Are you overwhelmed with so many types of insurance in the market? One first step is to investigate Term Life Insurance vs. Whole Life Insurance.
Term Life Insurance and Whole Life Insurance – What are they?
Term life insurance only covers a death benefit within a certain period (referred to as “term”) that you decide previously. For example, you decided to buy a 10-year term life insurance when you are 30. Your beneficiary would get the death benefit should you pass away before 40 (after ten years).
Whole life insurance is a permanent insurance policy. It includes a predetermined death benefit and a cash value. Policyholders will have to pay a fixed monthly premium as they live.
Whole life insurance is much higher than term life insurance, and this might mean a lot if you calculate the money according to years. Whether to buy whole life coverage or term coverage will depend on your financial circumstances and personal needs that might benefit you the most.
Comparing benefits between Term Life Insurance and Whole Life Insurance
Most salesmen will mention this when you are hesitant to choose between term life insurance and whole life insurance. This is something that is not included in term life insurance that makes whole life insurance so attractive.
‘Premium‘ in whole life insurance is composed of three parts:
- One part flows into the insurance company’s operating costs and expenses
- Another portion goes into the death benefit
- The final amount will become a form of investment, known as the cash value
Cash value is attractive because:
- It is your money, and it will grow according to a plan that the insurer offers. The cash value can be considered as a slow yet safe way of investing.
- Your earned money from the cash value isn’t taxed. You can take out some money from it as long as the amount you take is less than what you paid previously.
- For example, you’ve paid $50,000 for your policy and earned a cash value of 62,000. If you want to take out $60,000, the 10,000 (excess of $50,000k) will be taxed.
- As the cash value grows up to some extent, you can use it to pay for the premiums.
- You can make a loan from your own cash value. This is extremely helpful when you’re in urgent need of cash. One good news is that it is tax-free.
Cash value is not attractive to some people because:
- The price is too high. Some people cannot afford it.
Take a quick calculation from Compulife: Alex is a 46-year-old man. He is a non-smoker with regular health. If he buys a policy of $500,000 from Sun Life, he will have to pay $1,025 annually for a 20-year term policy or $10,040 annually for a whole life policy. The cost of buying a whole life coverage is five times higher than that of a term life insurance policy.
- It has a cost opportunity. Cash value takes time to accumulate. Instead of paying for the cash value and waiting for years, people can use this money to invest instantly elsewhere, such as in the stock market or real estate, which might be more profitable.
Let’s look back at Alex’s example. The difference between his term life insurance and whole life insurance is $9,015 in a year. If he invested $9,015 each year and got a 10% annual return, he would get $516,330. This is a fortune, and he can still buy a 20-year term insurance policy with just $20,500.
- Although the loan from the cash value is tax-free, you must pay for the interests. Interests from banks or third parties might be cheaper in some cases.
While your beneficiary will receive a death benefit with whole life insurance upon your death, this might not be the case with term life insurance if your term already expires. In other words, your death benefit will disappear when the term ends, and you receive nothing. This sharp difference between term life insurance and whole life insurance might dissuade some people from buying term coverage because they don’t want their money to go to waste.
Some people don’t buy whole life insurance simply because they cannot or don’t want to pay continuously for the coverage forever. On the other hand, term life insurance is more short-term, and both have pros and cons. One thing for you to decide is to think about when you might need a policy.
For example, Laura is a single mom with an eight-year-old son. She has quite a low salary, so she cannot afford whole life insurance. She worries that her son would have no financial means were she to die prematurely. Laura decides to buy a ten-year term insurance policy so that if the worst case were to happen, her son would receive the death benefit that helps him survive until he gets eighteen.
One thing to note is that many people might take advantage of the time benefit of term life insurance. To be clear, they would first buy a term life insurance when they cannot afford a whole life insurance policy and convert it into a whole life insurance policy later when they have more money.
This might be a clever idea if your term life policy is lapsing, and you’ve reached your old age. At this stage, term-life insurance can become expensive due to your age. Thus, you might want to convert it into whole life insurance so that you can obtain both the cash value and the death benefit.
In brief, term life insurance and whole life insurance have both pros and cons. If you don’t have lots of money now and/or you’d better invest your money somewhere else while worrying about your dependents, you’d better choose term life insurance. But if you wish for a tax-free investment and ensure a definite death benefit, you might opt for whole life insurance.
Frequently Asked Questions
It depends on the time of purchase. Term life insurance can be affordable when you buy it as you are young and healthy. However, in the long run, as your term expires, you may get older and develop any new health issues. By this time, if you apply for a new term life insurance, the premium can be exceedingly high.
Whole life insurance, on the contrary, is much more expensive. However, due to its guaranteed cost feature, the premium will be stable throughout the year. As time passes and you have built up a certain amount of cash value, you can use your cash value to pay for the premium.
It is possible, as long as you can afford the premium.
Technically, you can use a rider known as Term Conversion Rider to convert your term life insurance into whole life insurance. This is a common rider of term life insurance. As long as your term life insurance is still in force, you can contact your insurer to convert it into a whole life policy. Since your insurance is protecting you, there is no need to submit any proof of insurability for the conversion.
You will decide on the amount of coverage that you want to convert from your term life insurance into whole life insurance. In other words, you can choose to convert part or all the current coverage of your policy. When you only convert part of your term policy, you are making a partial term Conversion that divides your policy into:
+ a new whole life policy whose coverage is deducted from your previous one
+ a new term life policy whose coverage is the remaining money minus the value of the whole life policy. This new term life policy will expire on the same date as your previous term life insurance
Remember that by doing so, you must pay for two insurance one at a time. The premium of a new whole life insurance policy and that of a term life insurance policy may cost a fortune. So, calculate it carefully before landing your final decision.
As regards the procedure, you need to follow three simple steps. First, contact your insurer and check whether your policy qualifies for a conversion and the conversion deadline. If you want to make a partial term conversion, you must keep a certain face amount in your new term policy. In this case, ask your insurance company about the convertible amount. Next, you need to complete the application form and wait for approval. This step may take a certain period, though, so be patient.
Term life insurance is an attractive option for people who don’t want or cannot spend a lot of money at the time of purchase. Yet, as time passes, your age increases, and your health may get worse, which affects the premium if you want to renew it later. In some cases, if you develop new health problems, you may get declined when applying for a new policy.
When you choose to convert when your term hasn’t expired, no underwriting is required. You don’t have to worry anymore about chances of renewal and can start building up your cash value for later plans.