Term life vs. whole life insurance: What’s the difference?
Term life vs. whole life insurance: What's the difference?
Term life vs. whole life insurance: What's the difference?
Life insurance can be a valuable part of anyone’s financial plan. It provides financially for your family in case you pass away, and it can give you the peace of mind that if you die earlier than expected, your family will be taken care of.
While life insurance is critical for many people, it’s also complex due to the variety of types available. As a result, many people may find themselves putting off buying insurance because they aren’t sure which is right for them.
If you’re in the market for life insurance, even if you’re just in the learning phase, keep reading to learn about the difference between term life and whole life insurance and how to determine which is right for you.
Understanding the basics of life insurance
Before we dive into the different types of life insurance, let’s first discuss why we need life insurance to begin with. This may provide the context necessary to help you choose the right type of life insurance.
At its most basic level, insurance helps protect you in case you experience a certain type of loss. Homeowners insurance helps if you lose your home, and auto insurance helps you if you lose your vehicle. Life insurance helps your loved ones if you lose your life, especially earlier than expected.
Life insurance provides a death benefit, usually as a lump-sum payment, to your loved ones after you pass away. It prevents your family from landing in a difficult financial situation, especially if you provide income for your household.
Life insurance benefits can serve many purposes, including replacing someone’s income, paying off a mortgage, paying for a deceased person’s medical bills, providing for a child’s future education expenses, and more.
Term life insurance vs. whole life insurance
Term life and whole life are two of the most common types of life insurance. Each works a bit differently and is best suited for a different type of customer. Keep reading to learn how each type of insurance works.
Term life insurance
Term life insurance is the simplest type of coverage. It provides a death benefit that’s paid to your beneficiary (or beneficiaries) if you pass away during the policy term. Term life insurance includes a few important features:
- Term length: The term length refers to how long the policy lasts. For example, common life insurance terms are 10, 20, and 30 years. If you pass away during the policy term, your beneficiaries receive the policy benefit. But at the end of the term, the policy expires.
- Coverage amount: This refers to how much your beneficiaries will receive if you pass away within the policy term. For example, you might have a life insurance policy with a coverage amount of $500,000.
- Beneficiaries: Your beneficiaries are the individuals who will receive your death benefit. It may go to just one person or could be split among several.
Term life insurance can come in several different forms. The table below summarizes some of the most common types of term life insurance:
Your insurance contract allows you to renew your policy at the end of the term without a new application or medical exam, though your premium may increase.
Your insurance contract allows you to convert your policy from a term one to a permanent one during a predetermined conversion period without a new application or medical exam.
Your insurance contract stipulates that your policy benefit decreases throughout the policy term, but your premium remains the same.
Pros and cons of term life insurance
Term life insurance has several advantages and disadvantages. Here are a few to consider before you purchase a policy:
Pros of term life insurance:
- Affordable premiums: Term life insurance is the most affordable of all types of life insurance. According to Policygenius, the average term life insurance premium was $26 per month in 2023.1
- Easy to understand: Term life insurance is incredibly simple. In short, you pay your policy premiums, and if you pass away, your beneficiaries get money. There’s no complex fine print to navigate like there can be with permanent life insurance.
- Customizable: You can purchase term life insurance in a wide variety of policy terms and benefit amounts. As a result, everyone can design a policy that provides the protection necessary for their loved ones.
- No-penalty cancellation: If you feel you no longer need your life insurance or you find a policy that better fits your needs, you can cancel your policy with no penalties or financial consequences.
Cons of term life insurance:
- Limited coverage term: Your life insurance policy will only provide a policy benefit if you pass away during your policy term. If you pass away after the policy expires, your beneficiaries will receive nothing.
- Price increase to renew: You can often renew your insurance policy after it expires — or even sign up for a brand new one. But because you’re older than when you purchased your initial policy, your rates will be higher.
- No cash value accumulation: Unlike permanent life insurance, which we’ll discuss more later, term life insurance doesn’t accumulate any cash value for you to borrow against or use for your policy premiums later in life.
Whole life insurance
Unlike term life insurance, which is only designed to provide coverage for a set period of time, whole life insurance provides coverage for your entire life. That’s why it’s known as permanent life insurance. Like term life insurance, whole life insurance generally offers level premiums, meaning you pay the same amount each month that you have your policy.
Whole life insurance has two distinct components:
- Death benefit: Just like term life insurance, whole life insurance offers a death benefit, which is the amount your beneficiaries will receive if you pass away. A portion of your monthly premiums go to cover the death benefit of your policy.
- Cash value: The other portion of your policy premiums goes toward your cash value. Think of it as a bank account that you deposit some money into each month. You can access that money, either to withdraw or to borrow against. However, withdrawals can reduce your final death benefit, and withdrawing your full cash value generally terminates the policy. The cash value is invested and, as long as it remains in the policy, is tax-deferred. In many cases, the cash value of whole life insurance is used to cover the policy premiums when someone is older.
Universal life vs whole life: A comparison
Whole life insurance, which we’ve already discussed at length, is a type of permanent life insurance. Another type of permanent life insurance is universal coverage. The two have some key similarities, including their permanent nature and the fact that they include both a death benefit and the accumulation of cash value.
