As I was working today, I got asked a common question that many people ask and that is what is the difference between term and whole life insurance? In this particular case, the gal I was talking to had a term policy with her work and also some insurance with her insurance agent. She was trying to decide on whether she should take advantage of the whole life insurance plan offered through her employer. Based on the premium she was paying, I could tell that the policy she had through her insurance agent was a term policy as well.
It’s kind of hokey, but when I explain to people the difference between term life and whole life insurance, I tell it like this. In the beginning God created two types of life insurance, term and whole life. In the beginning, it was perfect. Everyone knew what they were getting because everything was guaranteed. Term lasted for a certain time or time period and then expired with no cash value to the owner; and, whole life was guaranteed to last your whole life and had a guaranteed cash value. Then, man got involved but more on that in a minute.
The most common type of life insurance that people own is called group term. This is the insurance that your employer gives you for free in most cases. It’s term is while you are employed where you work. While it is good insurance the reality is that in the vast majority of cases, it will expire unused. Which is good, because it means we will live along time but on the other hand, when we really need it, the insurance company takes it away from us. This means your beneficiary will probably never collect. It’s normally not a big deal, because you never put any money into it anyway.
You can also by term life insurance on your own. I know that in my case, I purchased a 20 year level term insurance policy. The great thing about term insurance is that is cheap. I think that in my case, I pay around $49 a month for million dollar policy. But again, it’s cheap for a reason. Why? Because, I’ll most likely outlive it. Term insurance has no value to it other than the death benefit. So, when it expires you have nothing, so it is more like renting your coverage. Should you have some term insurance? Definitely, because it is so cheap and it can help eliminate debt if you die too soon.
Whole life on the other hand, when it was first created, was designed to last your whole life and pay when you die as long as the premium was paid. You get less insurance and the premium is higher, but in the end, if you die, it will pay no matter when or how old you get. If you get to the point where you don’t want the coverage anymore, after you have had it awhile, it will start having some cash value that you could use for your own purposes while you are alive by either cashing it in or borrowing against it.
That is the simple explanation of the difference between term life insurance and whole life insurance. The fact is that of these two types of insurance, you’ll hundreds of different term and whole life products and that is because man got involved and screwed with a simple concept.
You see, in the early 80’s, interest rates rose to unseen before levels and many people questioned the logic of putting money into a whole life policy where the cash value was guaranteed low rate of return like four percent for example. After all, why put money anywhere earning 4% when you can double digit returns from a certificate of deposit from your local bank. The insurance companies heard these complaints and developed a new product called universal life insurance. In it, you could earn current rates of return from short term interest rates. But there was a trade off, and that was that you were no longer guaranteed that your whole life would last your whole life. In fact, interest rates declined to lows we have never seen before and a lot of these policies lapsed an in a sense became very expensive term policies.
Recognizing that short term investments had their shortcomings, a new product was introduced called variable life insurance. Now, you had the choice of where to invest the cash value of your policy from a selection of funds similar to what you might find in a 401k at work that basically resemble mutual funds. This was great as long as the market was good. But as 2008 proved to us, there are no guarantees here either. My mom owned a VAL contract from Prudential that tripled in premium because her fund values did not perform as was expected. And this was about eight years before the market collapse. Who knows how many people lost what they thought was whole life insurance only to discover that the premium wasn’t guaranteed for life. And again, it was another expensive term insurance policy.
The difference between term and whole life insurance has dominated financial talk shows and magazines to the point that no one knows what to buy and in the end the life insurance companies make double the money. First, let’s say someone has a whole life insurance policy like God created in the beginning. This would be one that was guaranteed for life, both premiums and face amount. Eventually, someone will come along and convince them to cash it in in favor of term policy. This is an easy thing to do, because the premiums are lower and the face amounts higher. So, the insured, cashes his policy in and let’s the insurance company off the hook. In exchange, the person buys a term policy that they will most likely outlive. Again, the insurance companies win.
So what is the answer? What should you do now that you know the difference between term life and whole life insurance?
Well, here is what I suggest. Purchase a little of both. Both are good and serve their purpose. Get enough guaranteed whole life insurance policy to cover the estimated burial cost when you retire. Above and beyond that buy a huge term policy with the longest duration premium guarantee, something like 20-30 years. As long as you are healthy, rewrite your term insurance every 2-5 years to extend your term.
Don’t let the difference between term life insurance and whole life insurance confuse you into buying nothing. Buy one that is guaranteed to last and one that will pay a lot when you need the most paid.