Whole vs. Term Life Insurance

Is a Lower Term Premium or Higher Whole Life Premium Better?

Jun 17, 2009 Miranda Miller

Whole life insurance (or universal life insurance) carries a higher monthly premium than term life insurance. Which type of policy is better in the long run?

Many people view life insurance as a necessary evil; just another monthly payment that will hopefully some day help provide for the insured's family and cover funeral expenses. Death certainly isn't a nice thing to think about, but it is important to understand two specific types of insurance policies and how they may benefit the insured's family after death- or even the insured during their lifetime.

The Truth About Term Life Insurance Premiums

Term life insurance is the least expensive type of policy, at least as far as the monthly premium is concerned. How term life insurance works is often misunderstood.

Many people believe that the "term" applies to how long the policy will be in effect. In truth, though, the term refers to the number of years the policy is guaranteed at a specific monthly premium. For example, a man buys a 20-year term life insurance policy at age 32. In reading the fine print, he realizes the policy is actually valid until he is 100 years of age. However, after the 20-year term, the insurance company can (and most likely will) raise the monthly premium. How much it increases depends on the company, but the predetermined rate is usually buried somewhere in the policy's fine print.

How Insurance Companies Make Money on Term Life Insurance Policies

The additional premiums may be so exorbitantly high that the insured has no choice but to let the policy lapse. In the example above, this would mean the man would have to either pay the new, higher premium, or qualify for a new policy at age 52.

Insurance companies collect the premium for the term of the policy, but don't pay a death benefit unless the insured dies within the life of the term. If the policy lapses, all of the premiums paid into it are wasted. In order to qualify for a new policy, the insured will probably have to undergo a medical and will pay higher rates reflecting their age.

The Truth About the Cash Value of Whole Life Insurance

Whole life insurance premiums are guaranteed for life. Monthly premiums are usually significantly higher than term life premiums. However, the rate will not increase later in life, the insured will not have to re-qualify at some point, and the policy builds cash value.

Whole life policies build cash value because the additional money paid in monthly premiums is invested and grows over the years of the policy. The insured can borrow against its value, or even sell the policy later in life. Since it is a guarantee that at some point, the insured will indeed pass away, they can choose to sell their policy on the secondary life insurance market.

This is how the secondary life insurance market works: Investors pay for the right to assume the policy. They pay a cash settlement to the insured, in exchange for the right to collect the settlement on the insured's death. It is a 100% fail-safe investment for the policy buyer, and the insured receives a large sum of cash to pay for retirement living expenses, special care, etc.

How to Choose Between Two Types of Insurance Policies

While the benefits and drawbacks of each type of policy seem clear, deciding which policy to buy isn't so simple. The decision must consider such factors as age, expendable income, children or other responsibilities, other investments, and overall health.

An insurance broker can be a great source of information when investigating different policies. However, a solid understanding of the basics is critical in ensuring insurance policy seekers end up with a policy that reflects their wants and needs, rather than one that provides a large commission for the selling agent.

Sources:

A. Haft, You Can Never Be Too Rich (Wiley & Sons, 2007), Ch.4: Life Insurance.
MSN Money, The debate over term vs. permanent life insurance, accessed June 15, 2009.

The copyright of the article Whole vs. Term Life Insurance in Insurance is owned by Miranda Miller. Permission to republish Whole vs. Term Life Insurance in print or online must be granted by the author in writing.