Horse Riding On The Beach

The Difference Between Term And Whole Life Insurance

in Financial Planning by

No one likes to think about it, but at some point we’re all going to die. Just as taxes are inevitable, so is death. While that may not be the best or most desirable thing to think over, the beauty is that you can start planning for it now.

According to LifeHappens.org, there are very few circumstances in which you will not find yourself needing life insurance. That even covers single individuals needing to fund final expenses and/or medical bills.

Unfortunately, when you discuss life insurance there can be a myriad of opinions that come into play. This largely goes back to the number of options available in the life insurance space and the way some insurance plans are sold.

To be simplistic, there are two major forms of life insurance – temporary and permanent or better stated term life insurance and whole/universal life insurance. Their features, generally speaking, go back to their names. Term insurance is for a given period of time, anywhere from 10 years to 30 years, with 20 year term life insurance being the most common. Term insurance is generally considerably cheaper than the permanent alternative and once the term period ends, your coverage ends. If you pass away prior to the term period ending, then your beneficiaries get the face value of the policy to cover any final needs, etc.

Life insurance chart

Duke University Life Insurance Comparison Chart

Whole and universal life insurance differ from term insurance in that they last for your whole life. With this extended period, premiums are considerably more expensive. Beyond that, the other major benefit whole/universal life insurance offers is that the premiums have the capability of growing as cash value over the life of the policy. This growth is generally tax deferred and can be accessed over the life of the policy, with some catches. However, if you do not touch this cash prior to passing it is then disbursed to your family members in addition to the face value of the certificate.

What Is Whole Life Insurance?

Now that we have a basic understanding of the differences between term and permanent life policies, let’s take a deeper look into whole life insurance. Whole life insurance, as the name states, is insurance that covers you for your whole or entire life.

While premiums will be more expensive than what you will generally find in the term alternative, the premiums do something else for you – they build over time. This will result, if left untouched, in a cash value that will add to the final value of the policy. Unlike some universal life policies which allow for limited equity investing, with whole life policies, these excess premiums are not invested in the stock market, but rather are invested at the insurance company provider’s discretion. This does mean that you will likely be hampered in regards to the return you will enjoy through a whole life policy, but you also get the benefit of having level terms for your life – assuming you hold the policy until passing.

In terms of purchasing whole life insurance, most will be better served by purchasing it at a younger age in order to secure lower premiums. They will still be higher than term insurance premiums, but will be able to lock in a lower premium rate. Those who do wait to purchase whole life insurance at a much older age are doing so in order to solidify the “burial coverage” that most refer to whole life insurance as.

How Is Universal Life Different From Whole Life?

Universal life insurance, much like whole life, is coverage that is considered permanent in nature. You can also build up cash value in a universal life policy like you can a whole life policy. The similarities between the two basically stop there, as we begin to see unique features within their intricacies.

The biggest difference between whole life and universal life is how the premiums are handled and how the excess is managed. With universal life, you can make premiums payments at any time you wish and in any amount you wish – thus pointing to the flexibility they offer. This is why some will refer to universal policies as adjustable life insurance. The important point to remember though is that if you cease making premium payments or withdraw built up cash value it can impact your coverage amount leading up to needing to put more cash in or surrendering the policy, if taken to an extreme.

Assuming you make excess premium payments, which is generally how these products are sold, they go into some sort of investment product. Those investments can be anything from stocks to bonds to mutual funds/annuities but is restricted by what the particular insurance company offers in terms of investment options for cash values. Options vary widely from company to company based off their investment philosophies and what they want to make available to their policyholders, which makes it critical to find a company and policy that aligns with your investing preferences. If you are able to find such a match, an investment-oriented universal life policy provides the potential for a better return than what you’ll see in a whole life policy. Just remember that it also presents greater risk. The other major difference you see with universal policies is that they offer more transparency with regards to fees.

Who Should Buy Permanent Life Insurance?

Whole and universal life insurance have earned a bad reputation over the years as many life insurance agents/companies sell these policies as something they shouldn’t be – an investment. Some of that criticism is well deserved and some of it it’s not. The key to remember is what your personal situation calls for.

