Comparing Term and Whole Life policies...

by Josh Preiser

For many folks, life insurance exists in the area of topics we don’t want to think about.  Admittedly it can be a bit morbid – you can’t think about your need for it without considering your own passing.  There is a statistic out there that says as many as 30% of adults don’t own this valuable financial asset simply because it means a discussion about death. However, once you get past that, you realize that life insurance is an important tool for protecting your family and assets.

People don’t think twice about having car insurance or homeowners insurance to protect them from things that might happen. Hell, those policies are a requirement for most of us. But they fail to see the benefit of insuring their life to protect their families from something that absolutely will happen to each and every one of us.  If you have debt, who is going to pay it when you’re gone? If you have loved ones that depend on you, who is going to provide for them? Who among us wants our family to have to deal with the thought of where the next paycheck is coming from in the days and weeks after we pass? The truth insurance professionals are trying to convey is that you don’t buy life insurance for yourself, you buy it for the people you love.  The trick now is deciding what kind of coverage you need.

Once a person has made the decision to buy life insurance, they inevitably come to a fork in the road: do I buy term or whole life? There are good reasons for buying either, and there are valid causes to go with a combination. The crux of the matter today is understanding the difference between them.

Term life insurance is temporary – it is to cover your obligations IF you should pass away during the chosen time period.  Because the policy covers a specific period of time, it is generally less expensive than whole life because the insurance company faces less risk.  Individuals often use a term policy to protect their families from various debts they might have, like a mortgage, auto loans, etc.  People with families frequently buy policies to provide a financial legacy for their family members.  These folks can either buy a large policy that will provide a big payout for a stated premium for the length of term, or they can layer several policies to cover several different obligations or goals.  Layering is a topic I will discuss in more depth at another time, but suffice it to say that it matches the declining need for insurance over time with the added benefit of reduced premiums as time passes.  Term policies do not have cash value, and if you live beyond the specified term and don’t renew, they expire without paying any benefits.

Whole life, on the other hand, is permanent insurance that pays out its benefit WHEN you pass away.  Also known as cash value insurance, whole life is more expensive than Term for a number of reasons, the most important of which is that it is going to pay out a death benefit (where term might not).  A typical policy is structured to have premiums paid to age 99 or 100 – should you be lucky enough to outlive that, the policy will be considered paid up and you won’t have to pay for it any longer.  One of the features offered by many insurance companies is a customized premium payment plan where you can pay off the entire policy in a specified term (i.e., 10 years, 20 years, age 65, etc.).

A real benefit to Whole Life that isn’t available with Term is that it has growing cash value.  Insurance companies will give you an illustration of how the cash value will build, which is an approximation based on current financial circumstances.  Growth is often centered on some stated range of interest you can earn, but if you choose to work with a mutual company (owned by policyholders), your cash value will be enhanced by dividends based on the performance of the company.  There is limited downside risk to this type of plan as compared to investing in the bond or stock markets, though return rates will vary by company and over time. You are free to use the cash value as you see fit – it is not restricted to any specific purpose like early IRA withdrawals, and most withdrawals are tax free.  Because of this feature, many people buy a whole life policy for their children (to help pay for college, home purchase, life events, etc.), or specifically to supplement their retirement income.  One just needs to keep in mind that funds withdrawn from the cash value will reduce the death benefit.

Surface also sells what are called Final Expense policies - you may have seen these advertised on television with Alex Trebec and the like.  A final expense life policy is a form of whole life insurance.  It is generally going to have a level premium and benefit that will cover you for the rest of your life. One caveat to that is if you have health issues, you may have to work your way up to the full benefit via a 1 to 2 year build up, or probationary, period.  These policies have simplified underwriting, and quite often will be "guaranteed issue," meaning they will issue the policy no matter your health condition (or with very few exceptions).  These are generally offered in smaller increments than regular whole life policies, and may or may not build up cash value.

Remember, Term is temporary insurance that pays if you pass while it is in place, and whole life is permanent insurance that pays when you leave this mortal coil. There are plusses and minuses to both, so understanding what you are trying to accomplish is the key to making the best choice. Always remember, when in doubt you should contact a professional!

Josh Preiser is the Founder and President of Surface Financial LLC.  He has a Bachelor's degree in Economics, an MBA, and nearly 15 years of professional experience in the field of financial services.  He is a licensed life &health insurance agent and registered investment advisor in the state of Wisconsin.