Life insurance. It's one of those things that no one ever likes talking about, but it's essential to ensuring any wealth you've built is preserved for your future generations as an inheritance. Something that isn't discussed enough is term vs whole life insurance pros and cons.
In a study by the Life Insurance and Market Research Association (LIMRA), it was determined that over 100 million households (40%) are uninsured and underinsured. In addition, 44% of households in the U.S. would face financial hardship if the primary wage earner died.
These stats highlight why having life insurance is essential. No matter what type of life insurance you choose, it's a way to shield your investments and assets to make sure they're distributed properly to your designated beneficiaries if something happens to you.
Even if you have no investments or assets at the time of your death, having life insurance can ensure that your loved ones are taken care of when you are no longer here.
So, the two types of life insurance are term life insurance and whole life insurance. But which should you get? Let's get into the difference between term life insurance vs whole life insurance, and the benefits of term insurance and whole, so you can make a financially sound decision.
Term life insurance vs whole life insurance: What's the difference?
Let's take a look at each, along with the term vs whole life insurance pros and cons:
What is term life insurance?
A term life insurance policy is life insurance coverage that covers you for a set period of time and has no cash value account associated with it.
As a result of this, the premiums are often lower than a whole life policy, which is one of the benefits of term insurance. When you choose a term life policy, you'll choose a certain duration of years to be covered; typically a 10 or 20-year term policy. So it's long-term but not lifetime insurance.
This insurance breaks down into two different types of term life insurance:
Group term life insurance
Group term life insurance is insurance that an employer offers to its employees as a benefit. It covers the employees of the company instead of a single individual.
However, the coverage of this policy can run short of what your needs may be, so you may want to consider purchasing an individual policy. Or you could expand your existing coverage and pay the premium difference that your employer provides.
Individual life insurance
Individual life insurance is more expensive but provides more coverage that will fully protect your loved ones when needed.
You also get to customize your coverage with this type of policy rather than settling for what your employer offers with their group plan. It's good to research and calculate how much life insurance you need for your unique situation.
What is whole life insurance?
Whole life insurance, also called permanent insurance, is life insurance coverage that combines life insurance with investments and lasts the entire lifetime of the person insured.
This is one of the big differences when considering term life insurance vs whole life insurance. This addition of investments is called "cash value" and is placed in a cash-value account. It is also known as cash value life insurance.
With a whole life insurance policy, you'll pay monthly premiums for coverage, but a portion of that amount will be put into an investment account. Your beneficiaries will receive any excess premiums at the time of your death.
With a policy like this, the premiums are often higher due to the additional benefit of the cash value account.
What is a cash value account and how does it work?
When you pay your insurance premium, they will use part of it to actually pay for your insurance. But the other part goes into an investment account that accumulates wealth over the life of the policy, aka, your lifespan. This account is called a cash value account.
With a cash-value account, you can withdraw money from your policy in the form of a loan plus interest. This is a great feature, but one catch is that if the loan hasn't been paid back at the time of your death, the death benefit amount paid to your beneficiaries is decreased by the outstanding loan amount.
Here are a few ways you can use a cash account:
- To create supplemental income in retirement
- For payments toward future policy premiums
- To pay for you or your child's education
Other types of permanent life insurance
Index universal life is another type of universal life insurance. You can't lose money with an index universal because the cash value interest rate can't go down, but it can go up. However, there's a limit to how high it can go.
Variable universal life insurance has no limit on how high or low it can go. So there's the potential to make a profit on the cash value, but it is riskier than an index universal.
You've already heard about traditional whole life policies, and that will be explained in more detail soon.
Pros and cons
When it comes to term life insurance vs whole life insurance, how do you decide what is best for you? Well, just like any big financial decision, it comes down to the advantages and disadvantages. So let's dive into the term vs whole life insurance pros and cons.
Benefits of term life insurance
It's always better to start with the good news first, right? So here are a few benefits of term life insurance:
Specified coverage terms
With a term life policy, coverage lasts for a specified number of years instead of for your entire life. For example, you can choose a policy term of 10 years.
So if you have a life insurance policy of $150,000 for a 10-year term and you passed away, then your family would receive the $150,000 from the policy. This makes term life insurance more affordable than a whole life policy.
Fixed payment premiums
One of the benefits of term life insurance is that your premium payments are a set amount for the specified coverage period. You can choose terms ranging from 10, 15, 20, and 30 years and the premium will be that price through the entire term.
Can convert to a whole life policy
If you decide to, you can convert your term life insurance into a whole life policy. However, you will have to convert it before the deadline clause. Be sure to know the details of the conversion clause because it can save you from having to do it later if you need it.
More affordable policies
Because there is no cash value accumulation like there is with a whole policy, the premiums are lower. This could be a good option if you are searching for a more affordable policy that fits into your budget. Price is one of the big benefits of term insurance.
