What is Life Insurance?
Life insurance is like a safety net for your dependents. In the simplest definition, you pay an insurance company a certain amount each month (the premium) and if you die, your beneficiaries will receive the death benefit of the policy. Sometimes the death benefits is the face value (or coverage amount) of the policy, like in term life insurance or guaranteed universal life insurance policy; or the face value, plus cash value account in other permanent life insurance policies such as whole life, indexed universal life, or variable universal life.
There are many different types of life insurance. In this article, we will focus on the two most popular types: term life insurance and whole life insurance.
What is Term Life insurance? And Its Benefits?
Term life insurance covers you for certain number of years—the term. Term life insurance is sold in terms of five, ten, fifteen, twenty or thirty years. It’s meant to support the remaining dependents if their primary breadwinner(s) dies sometime during the term of the policy. If you outlive the policy, you can renew (usually at a higher rate) or the policy just ends.
Your surviving dependents can use the money to pay off debts, pay for college, pay off the mortgage, or whatever else they decide is necessary.
It is possible to convert your term life insurance policy to a whole life insurance policy. Many companies allow this, but it will cost you. Whole life insurance premium is significantly more expensive than term life, sometimes can be 10-15 times more, especially if you are older when you decide to convert. You might still want to do this to get the benefits of whole life insurance product such as providing for special-needs dependents, setting up a trust, or setting up an estate.
Death benefits of any life insurance policies, including term life, are not considered income, therefore the beneficiaries do not have to pay tax on it. However, it could be different in some circumstances:
- If the death benefits of a life insurance policy is paid to an estate as a beneficiary, and then paid to a person or persons from the estate. The person might have to pay estate tax.
- If the insurance company has to hold on the death benefits for some time before paying to the beneficiary, the interests accumulated during this period is subject to income tax.
>>MORE: Learn more about Term Life Insurance: How It Works and Its Costs?
What is Whole Life Insurance? And Its Benefits?
Whole life insurance is much more complicated that term life insurance. It is a type of permanent life insurance. Whole life insurance covers you for your whole life, although you can choose to pay premiums for 10 years, 20 years, 30 years, 40 years, or your whole life. Of course, monthly or annual premiums of different payment terms are different for the same coverage.
At the end of a whole life policy, your heirs get the face value or coverage amount of the policy, plus any interest accrued and dividends invested. This is called the death benefit. However, the calculation of the death benefits of a whole life policy is usually considered as in a “black box”. If you look at an illustration of a whole life policy, the sum of net cash value and coverage for each year of the policy is often not equal to the death benefit. This is one of many reasons why more and more people do not prefer whole life insurance product.
Whole life insurance includes something called a cash value. It’s like a savings account attached to the policy. This is one of the two main differentiators between a term life and a whole life policy; the other being insured for your whole life vs. for a term only.
Whole life insurance policies often offer guaranteed interests on the cash value account. And this is the main differentiator between whole life and universal life polices. Universal life insurance is another type of permanent life insurance. Other universal life insurance policies such as indexed universal life (IUL) or variable universal life (VUL) also offer cash value account, however, they do not offer guaranteed return rate on these accounts.
After an initial period, usually the first 10 years, you can borrow against the cash value account of the policy for any purpose. However, you have to pay interest rate set by the insurance companies. If you fail to pay back the principal and interests, it will be deducted from the death benefits of the policy.
Whole life insurance is much more expensive than term life insurance—up to 10-15 times more expensive. And this is another big reason why more and more people are choosing term life over whole life.
However, that is not to say whole life insurance product doesn’t have its solid value proposition. According to LIMRA, 35% premiums of all life insurance policies in 2018 were on whole life. There are still good reasons for people to buy whole life insurance. Unlike term life, whole life offers four distinctive benefits:
- However long you live, when you pass away, your loved ones will have the death benefits.
- You will have access to your death benefits when you are still alive if you are diagnosed with a chronic or terminal illness.
- You are guaranteed with the cash value account and its returns and you will have access to the cash value account to supplement your retirement income or for any other purpose.
