Whole vs. Term Life Insurance: Why Your Choice Matters
Life insurance is a vital part of your family's long-term financial plan. In essense, life insurance is a means to protect your family and loved ones from the financial consequences of your death. But there are many different options and policies available, and deciding which is right for you can be a hair-pulling experience.
One of the first steps in determining which life insurance policy best meets your needs is to decide between term insurance and whole life insurance. Although both technically "life insurance" they are very different products and each will fit differently into your financial plans.
The Basic Difference Between Term and Whole Life Policies
A term life insurance policy only provides coverage in the event of your death. Terms can be anywhere between one and 30 years long, and the term is generally selected based on the projected needs of your heirs or dependants.
Term life insurance doesn’t benefit the covered person, it provides financial protection for those who are left behind. With term insurance, the insurance company is pooling premiums and is generally paying benefits to the survivors of those who suffer an early death.
Since actuarial tables provide a good indication of the risk of premature death in any given population, the insurance company has a fairly good idea of how many policies will actually have to be paid on.
They know about how many people will die in a given period. The only unknown is whichpolicyholders will suffer an early demise. A whole life policy, on the other hand, doesn’t just provide insurance coverage in the event of death. It also involves an investment component that can be used to benefit the covered person.
These policies build cash value over the years that can be borrowed against in the event of need. In some situations, they can be useful in estate planning, and some people use it as part of their retirement planning.
Cost Differences Between Term and Whole Life Policies
Term insurance is definitely the less expensive of the two. For people under the age of 50, who really have little likelihood of dying in any given year, these policies can be very cheap indeed. As you get progressively older, and the risk of dying increases, so does the premium. However, as you reach the age of 60 and beyond, it becomes increasingly difficult to find term insurance.
For those over the age of 65, it can become nearly impossible to purchase term life insurance. Whole life insurance is much more expensive since you aren’t just paying for insurance. There is also an investment component involved.
If they were actually a good investment vehicle, the extra charges might make sense. Unfortunately, they have not traditionally fared well as investments. There are many other retirement planning tools that make much more sense than a whole life insurance policy.
Other Costs for Whole Life Insurance Policies
Even if they didn’t have such mediocre investment performance, there are other factors that may make you decide that a whole life plan isn’t right for you. There are often up front commissions paid to insurance agents that may typically be as high as 100% of the first year’s premium. Then, as long as the policy is in effect, there are yearly commissions that may be as high as 3% of the annual return. Additionally, these programs are often structured in such a way that it is very difficult to see how much of your premium goes to the actual insurance portion, and how much is left over for investment.
Often, it takes an investment expert to actually figure out the value of your investment over the years. Another often overlooked cost is the cost of surrendering the policy early. If you decide after the first 10 years that the policy isn’t for you, you may suffer a substantial penalty for early withdrawal. Most policies don’t begin to build any kind of value for the first 12 to 15 years. Withdrawing before that will only net you a minimal gain. And surrendering in the first five years will probably yield you nothing.
When Does Whole Life Make Sense?
There are times when a whole life policy does make good financial sense. For example, for those in their 40s or 50s who are just starting a family, a whole life policy might be the only financially viable option. As mentioned earlier, this may also be the case for those in their 60s and beyond who find they need insurance.
Additionally, there are also financial plans that can use the proceeds from a whole life policy as an estate planning tool for wealthy individuals, as stated by an article from MyCheapLifeInsurance.com.
The proceeds from the policy can be used to pay estate taxes or make some sort of a donation to their favorite charity. The key to judging the financial advantages of a whole life policy is in its internal rate of return. This is the yield of the investment after all the fees, commissions and other charges re subtracted. For some policies, the weight of these internal fees and charges prevent them from providing any worthwhile return.
Such an analysis should also help pinpoint the value of the policy in any given year. This amount can then be compared against some other combination of products, perhaps a term insurance policy for protection coupled with a mutual fund for retirement purposes. This analysis will show whether a whole life policy is god for your insurance needs.
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This was written by Susan Arbor, a staff writer at MyCheapLifeInsurance.com.