Here are some differences between whole life and universal life insurance:
- Premiums: Whole life insurance has level premiums. However, universal life insurance has flexible premiums. You can pay more than the minimum premium to grow your cash value or pay less and have the rest covered by your cash value. However, this means you could see your account balance decrease.
- Dividends: As we mentioned, whole-life policyholders may get dividends from their plan, which they can cash out, reinvest in their cash value, or use to cover their premiums. Universal life insurance doesn’t offer dividend payments.
- Interest rates: Both whole life insurance and universal life insurance allow your cash value to grow once it’s paid into the account. However, the amount your cash will grow depends on the policy type. Whole life insurance often has guaranteed interest rates, while universal life insurance doesn’t. Universal life insurance will sometimes grow faster, thanks to a booming market, but sometimes it will grow more slowly.
Read more: What is an interest rate?
Pros and cons of whole life insurance
Just like term life insurance, whole life insurance has several key advantages and disadvantages that you must consider.
Pros of whole life insurance:
Lifetime coverage: Once you sign up for whole life insurance, you’ll have it for your entire life unless you cancel the policy. As a result, your beneficiaries can receive a death benefit no matter when you pass away.
- Cash value accumulation: Unlike term life insurance policies, whole life insurance accumulates a cash value. You can use this money to pay for your premiums later in life. You can also borrow against or withdraw a portion later on.
- Fixed policy premiums: If you have a term life insurance policy, your premiums are likely to increase if you renew your policy. But with whole life insurance, you can pay the same premium your entire life.
- Tax-deferred growth: Like tax-advantaged retirement accounts, whole life insurance policies don’t require taxes on your cash value growth until you withdraw money from the policy in excess of your contributions.
Cons of whole life insurance
- Higher policy premiums: Whole life insurance premiums are considerably higher than those of term life insurance as a result of the cash value component. As a result, you may not be able to purchase as high of a death benefit.
- Slow cash value growth: Many people think of the cash value accumulation of a whole life insurance policy like any other investment. However, your money will grow more slowly in your life insurance policy than it would have invested elsewhere.
- Lack of flexibility: Whole life insurance premiums lack flexibility. Many people sign up for their policies when they are young, but then aren’t able to increase their death benefit later on as their family’s needs change.
- More complex: Whole life insurance policies aren’t as easy to understand as term life policies are. Many people aren’t able to maximize the benefits of whole life insurance simply because they don’t fully understand how it works.
Key differences between term life and whole life insurance
To help you gain a greater understanding of term life and whole life insurance, let’s talk about some of their key differences.
Duration of coverage
One of the most important differences between term and whole life insurance is the duration coverage. It’s right in the name — term life lasts for a designated term, while whole life lasts your entire life.
It’s worth noting that while the life-long coverage might seem like an obvious benefit, that’s not necessarily the case. Once we reach our older years, there may be fewer people relying on us financially. Our children may be grown and our home paid off, meaning we have fewer financial responsibilities that we leave behind.
Additionally, we are all (ideally) saving for retirement. So by the time you reach your 60s, when your term life insurance policy might be expiring, you may already have more than enough money in your retirement account to support your family at the time of your death.
Another key difference between term life and whole life insurance is the cost. According to Policygenius, the average term life insurance for a 30-year-old on a policy with $500,000 of coverage is just $26 per month. Nearly anyone could fit that into their budget.
On the other hand, a whole life insurance policy of the same size for the same person carries an average price tag of $451 per month — much less affordable. Unfortunately, whole life insurance can put a strain on people’s budgets. You may even find yourself purchasing a significantly smaller death benefit to help offset the cost, which starts to defeat the purpose of life insurance in the first place.
For both term and whole life insurance, your age when you sign up is an important factor. Life insurance is generally the cheapest when we are young and healthy. As you age and your chances of dying increase, so do your premium quotes. For that reason, it’s best to sign up for life insurance when you’re younger.
Cash value and investment
Another of the most important differences between term life and whole life insurance is the cash value component. When you pay your whole life insurance premiums, a portion of that money goes toward building your cash value. Your life insurance company invests that money, and you get a portion of the returns.
Term life insurance, on the other hand, doesn’t have a cash value component. It’s simply a death benefit for your family if you pass away.
An alternative to purchasing a whole life insurance policy is purchasing a term life insurance policy and investing the money you’ve saved on your premiums into a brokerage account. You could see higher investment growth than you would in the insurance policy.
Term life insurance offers several key benefits, including flexibility. You get to choose your policy term and coverage amount, which can help you get an affordable premium. Additionally, you can choose a policy that’s automatically renewable or can be converted into a whole-life policy.
Finally, term life insurance gives you the flexibility to purchase the coverage you need at the time you need it. If you purchase whole life insurance when you’re 20 and single, you’ll find your needs are very different a couple of decades later when you’re married with children.
Unfortunately, you can’t change your life insurance benefits to reflect that change. However, term life insurance gives you the flexibility to change your policy as needed by purchasing a new policy without losing any of your built-up cash value.