- Most whole life policies are sold by mutual insurance companies, which means that as a policyholder, you will be entitled to receive dividend
It is also worth mentioning that other than the last benefit, universal life insurance products such as indexed UL and variable UL also offer these benefits. Even better, they are usually cheaper and less of a “black box” as in whole life insurance. So, if these benefits are important to you, you might also want to consider universal life insurance products instead.
>>MORE: Whole Life Insurance Explained
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Differences Between Term Life and Whole Life Insurance
Most people should consider term life insurance. It’s significantly cheaper than whole life insurance, and it does what insurance is supposed to do: provide financial support in case of a disaster.
Whole life insurance is often sold as an investment in the future. It offers cash value you can borrow against, and it lasts your whole life. However, whole life insurance is so expensive that most people eventually let the policy lapse because they can’t afford it. Somewhere between 15% and 20% of whole life insurance policies actually pay out. It’s how insurance companies make money—you pay them premiums over a certain number of years and they never have to pay anything when the policy lapses.
However, despite being much much cheaper, according to a popular study by Penn State University in 1993, more than 90% of term life insurance policies are either terminated or converted; 45% within the first year and 72% within the first 3 years; and only 1% of all term life policies resulted in death claims.
So it seems that in general people who buy life insurance policies tend not to stick to them till the end.
Below is the comparison of term life vs. whole life insurance in various dimensions:
| Term Life | Whole Life | |
| Choice of policy length | ✓ always | X (but you can choose to pay 10, 20, 30, 40, etc. years only instead of paying lifelong) |
| Provide lifelong coverage | X | ✓ |
| Renewable and convertible | ✓ | X |
| Low premium | ✓ | Very expensive. Can be up to 10-15 times more expensive than term |
| Accumulates cash value and can borrow against it | X | ✓ |
| Guaranteed face-value of the policy (or coverage amount) | ✓ | ✓ |
| Access to death benefits while being still alive | ✓ (with accelerated death benefits rider) | ✓ both with accelerated death benefits rider and borrow against cash value account |
| Premiums generally stay the same | ✓ | ✓ |
| Might be eligible to receive dividends | X | ✓ if policy is issued by mutual companies |
| Simple and straightforward | ✓ | X (Very complicated with lots of nuances) |
| Easy to compare online quotes from various insurance companies | ✓ (many digital brokers offer quote comparison: PolicyGenius, Quotacy; HealthIQ; and SelectQuote) | X (Often have to work with an agent or advisors to compare quotes) |
| Can be purchased completely online | ✓(50% chance that you don’t need a medical exam, especially if you are healthy and in your 30s) | X (no digital solution available yet) |
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Cost of Whole Life vs. Term Life Insurance
First of all, life insurance quotes vary by individuals since quotes, both for term life and whole life policies, are heavily affected by health conditions of each individual. And each individual has his or her unique health condition. Having said that, we use a standard consumer health profile, the best healthy condition, to get quotes from 15+ life insurance companies for both 20-year term life and whole life policies to compare quotes. We outline the lowest quotes and the highest quotes of annual premiums and the insurance companies that the quotes belong to in the table below for your reference.
Again, these quotes are just for reference. Your quotes will certainly be entirely different, even if you believe that you are also 40 year-old male and with the perfect health condition.
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>>MORE: How Much does Whole Life Insurance Cost? and How Much does Term Life Insurance Cost?
Last Thoughts
Both term life and whole life have their own strengths and weaknesses. However, term life insurance is probably suitable for most people shopping, especially young parents who realize that they now have dependents for the first time in their lives.
Whole life insurance is very expensive, so expensive that it might be out of reach for many people. It does offers its strengths and is suitable for many of us, especially those who value lifelong coverage and guaranteed returns on the cash value account tied to the whole life policy; and use whole life insurance as a financial planning tool to support child or children with special needs or as a part of estate planning like paying estate tax. However, if these benefits are important to you, you might also want to consider universal life insurance products such as Indexed UL, variable UL, and even guaranteed UL since they are usually cheaper and a bit clearer and less complicated.
If you choose either whole life or universal life insurance product, you should discuss your needs with a life insurance agent or financial advisor to get the proper advice and counseling before you buy the final policy. Never buy an insurance policy that you don’t fully understand.