Insurance companies base premium amounts on actuarial tables that are weighted by age and health factors. Obviously, the older a person is, the more likely they are to die, which causes the cost of life insurance to be exorbitantly high. Because of this, if you’re older and approaching retirement or are in retirement, then purchasing permanent life insurance likely isn’t going to be the wisest use of your funds. This is especially the case if you’re able to self-insure through other investments and have a way to provide for your family members upon passing and cover your financial responsibilities at death. If that is not the case, then purchasing permanent life insurance is something that could be considered, in addition to looking at viable alternatives such as long term care insurance.

If you’re wanting permanent life coverage, then the best alternative is to purchase coverage as young as you can. While you can still get lower premiums under the term alternative, (where it’s not unheard of to get at least $250,000 of term coverage for $20 per month for a healthy individual under 40) that term will run out. Similar coverage under a whole life plan will easily cost five times that amount, but it also guarantees the death benefit for your entire life. The following sample charts illustrate the difference in premium cost by age for whole life and term life insurance.

Whole Life Insurance Chart

Whole Life Insurance Sample Premium Comparison Chart from AAA of Southern California

Term Life Insurance Chart

Term Life Insurance Sample Premium Comparison Chart from Gaudette Insurance

Again, it all goes back to your personal situation and what fits best.

Lastly, what has become popular amongst older generations in to purchase whole life policies for children or grandchildren. This allows them to lock in lower rates for the recipient while also providing for their future families.

Why Life Insurance Is A Bad Investment

Going back to the problem with permanent life coverage, the issue is when it’s sold as an investment. Having appropriate life insurance coverage is an essential part to proper retirement planning, however, it should by no means be viewed as an investment. This is due in large part because life insurance was never meant to be an investment, but something to enable you to provide for final needs and for your family members once you do pass. The problem comes into play when life insurance companies promote permanent life insurance as an investment and thus play on the naivety of those who’re uninformed about the various options presented with life insurance.

Beyond the misuse of the whole/universal life product, the other major problem behind using permanent life insurance as an investment is that you have no control over how the funds are invested. Yes, you can find a company that might fit alongside your general investment philosophies, but you still have little to no control over how the excess money is allocated and invested. While you can access the cash value, if in need, it comes with a cost. In the event of it being a whole life policy it generally means the lowering of your face value (or death benefit) of the policy.

In the event of trying to access cash values from a  universal life policy, such an action could cause the cash values to go lower than the associated costs and thus harm the policy. That’s also not to mention the fact that any loans taken out against these policies, while tax deferred, do incur interest, which must be paid back. If you’re young that might not be a problem, but many in retirement aren’t seeking to pay back loans on things such as life insurance.

Purchasing life insurance is a personal decision. Don’t allow sales materials to convince you that one item is better over another, but look at what the needs of you and your family are – whether it be investments or life insurance. In the case of life insurance, there are other ways to provide the same benefits you’d receive from a permanent policy, whether that be from purchasing term coverage or simply self-insuring.

Photo: Horseback riding in Cabo, Mexico. FinancialSamurai.com.

The following two tabs change content below.

John Schmoll

John Schmoll is the founder of Frugal Rules, a blog created to help people experience financial freedom through frugality. John is passionate about budgeting, saving and investing and enjoys sharing his knowledge and experience with others so they can avoid making some of the mistakes that he made. A veteran of the financial services industry, John has an MBA in Finance and experience as a licensed stockbroker. You can follow him on Twitter at @FrugalRules

14 comments

  1. Financial Samurai

    It really does seem like Term is the way to go. It’s simple, cheaper, does it’s job of protecting your dependents from your demise, and doesn’t tie up unnecessary funds.

    Of course, if you are loaded with excess cash, then Whole/Universal doesn’t seem that bad, especially with the tax free compound growth factor.

    Reply
    • John Schmoll

      Generally speaking it really is. If you can get it young you can hopefully lock it in at a lower rate. The catch, I guess, is that once it expires you’re left with the possibility of needing more which will cost more.

      Personally speaking, beyond maybe burial coverage through a low face amount WL policy, I wouldn’t be using it on insurance. There are costs associated with it that I’m not the most comfortable with, especially if it’s viewed as an investment vehicle. That’s of course assuming you’re in a place where you can self insure. If you are then great, if not then you’d want something to provide for your family and cover any final needs just without an exorbitant cost.

      That investment piece is really the catch in all of this. Way too often WL or U/L is sold as an investment vehicle when it really shouldn’t be.

      Reply
  2. David @ Simple Money Concept

    Great post! I couldn’t agree more on the part where permanent life insurance policies are being sold as investments.