Premium stability over time
Technically, both term and whole life insurance policies offer level terms, meaning you pay the same each month. However, whole life insurance offers a level term for your entire life. Term life insurance only offers a level term until your policy expires. At that time, you’ll need to purchase a new policy with a new — and likely higher — premium.
Health exam requirements
Many life insurance policies require a health exam when you sign up. Your insurer wants to make sure that you’re healthy and won’t pass away shortly after you sign up for the policy.
In most cases, both term and whole life insurance require health exams — though some providers offer policies where you can avoid them. However, purchasing whole life insurance ensures you only have to go through the health exam once.
If you purchase term life insurance when you’re 30 and then want to buy a new policy when it expires in 30 years, you might have to go through a new health exam when you’re older and potentially have health issues that have arisen. Those health issues could result in increased premiums, or even a complete denial of coverage.
Eligibility for company dividends
Some whole life insurance policies offer dividend payments. These dividends are the result of excess investment earnings, which are then passed along to policyholders. You may use your dividends to reinvest into your policy or reduce your policy premiums. You could also receive them in the form of cash.
Term life insurance, on the other hand, offers no dividend payments.
Guaranteed death benefit
Term life insurance offers a guaranteed death benefit. The amount of coverage you sign up for is the amount your beneficiaries will receive if you pass away during the policy term.
While whole life insurance theoretically has a guaranteed death benefit, that isn’t always the cash. If you withdraw money from your accumulated cash value or take out a loan from the policy and don’t repay it, your death benefit will be reduced.
Choosing the right insurance for your situation
When you’re in the market for life insurance, it can be difficult to determine which type is right for your situation. Given the vastly different costs and characteristics of term and whole life insurance, it’s important to choose the policy type that best fits your situation.
Factors to consider
When you’re deciding between term life insurance and whole life insurance, there are a few factors you should consider to help you choose the right policy:
- Financial goals: As with other major financial decisions, it’s important to ensure the life insurance policy you choose fits in with your other financial goals and overall financial plan. Paying a large monthly premium on a whole life insurance policy that builds cash value might be at odds with your goal of investing more in your IRA.
Read more: 10 things to do to improve your finances
- Premium affordability: The premiums on term versus whole life insurance vary significantly. A term life insurance policy can cost less than $30 per month. Meanwhile, a whole life insurance policy will cost hundreds.
- Duration of coverage needed: Term life insurance has a limited policy term, while whole life insurance lasts forever. You might choose whole life insurance if you know you want a lifetime death benefit without having to repurchase life insurance several times.
Who should choose term life insurance
Term life insurance is the best option for most people. After all, at its very root, the purpose of life insurance is to protect your family if you pass away. You want to make sure your family is taken care of and won’t struggle financially. Life insurance can do just that, and it does so at a very affordable rate.
While many people worry about the limited coverage period of term life insurance, the right policy will cover you when you need it. For most people, term life insurance is most important when they have a family who relies on them financially. And in many cases, by the time your term life insurance has expired, you may have fewer financial responsibilities or have other significant wealth built up in your retirement accounts, making life insurance less necessary.
Term life insurance can also be a good option for people who want to invest but want to do it on their own terms. Yes, permanent life insurance allows you to grow a cash value. But you can’t choose your own investments the way you could in a brokerage or retirement account. Additionally, you’ll probably see better investment growth by investing yourself rather than doing so in a permanent life insurance policy.
Who should choose whole life insurance
Whole life insurance isn’t right for everyone, but it does have its purpose. You might prefer whole life insurance if you can easily fit the higher premiums in your budget and want guaranteed coverage for your entire life.
Whole life insurance is a particularly attractive option for high-income individuals who have already maxed out their tax-advantaged retirement plans.
As we’ve mentioned, life insurance may not provide as good of returns as investing directly in a brokerage or retirement account. However, it does allow you to defer taxes on your earnings. For that purpose, someone who has maxed out their retirement accounts and wants more tax efficiency might put money into a whole life insurance policy rather than a taxable brokerage account, where they’ll be taxed on their earnings sooner.
Seek the help of an expert
If you’ve read this article and still aren’t sure which type of insurance is right for you, consider speaking with a financial professional.
However, if you do this, consider working with a fiduciary financial advisor, such as a certified financial planner, who doesn’t make money from the insurance products they recommend. Permanent life insurance policies offer notoriously high commissions for the agents that sell them, which can create a conflict of interest. You may feel more comfortable taking advice from a financial professional who doesn’t receive any financial benefit when you choose one type of insurance over the other.
The bottom line
Life insurance is an important component of any financial plan. It can provide you the peace of mind that your family will be financially secure if you pass away. However, several things hold people back from purchasing insurance.
First, no one likes to think about their death, and buying life insurance can force us to do just that. Additionally, given the different types of life insurance on the market, it can be difficult to know which to purchase.
Before buying a life insurance policy, make sure to familiarize yourself with the different types available. Once you understand how each works, take a hard look at your personal finances to determine which policy type best fits in with your financial goals.
1 Policygenius, “Average life insurance rates,” January 2024.
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