Most individuals understand the inherent need to purchase health, automotive, and home insurance. If you become ill, get into a car accident, or sustain damage to your house, these insurance policies will help protect you by covering at least a portion of your costs. Life insurance is designed to support your loved ones, who will receive a monetary payment in the event of your death. There are two main types of life insurance: term life insurance and whole life insurance.
Term life insurance ends after a predefined period of time, while whole life insurance has no expiration date. There are a number of important distinctions between the two options, and it is important to understand the dynamics of each before making a decision regarding which one is best for you.
What is Life Insurance?
Any insurance policy is meant to protect you from future events, and life insurance is no different.
The difference is that in this case you are planning for a future in which you are no longer present. While this can be a morbid exercise, it is important to consider every contingency and think about how best to protect your loved ones after you are gone.
The common denominator linking term and whole life insurance plans is that payments today will be exchanged for a future death benefit for your family. However, they are each designed to appeal to individuals at different stages of life and varying financial circumstances.
What is Term Life Insurance?
Term life insurance is the most economical type of life insurance, and it is also in many ways the most straightforward. When purchasing term life insurance, policy holders will decide to become insured for specific periods of time. These terms vary in length, usually between 10-30 years.
Similarly to other types of insurance, you will pay a monthly premium in order to enjoy the coverage. The death benefit payments will be activated if you pass away during this pre-defined term. However, if you outlive your policy, your beneficiaries will not receive any payments.
Term life insurance makes the most sense for those simply looking to cover future fixed costs. For instance, this type of policy can be appropriate if you are looking to make sure that your children are taken care of until they are able to support themselves, or to pay for the remaining balance on a home mortgage.
Because there is a predefined end in sight, these policies are cheaper than whole life insurance.
What is Whole Life Insurance?
Whole life insurance consists of lifetime coverage, without an expiration date. Whole life insurance is therefore a type of permanent insurance, allowing your designated beneficiaries to receive a death benefit payment when you eventually pass away.
The premium payments policy owners make to the insurance provider are divided into three different buckets: the predefined death benefit, the insurer’s fees, and contributions to the plan’s cash value.
In addition to the death benefit, whole life insurance also comprises what is called cash value. This is another tranche of money which gains in value over time, and can be used for a variety of different purposes while the policy owner is still alive.
The cash value portion of a whole life insurance plan can act like a savings account, gaining a tax-deferred, fixed interest rate as well as a portion of the monthly premiums paid by the policy holder. Owners of whole life insurance can withdraw monies from their account or access these funds as a loan, though doing so will often decrease the subsequent death payment for their beneficiaries.
For most plans, the cash value is considered a living benefit. Therefore, when a policy holder dies, any money that remains in the cash value will revert back to the insurance company.
Because it never expires, and because it allows your money to grow over time, whole life insurance is significantly more expensive than term life insurance. Therefore, whole life policies tend to make the most sense for wealthier individuals, especially those who have maxed out their contributions to their 401(k) and IRA accounts and who can afford the higher premiums.
How to Choose Between Term and Whole Life Insurance
Before making any financial decision, you should first understand your finances and make a decision that fits with your budgetary needs.
Term life insurance is much cheaper than whole life insurance. It provides a death benefit coverage for a specified period of time, and is a good solution for those without the means to devote significant sums of money towards a life insurance policy.
Whole life insurance is much more expensive, though it offers significant benefits that extend beyond a predefined period of time. It makes the most sense for those individuals and families that have the means to comfortably cover their monthly expenses, save for the future, while also paying the higher premiums that whole life insurance charges.
Conclusion: Choosing Between the Options
Part of good financial hygiene is planning for all sorts of contingencies, while making sure that you are covered in case the worst happens. The essential of trade-off of any investment decision is putting money aside today for a potential payoff in the future. Unlike standard investments, when it comes to life insurance the benefits will go to help those who you care about the most.
Term life insurance allows you to enjoy the security of a limited-term life insurance policy for significantly less money, making it a good option if you are somewhat strapped for cash.
In contrast, whole life insurance can provide you with long-term protection that never expires, and a pot of money that you can dip into during your lifetime. It is significantly more expensive however, making it less feasible for those who are on a tighter budget.
Deciding between these two types of life insurance boils down to understanding the trade-offs between your current budget and the future financial needs of your family.
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