Disadvantages of term life insurance
Now that you know the benefits of term life insurance let's dig into the disadvantages of term life insurance.
You could potentially be denied
When you renew your policy, your insurance company may require you to answer questions about your health and submit to a physical exam all over again.
If you were to develop a health condition it could increase the cost of a new policy. Also, the insurance company may prevent you from renewing your policy due to your age.
Limited coverage due to age
One of the big disadvantages of term life insurance is limited coverage. As you get older, the number of years your life insurance coverage may be renewed is limited.
For example, if you obtain insurance at 20, you can choose coverage for 10, 15, 20, and even 30-year terms. But at 60, providers may limit you to shorter terms of 10 or 15 years.
Premium costs for a term life policy can increase with each policy renewal. So if you choose a ten-year policy and then decide to buy another, the life insurance cost could increase significantly with each renewal.
Benefits of whole life insurance
There are many benefits of whole life insurance; here are a few of the biggest reasons you should consider a whole life insurance policy:
The biggest difference when comparing term vs whole life insurance is the type and length of coverage you get.
Remember with term life you will have coverage for a certain timeframe, but with whole life, it is lifetime coverage. That is great for peace of mind when it comes to protecting your family financially.
Whole life policies have cash value
Another one of the biggest benefits of whole life insurance is you have the benefit of cash value accumulation. Again, you can borrow from your cash value account to supplement retirement, future premium payments, or your child's education.
If you invest in a dividend-paying whole life policy, you have the potential to earn annual dividends based on your policy amount.
This is when the company pays an annual amount to its policyholders if they perform well. Although the amount may vary, it's still one of the best benefits of whole life insurance.
Disadvantages of whole life insurance
Let's get down to the nitty-gritty of the disadvantages of whole life insurance.
Premiums are higher
Since you will have lifetime coverage and cash value with your policy you will pay a higher premium. So you will need to review your budget to see if you are able to afford the coverage you will need to invest in.
Benefits can reduce
Again, if you borrow from your policy and there is an outstanding balance, the amount of benefits will reduce.
You will need to determine if it's worth risking that chance when borrowing from your policy fund. Assess your financial situation first before diving into your cash fund.
You could earn more with better investments
You are likely to get better returns investing in an index fund for example. Building generational wealth through strategic investments may earn you more return than what a whole life policy could offer.
So now you know the disadvantages of whole life insurance and the term vs whole life insurance pros and cons, but do you even need life insurance? Let's discuss.
Is it necessary?
You probably have insurance on your home, rental property, car, cell phone, pet, jewelry, and even your vacations, right? So why not your life? After all, your life is your most valuable asset!
You've heard about term vs whole life insurance pros and cons. But, if making the decision to purchase life insurance is difficult, answer these questions first:
- Does anyone rely on my income for their daily living?
- If I pass away today, is there enough money to cover the mortgage and other bills and debts?
- How would my income be replaced to provide for my family and support the education or college tuition of my kids or dependents?
- Will my family have enough to cover my funeral expenses without causing financial hardship?
Two main reasons to get life insurance
Depending on how you answered the above questions, here are 2 main reasons why you may want to consider getting life insurance:
- For the cost of your burial and final expenses.
- To replace lost wages from your passing.
Which should you get?
Term life insurance vs whole life insurance can be tough to compare. But it's important to come back to what your needs are. As stated earlier, life insurance is a way to shield your investments and assets and make sure they're distributed properly to your designated beneficiaries in the event of your passing.
It is not designed to be a money-making scheme. And if you are leaning towards whole life insurance solely for that reason (cash value), you should seriously consider the high premiums and sub-par returns on whole life insurance investments, which is one of the disadvantages of whole life insurance.
Ideally, your goal should be to pay off your debt and bulk up your savings and investments. Once you are able to achieve this level of financial wellness, you are less likely to need insurance for your entire life. This is because you would have built up considerable assets if you follow a solid financial plan.
And so the benefits of term insurance may outweigh whole life insurance in some cases. You can put the money you would otherwise be paying to higher premiums towards achieving the financial goals you have laid out in your financial plan.
There are instances where lifelong coverage (whole life insurance) may work for you. For instance, if you are a high-income earner with a need for life insurance. Or you have maxed out your 401k, traditional IRA and ROTH IRA, and 529 savings options and are seeking additional diversification.
Still unsure? To help you better make the decision of term life insurance vs whole life insurance, it may be worth meeting with a licensed life insurance professional who will act in your best interest. That way you can take a closer look at your options.
Term vs whole life insurance: Pick what's best for you!
The cost of insurance, especially term life insurance, is much lower than most people think. So it's a good idea to have a conversation with your family about life insurance. But there are both benefits and disadvantages of term life insurance and whole.
You don't want to put money into a life insurance policy if it is not necessary, but you also want your family's financial needs to be taken care of in the event of your passing. Be sure to determine what works best for you when it comes to choosing term life insurance vs whole life insurance.
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