Out of these two types of life insurance, which is better?
Here’s a clue—they each have a different purpose. Because of this, people shouldn’t be deciding between term life or whole life. Instead, let’s explore each type and assess when to use them.
Term Life Insurance
How does term life insurance work?
Like its name suggests, term insurance gives you protection for a specific term, often anywhere from 10 to 30 years.
Term insurance is protection from a catastrophic loss. If you don’t end up needing it, great! However there are no other benefits embedded in a term insurance product. Because of this, term insurance is often inexpensive (if you get it when you’re relatively young and healthy).
When you’ve reached the end of the term, the policy stops, and you are no longer insured. If you think you still need life insurance, you can apply for another policy. However, the premium will be higher because you are older. If you’ve developed any sort of health issue, you might not be eligible for a new policy.
Why should I buy term life insurance?
- To protect your family. If someone else is dependent on your income, you need life insurance. Think of the amount of life insurance to get as “years of income replacement” for your family.
- To protect your share of the business. If you’re in a business partnership with one or more people, what happens if you pass away? Ideally, a buy-sell agreement outlines how your share of the business is reassigned. The proceeds from the life insurance can be used by your partners to buy out your share from your spouse.
- To cover a key employee. If your business employs a key employee whose untimely death would hurt the business financially, a life insurance policy can be bought to help with the transition period.
- If your budget is tight. Since term insurance is fairly inexpensive, this is probably the best option for getting the death benefit you need.
Whole Life Insurance
How does whole life insurance work?
Term insurance protects you for a specific period of time, but whole life insurance is designed to insure you for your whole life.
Besides having a death benefit, a whole life policy also builds a cash value that grows over time. You can access this cash value when you’re alive through withdrawals and policy loans.
Because everyone eventually dies, you can be sure your whole life policy will be used for its intended purpose—to pay a death benefit. This means premiums for a whole life policy are much higher than term insurance premiums.
If you buy a participating whole life policy, you will receive non-guaranteed dividends from the insurance company. Most of the time, people keep these dividends inside their insurance policy to purchase more insurance. While your premium is fixed, both your cash value and your death benefit can increase over time!
Why should I buy whole life insurance?
- To protect your family. Because of the higher cost of insurance, a family opting for whole life tends to buy a combination of whole life and term life to get their desired death benefit.
- When planning for retirement. A whole life policy can make retirement easier. The death benefit can be used to backstop the purchase of an income annuity, creating your own lifetime pension.
- If leaving a legacy is important. When used as part of a retirement income plan, a whole life policy can increase not only retirement income, but legacy wealth for your heirs.
- To fund a conservative growth asset. Cash value in a participating whole life policy can be an alternative to fixed income and should complement a growth portfolio like stocks or a privately-owned business.
What’s best for you?
For most, a term policy will provide the necessary death benefit while the need is most important (usually to protect your family). However, it’s important to weigh the merits of a whole life policy and decide for yourself if you would like to incorporate it into your financial plan.
As you can see, the benefits and uses of whole life extend into retirement and are really a retirement planning tool.
If you do purchase a whole life policy, be sure to know why you are buying it. You need higher cash flow to commit to the insurance and it will take several years for the internal rate of return on the cash value to be positive. This makes it tempting to dump your whole life policy after a couple years, which would be a waste!
Need help determining your life insurance needs? Schedule a phone call with me to discuss your personal goals.
