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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.
In a study by the Life Insurance and Market Research Association (LIMRA), it was determined that over 60 million households (48%) are underinsured with an average life insurance gap of $200,000. In addition, 70% of households in the U.S. would face financial hardship if the primary wage earner died.
These stats, highlight why having life insurance is important. I could go on about the importance of life insurance. But simply stated, it is 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.
That being said, the two types of life insurance are term life insurance and whole life insurance. But which should you get? Term vs whole life insurance? Let's get into it.
The difference between term and whole life insurance
Let's take a look at each, along with the differences between them.
What is term life insurance?
Term life insurance is life insurance coverage that covers you for a specified number of years and has no cash value account associated with it. As a result of this, the premiums are often lower than a whole life policy. When you choose a term life policy, you'll choose a certain number of years to be covered; typically 10 or 20 years.
Term life insurance can further be broken into two different types of term life insurance:
- Group term life insurance, which is insurance that an employer offers to its employees as a benefit.
- Individual life insurance, which is insurance that an employer offers to its employees as a benefit.
Some of the key features of a term life insurance policy include the following:
Characteristics/benefits of term life insurance
- Coverage lasts for a specified number of years instead of for your entire life.
- Your premium payments are fixed for the specified coverage period.
- Your term life policy can be converted to a whole life policy.
- Because there is no cash value accumulation like there is with a whole policy premiums are lower(which I'll explain shortly).
Main cons of term life insurance
- 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.
- The insurance company may prevent you from renewing your policy due to your age.
- 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, you may be limited to shorter terms of 10 or 15 years.
- Premium costs for a term life policy increase with each policy renewal.
Term life insurance policies are attractive since they can be much less expensive than whole life policies.
What is whole life insurance?
Whole life insurance, also called permanent insurance, is life insurance coverage that combines life insurance with investments. This addition of investments is called "cash value" and is placed in a cash-value account.
With a whole life insurance policy, you'll pay monthly premiums for coverage, but a portion of that amount will be placed into an investment account. Any excess premiums at the time of your death are simply paid out to your designated beneficiaries.
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?
Well, when you pay your insurance premium, part of it is used 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, yes, 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.
A cash value account can be used:
- To create supplemental income in retirement
- For payments toward future policy premiums
- To pay for you or your child's education
- For a down payment towards a home
Characteristics/benefits of whole life insurance
- Coverage lasts for your entire lifetime
- You have the benefit of cash value accumulation
- You can borrow from your cash value account
Cons of whole life insurance
- You pay higher premiums
- Your death benefit is reduced if any loans you took out aren't paid back
- Marginal rates of return on investments. You are likely to get better returns investing in an index fund for example.
Do you need life insurance?
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!
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 passed away today, is there enough money saved to cover the mortgage and other bills and debts?
- How would my income be replaced to provide for my family and support the education of my children or dependents?
- Will my family have enough to cover my funeral expenses without causing financial hardship?
Three main reasons to get life insurance
Depending on how you answered the above questions, here are 3 main reasons why you may want to consider getting life insurance:
- For the cost of your burial and final expenses
- To create generational wealth for your next generation
- To replace lost wages from your passing
So, should you get term or whole life insurance?
When you think about life insurance, it's important to come back to its real purpose. 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 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 sub-par returns on whole life insurance investments.
Ideally, your goal should be to pay off your debt and to 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 term life insurance may be a better option and you can put the money you would otherwise be paying to higher premiums towards achieving the goals you have laid out in your financial plan.
There are instances where 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 this decision, it may be worth meeting with a licensed life insurance professional who will act with your best interest. You can also check out Ladder term life insurance. Ladder allows you to shop for the best rates, apply, manage and adjust your policies online and you may qualify without needing a medical exam.
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. You don't want to put money into a life insurance policy if it is not necessary, but you also want your family 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 vs. whole life insurance.