    However, while I also agree on how, generally speaking, term insurance policy is the way to go, it’s actually one of the most profitable products for the insurance companies. I don’t remember the exact pay-out ratio, but I remember it’s a fair low number as most people don’t get to collect it. Most people either cancel their policies, or the term ends before they do. If you have the actual statistics, please share it.

    Picking the right insurance isn’t easy, because the reality is that we don’t know when the final day will come. I used to tell people that if they can tell me when they will die, I will sell you the best insurance policy in the world.

    Having said that, life insurance is about managing risk, not investment. As Sam pointed out, if you have extra cash, get a permanent policy too. Since death is certain, might as well make the death benefit certain. I haven’t met a beneficiary who said, “that’s too much money.”

    Reply
    • John Schmoll

      Thanks David! That’s a great point about Term coverage being one of the most profitable items in the industry. I don’t know what the exact stats are, but I know when I was in the industry it was a fairly well-known fact that it was greatly profitable in many cases.

      You’re right though, it is about managing risk and not an investment. It’s when companies turn it around that makes it bad in my opinion.

      Reply
  3. Barbara Friedberg

    We’ve always carried term, and prefer to keep our investing and insurance separate. although I understand that for some, whole life might be suitable.

    Reply
    • John Schmoll

      That’s all we have ever done as well Barbara. I think for some WL will be a good fit, though not as many as the insurance industry would like us to think. 🙂

      Reply
  4. Jack Heart

    Thanks so much for this post. I only recently ever even thought about getting life insurance. Oh, how life just slips by.

    Reply
  5. christina

    Thank you for this blog post. I am shopping around for life insurance and was really confused what was the difference between whole and universal life. The charts really helped!

    Reply
  6. dave

    You are woefully misinformed about the growth potential and returns from the right kind of universal life policy

    Reply
  7. suraj

    Nice article . Really helpful for those who invest in insurance for investment. Last para gives and idea why shouldn’t invest in Insurance for investment.

    Reply
  8. David - beaconlifefunds.com

    Yeah. I have heard that you could even pay the premium with your own universal life insurance saving! Certainly great right? However, I have read that it does not go very well for the owners though because they don’t closely managed the insurance I think and it can’t pay itself anymore after several years.

    Reply
  9. Nash Rich

    I have never heard of whole or permanent life insurance referred to as universal, until now. I think it’s nice that it adds up over time. I didn’t know there were insurance policies that did that, though, I’m new to the whole insurance thing. Thanks for helping a guy out.

    Reply
  10. Billy

    What if it’s not seen as a traditional investment. If you have enough to set aside to guarantee a payoff (money for spouse, inheritance for kids), doesn’t it always pay off in the end unless you live to 150? Keeping the money and putting it in the market is no guarantee that there’s a payoff.

    Reply
  11. Nick

    I agree that Whole Life should not be considered as an investment. However, one of the benefits that gets overlooked many times is tax diversification in the long run. Getting Whole Life at an early age (if you have the excess cash after other retirement investments) allows you to build your own bank.

    As cash value builds up and as your tax bracket goes up, it gives you many options. If interest rates go up, it gives you many options. Essentially if you need capital down the road, instead of borrowing or taking a loan from an actual bank, you can take a loan from your whole life policy. Depending on your policy, your rate might be lower than the borrowing from the bank at that time. You can borrow that money from your policy and invest it or put it to use. When interest rates go down, you can then take a loan from a bank to pay back the loan you took out from the Whole Life insurance policy. Cash value grows tax deffered as well. I essentially use Whole Life as my own personal bank. I can also use it as collateral if I see an attractive investment opportunity. Its about options. We do not know what the interest and tax rates are going to be in the future so having more options helps big time.

    Again as the article rightly stated, do not get Whole Life as an investment but if you have excess cash it can help you with giving you more options to working your capital efficiently long term. At the end of the day, if you paid your premiums there is a guaranteed death benefit (which will be way more than what you paid in premiums); although you will not be around to enjoy it. Your family will thank you for it…Its guaranteed

    Reply

Leave a Reply

Your email address will not be published.

Disclaimer. This Website may contain links to third-party websites. These links are provided solely as a convenience to you and does not imply an affiliation, sponsorship, endorsement, approval, investigation, verification, or monitoring by PCAC of the contents on such third-party websites. Please be advised that PCAC is not responsible for the content of any website owned by a third party.