Term vs Whole Life Insurance: It’s a discussion everyone should consider before purchasing a life insurance policy.
A Money Talks News reader named “Richard” wrote us the following question about this decision:
“I’m 40, and I have two kids. I’ve been checking out life insurance recently, and a friend of mine told me I’d be better off getting life insurance than for the term. What do you think?”
You’re right about thinking about life insurance, Richard. Unless you have a lot of savings or your spouse has a high income, life insurance is a great way to protect your family in the event of an early death.
The term versus whole life argument has been around for decades. Here are the pros and cons of each.
Types of life insurance
There are two types of life insurance. There is a term that secures your life for a certain period – like five, 10 or 20 years. Next, there’s permanent life insurance — like “whole life” coverage — that you theoretically keep until your death.
Now, think about how people use insurance. They buy term insurance when they are relatively young and have young children. If they die prematurely, the death benefit will take care of their families.
They maintain their coverage until age 60 or so, when the kids are old enough to be on their own and the need for insurance wears off. When they reach the end of the term and the insurance starts to go up, they no longer need it, so they drop it.
Note that with term insurance, the only way to get cash out of the policy is to die. Like your car, home, and health insurance, it’s protection. It is not an investment.
As the name suggests, perpetual insurance is a policy that you intend to keep permanently. Part of your monthly payment for death benefits is paid, and another part is paid into an internal savings account.
With perpetual policy, you don’t have to die to reap some benefits because you are building monetary value. This type of insurance can be considered an investment.
permanent is more expensive
You might be thinking, “Since life insurance comes with an investment account and is sure to pay off sooner or later, it’s a better deal, right?” Well, not necessarily, because it costs a lot.
Here’s an example I read recently: A healthy 30-year-old woman who doesn’t smoke can get a $1 million life insurance policy for 20 years for $500 a year. But that same woman who buys the same million-dollar death benefit on a permanent document may pay $10,000 a year.
It builds some cash value, but is this the best possible use of your extra cash?
In other words, it’s an investment, but is it a great investment?
There is a common expression among many financial advisors: “Buy the term and invest the difference.” This means that instead of putting $10,000 a year into a permanent cash-value policy, it’s better to pay $500 for a fixed-term policy that protects your loved ones, and then invest the difference of $9,500 in something else, like perhaps a mutual fund. .
why? Because permanent life insurance policies have a lot of fees and administrative expenses that often make them less efficient as an investment than other options.
Permanent is not always bad
There are cases where permanent insurance makes sense. For example, if your heirs are having an estate tax problem, permanent life insurance can help pay the taxes upon your death.
However, you must be wealthy for this strategy to make sense: Your property must be worth $11.7 million or more to apply federal estate taxes.
Life insurance as an investment has other benefits. For example, you don’t pay taxes on interest or other earnings until you take it out. Also, you have the ability to borrow against the cash value policy.
However, most experts will say that these benefits are not enough to offset the high expenses that often accompany these policies.
I hope I answered your question, Richard. If you feel you got some value out of my ideas, sign up for my awesome free newsletter.
For more information, see “7 Questions You Should Ask Before Buying Life Insurance.”
If you’re shopping for life insurance, you can click here for quotes from multiple companies.
I founded Money Talks News in 1991. I am a certified public accountant, and I also hold licenses in Stocks, Commodities, Capital Options, Mutual Funds, Life Insurance, Securities Supervisor, and Real Estate.
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