows. Essentially, a portion of your premiums goes toward funding the cash value, which will never go down in value.

Over time, after enough cash value has accumulated, you can access it during times when you need cash or borrow against it (although doing so could lower your death benefit).

Dividends

Some insurance companies may pay dividends on whole life insurance policies, which can be taken as a distribution or used to increase the value of your policy (While a dividend is not guaranteed, Northwestern Mutual has paid a dividend every year since 1872.)

Limitations of whole life insurance

Higher premiums

Whole life insurance premiums are higher than term life premiums for the same death benefit. If you're on a tight budget and want whole life insurance, you may have to go with a smaller death benefit versus what you would get with term life insurance.

More complex than term

Term insurance is pretty basic, but whole life and other forms of permanent life insurance have extra features you need to consider. Depending on your policy, your cash value my grow at different rates, or how dividends are paid out can differ by company. That’s why it’s a good idea to talk to a financial professional to talk through your options before choosing the best policy for you.

Whole life insurance cost ranges

The cost of getting whole life insurance, like all life insurance, goes up as you get older or your health changes. Gender also plays a role: women live longer than men on average, so women are considered less risky to insure and tend to pay lower premiums than men for the same policy.

The best way to get as low a premium as possible is to apply for a policy at a young age. A woman who applies for a whole life insurance policy at age 30 could pay as little as $1,200 per month for a $100,000 policy. The same woman would pay more than double that amount if she waited until age 50 to get whole life insurance.1

How to choose the right life insurance for your budget, family and future

Life insurance is an essential part of a comprehensive financial plan. Your policy should always be personalized for your circumstances, taking into account your dependents, your financial situation and your health. When you compare whole life insurance vs. term life insurance, you'll want to consider all the following factors:

  • How much of a death benefit do you need?

  • How long will your dependents need financial support?

  • How much can you afford in premiums?

  • Will you benefit from having access to the cash value in your life insurance policy?

  • Are you in good health?

It can be complicated to compare the pros and cons of whole life insurance to those of term life insurance, but a financial advisor can help you choose the best policy to meet your needs.

Utilizing the cash value through policy loans, surrenders, or cash withdrawals will reduce the death benefit; and may necessitate greater outlay than anticipated and/or result in an unexpected taxable event.

1Rates are for a 30- and 50-year-old female, best rating class, using Whole Life Plus 100.

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