What Is The Difference Between Term & Whole Life Insurance?

One you have decided how much life insurance coverage you need, your next step should be to determine what type of policy is best suited to your specific needs and requirements. In general, there are two main types of life insurance policies that you can choose from: temporary, also known as “term”, or permanent, also known as “whole life”.

Term life insurance is a type of temporary policy, whereas whole life insurance is a type of permanent policy.

Although there can be many individual differences between the two policies, the main difference is in how long each policy lasts for, or in other words, how long it will provide your dependents with coverage.

Permanent Coverage

Permanent life insurance provides you with coverage for your entire life, and when you die, it will pay out a monthly death benefit to your dependents. With a whole life policy, you can also save money in a cash value reserve and will benefit from level premiums.

Per Term Coverage

Unlike permanent life insurance, term life insurance only provides you with coverage for a limited amount of time called a “term”. When your term ends, so does the coverage your policy provides.

In order for your dependents to receive a death benefit from this type of policy, you must die within the designated term that you have been insured for. If you die outside of this term, then your beneficiaries will not receive any money as your insurer will not pay out.

Hungry For More?

We have just described the main differences between term and whole life insurance, but if you are interested in finding out more about these individual policies then please continue reading below.

What Is Permanent Life Insurance?

One of the main advantages of permanent life insurance is that you can take out such coverage without having to worry about it expiring and your loved ones not receiving any money. As a result, this type of policy is suited to more permanent needs, whereby you want to be 100% certain that your dependents will definitely receive financial assistance after your death, whenever that may be.

This money could be used for example, to support your spouse after your passing, support your children through college or university, cover any outstanding debts and/or pay for burial fees and other end of life expenses.

What Determines Cost?

There are two main factors which are used by insurance companies to determine the price of your policy:

1 – Mortality Cost

Mortality cost takes into consideration the likelihood of you dying within a specific time. The more likely you are to die, the higher your premiums are going to be. Age is also another factor that is used in calculating the mortality cost, as the older you are, the more likely you are to die and so the higher your policy costs are going to be.

So in summary, whole life insurance will be more expensive the older you are and the worse your level of health is. But it will be cheaper the younger you are and the better your level of health is.

2 – Policy Costs

Policy costs relate to any expenses incurred by the insurance company such as staff wages, rent of premises and agent commission. These costs may vary each year, although in general, they tend to remain relatively stable in line with inflation.

Policy costs can be considered as a “hidden fee” as it is generally not something that is advertised by insurance companies. You may however, be able to enquire about these costs and then compare the difference policy costs charged by different insurers to help you find the best deal.

Premiums

Even though mortality costs increase each year, most whole life policies offer level premiums throughout your entire life. The reason that life insurers can afford to do this, is because during the early years of your policy you are essentially overpaying due to your insurer averaging mortality costs over your expected life.

These overpayments are set aside in a reserve called a “cash value”, which ultimately allows you to underpay in the later years of your policy. This cash value reserve tends to be quite small during the first few years of your policy due to expenses such as medical exams and agent commissions, but gradually it does build up throughout the course of your policy.

If for whatever reason you choose to cancel your policy agreement, then you are entitled to collect the cash value reserve just as you would collect your savings in a bank. But if you don’t cancel your policy, then that money can be passed on to your beneficiaries when you die, or, it can be used during your retirement years to provide you with an extra source of income to live off.

Because of the cash value reserve, permanent policies are usually much more expensive than temporary policies for the first few years. This is why most people who have a whole life policy tend to be either very wealthy or elderly adults who have upgraded from a term policy, as most young adults cannot afford such high costs straight away.

It is also worth knowing that there are different types of policies that you can take out, each of which offer different options on how your cash value reserve is treated. These policies are whole life, variable life and standard life. The main way in which these policies differ is in the amount of interest that you get on the money in your cash value reserve, and whether or not you can use that money to invest in something else such as stocks in the stock market.

What Is Term Life Insurance?

Term life provides you with coverage for a specific period of time, and it is only during this time, or term, that any death benefit will be paid out to your dependents.

Typically, people take out term life policies in order to insure their loved ones during major life events. For example, you may take out a term life policy to cover a 15 year mortgage, to cover the time while your children are in full time education or to cover a 20 year period while your children are growing up.

The basic premise behind term life insurance is that you are using it to financially protect your loved ones, during the times when they would not be able to survive by themselves without any income. As a result, it is quite common for single parents or sole income earners to take out an insurance policy, as this way they can safeguard the livelihood of their loved ones who depend on their income.

Cost

Another significant difference between term and whole life, is that with term life insurance your policy costs increase as you get older. Depending on your individual policy, this increase may occur every year, every five years or even every ten years. Some insurance providers may even give you a choice as to when you would like this increase to occur.

If you choose to have your increase occur annually, then the rise in your policy costs will occur gradually which may make it more affordable for you. If you choose for your rise to occur every five or ten years however, the rise will be much steeper giving you less time to adjust to the changes.

With some insurers, it is possible for you to pay a level cost each year as you do with permanent life insurance. But this can work out to be quite expensive, as your costs start high straight away rather than increasingly gradually. If you do choose to opt for level costs, your insurer will calculate the amount that you will be charged by taking the total length of your policy, your term, and then dividing that term by the total overall cost of your policy. This produces an average yearly level cost.

But it is important to note that unlike whole life policies, if at any time you choose to end your term agreement, that you will not receive a cash value settlement. This is why term life premiums tend to be significantly less than whole life premiums during the first few years.

However, because premiums will increase each year with a term life policy, eventually, the rising costs do not make it cost-effective to maintain. As a result, most people only tend to take out term life policies for a maximum of 20 years.

Summary Of Differences

Below is a brief summary of some of the main differences between term and whole life insurance policies.

Whole Life Insurance

• A type of permanent insurance.

• Coverage is valid throughout your whole life.

• Offers level premiums.

• Higher premiums.

• Generally a more expensive policy to maintain.

• Offers a cash value reserve.

Term Life Insurance

• A type of temporary insurance.

• Coverage applies only to a specific term.

• Lower premiums at the start.

• Premiums increase over time.

• Generally a less expensive policy to maintain.

• No cash value reserve.

Which One Is Better?

Which policy is better really depends on your reasons for having life insurance and your current financial situation.

With a permanent policy, such as a whole life policy, you will know that regardless of when you die your dependents will still receive coverage from your policy. This means that you can accumulate your policy over time thereby increasing its value, and when you do die, your policy won’t be “wasted”  as your dependents will still receive benefit from it.

If you had a term policy and you didn’t die within the term that you were insured for, then your policy could be viewed as having been wasted because your dependents will not receive any money from it. As a result, a permanent coverage policy tends to offer you the most value for money and the greatest level of coverage.

It is however, also the most expensive life insurance policy that you can take out, especially at the start of the policy. But for those who can afford it, taking out a permanent life insurance policy is usually the best option, although some financial experts will argue that you are better off investing your money rather than spending it on a whole life policy. This statement is only true though, if you are able to invest your money elsewhere and make a greater return on it which is not guaranteed to happen for everyone.

Term life insurance can still be a very useful policy to have, as essentially, you are financially safeguarding important periods in the lives of your loved ones. Hopefully, nothing will happen to you during that period, but if it does, then at least you know that your loved ones will be looked after. And best of all, most people should find this an affordable policy to maintain, and so won’t have to struggle to pay their premiums.