A battle is raging in online communities between those who believe that term life insurance is the only kind of life insurance to buy and those who tout the virtues of whole life insurance. Strong opinions abound, but what are the facts?
Both term life insurance and whole life insurance pay a sum of money--the death benefit--to an individual named in the policy, known as the beneficiary, when the policyholder dies. The purpose of any life insurance is to protect a family against the financial burdens that accompany the unexpected, premature death of a family member, especially one who is a main source of income for the family. The insurance money replaces the policyholder's income, allowing the family to make house and car payments, pay utilities, save for higher education, and anything else it was doing before the death of the loved one. Some insurance professionals advise taking out a policy with a death benefit equivalent of 7-10 years of a breadwinner's annual salary, providing the family with a financial cushion that should last several years.
One of the differences between term life and whole life is the period the policy covers. The difference is reflected in the names of the policies. A term life insurance policy insures the policyholder's life for a set period of time--the term. The term can be any amount of time, but policies generally are sold in increments of ten years, up to 30 years. For example, a person who takes out 20-year term policy on his thirtieth birthday will be covered by the policy until he turns 50. If he dies at any time during the term, the death benefit will be paid. However, if the policyholder dies the day after his fiftieth birthday, no benefit will be paid, because the policy will have expired.
A whole life insurance policy insures the policyholder until death--thus the name whole life. As long as the premiums are paid, the policy remains in force. The premium amount for a whole life policy is set at the beginning and does not change. This is one of the reasons that whole life policies are popular for insuring children: the cost of the premiums remain the same throughout the child's life, even throughout adulthood.
Because term life policies routinely expire without paying a death benefit, they cost 5 to 10 times less than whole life policies do. Affordability is the main advantage of term life. Term life advocates argue that the low cost allows flexibility that matches or surpasses the benefits of whole life. With the low premiums, a person can afford to purchase another term life policy after the active one terminates. In the example above, the person with the 20-year term policy that expires on his fiftieth birthday can purchase another 20-year term policy. Even though the policyholder will pay higher premiums at 50 than he did at 30, over the long haul he still will pay less than with whole life. By the time the next term policy expires, when the policyholder turns 70, he presumably will not need another policy, because his family will no longer depend on his income.
Critics of term life point out that there is no guarantee that a person with term life can get another policy. If the person develops a serious illness, such as cancer, he or she might be deemed uninsurable. A key advantage of whole life is that the policy cannot be cancelled, no matter what medical condition the policyholder develops.
Whole lifers also point out that if the term policyholder outlives the policy, all the premium money is gone. Neither the policyholder nor his family will ever see that money again. The opposite is true with whole life insurance: the money paid in premiums is guaranteed to be paid out in the death benefit. With whole life, the insurance company also agrees to pay the policyholder a sum of money should the policy be cancelled at any point. This amount is known as the surrender value or the cash value of the policy. The cash value can be used as collateral for a loan, or it can be borrowed from the insurance company.
The term lifers argue that even with the accrual of cash value, a whole life policy is a poor investment. They say that a person who needs insurance is better off taking out a term life policy for the same amount as a whole life policy and investing the premium savings in stocks, mutual funds, or even bonds. This would give the person the same amount of life insurance coverage but a larger return on investment.
The investment strategy proposed by the term lifers is sound. Virtually any investment will out-earn a whole life policy. There is a problem with the term life insurance solution, however. It assumes that people will save the difference between the whole life and term life premium amounts. Americans are notorious for taking whatever money they save in one area and spending it in another. It also assumes they have the skill and know-how to invest the savings in something that will outperform whole life insurance. Investments are not guaranteed to grow, as whole life is. It is always possible to lose money on an investment.
The choice between term life and whole life depends on a person's goals, tolerance for risk, and investment style. A person who wants to insure his or her life until death, no matter what illness or condition they develop, probably should opt for whole life. That person will enjoy the security of knowing that the premium money will be paid back in a death benefit and the policy will earn cash value. They will enjoy the convenience of getting life insurance and savings in one payment. A person who cares only about protecting his or her family during the peak earning years and is willing to accept the risk of not being able to get insurance later should opt for term life. This person will pay much less for the insurance, and, if he or she is a disciplined and savvy investor, will be able to invest the savings in riskier but most likely more profitable vehicles.
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