How do I think about buying term life insurance versus whole life insurance?

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  • 22 out of 28 people found this answer helpful

    CFP®, EA Alexandria, VA

    Another way to "Think" about term versus whole is to determine whether you are protecting a risk of IF I die or WHEN I die.

    For example, IF you die before the mortgage is paid off, then you want to pay it off.  IF you die before the kids start school you want to pay for tuition.  Or...

    WHEN I die, the business needs to be sold/bought.  WHEN I die there will be estate taxes.

    IFs are candidates for term insurance, WHENs are candidates for whole life.

    It is never quite this simple, but IF or WHEN is a good place to start.

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  • 12 out of 14 people found this answer helpful

    ChFC Mill Valley, CA

    I reread your question several times as I wanted to be certain as to the answer you are looking for. You asked "How do I think about buying term llife insurance vs. whole life insurance". Christopher's answer addressed this question, but the other two did not. You didn't ask "should I buy" or "is whole life insurance a good buy". So here is how I work with clients to answer this question. We can't cover all the considerations due to space limitations here. I will try to hit the major points.

    First and foremost, if you are looking at life insurance to protect loved ones or a business interest, you need to purchase the proper amount of death benefit to protect those interests. Most folks buy far too little death benefit and their beneficiaries find out too late that they still have hard choices to make. You should find out what the maximum amount of coverage that the company will issue based on your circumstances. Companies will not sell you an unlimited amount of coverage, just the amount that is economically justified by your age and financial standing. No insurance coverage will pay you more than the risk is worth. There is too much incentive for someone to commit fraud in order to make a profit and that is why you cannot buy "too much" coverage from a reputable company" only the amount that can be justified through underwriting. Now that you know that amount. Decide what you want the coverage to do by answering this question: "If I died tonight, what do I want to happen to my family (business) tomorrow?" So if you have a non working spouse and 3 young kids, what do you spend a year supporting them? Do you want them to go to college and when? Do you want to pay off the house?, etc. Then you decide if you maximum coverage amount is too high based on your objectives and adjust down accordingly.

    Here are the considerations as to which to buy. Do you have enough money or income to pay the premium. As the others pointed out, you write a smaller check for the term insurance than the whole life alternative. If you have limited funds, then the decision is made for you. I would, however, pick a term insurance product that is fully convertible, to ANY permanent product that the company offers. I can't emphasize how important this is. If your health changes and you can't replace the term coverage when the level premium period expires you will definitely want to exercise your conversion option. Companies who limit your conversion choices usually provide relatively unattractive permanent policies to those wishing to convert.

    The next consideration is how long will I want the coverage to be in place? Life insurance is unique in that it is the only insurance product that insures something that is GUARANTEED to happen! We are all going to die. Usually if the coverage is desired for more than 10 years you will be economically better off with the whole life product when looking at the total "net economic cost" which is the cost of term plus the "lost opportunity cost" for the insurance. (That is the amount you would have earned on the money had you invested it instead of sending it to the insurance company).

    Third is your overall financial plan. There are many ways to structure a whole life or other permanent policy (not a variable universal life though, that is different) to generate lots of cash value in the early years. It requires someone who understands the tax code and various insurance policy contract provisions in order to do this. Most agents and financial planners don't know how to make this work, so ask if they have experience with policies that will perform this way and what part of the IRS code they need to understand (sect 7702). I have clients who use this tool as an alternative to investment grade bonds. You get a better guarantee of principal, generally higher interest rates earned, compound instead of simple interest, and the book value actually goes up if interest rates rise (a bond will lose value if that were to happen). You enjoy guarantees of principal every day you own it unlike a bond which is only guaranteed to have it's full value on the day it matures. Others use it instead of a bank savings account or money market fund. It pays far more interest, is very liquid and enjoys tax deferred growth with tax free access options to use the money in the policy when you are alive.

    This discussion could go on much farther covering how to use the policy to be your own banker, provide lower car and homeowner's insurance costs and a variety of other benefits. I hope this discussion helps you in evaluating your options.


     

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  • 4 out of 4 people found this answer helpful

    CFP® Asheville, NC

    Term is the bare minimum tax expense.  It is specifically designed to cover a period of years that are most important in your earnings and savings.  For example, I purchased a term policy when my daughter was born for 20 years.  By that time she should be into college and not relying on my income or finances as much.  At least I hope :)

    Whole life is a form of forced savings.  They will put you on a schedule to pay premiums for the remainder of your life that equals your death benefit.  So if you live a full life...at death you will be returned your savings.

    Best wishes,


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  • 5 out of 6 people found this answer helpful

    CFP® San Francisco, CA

    Think about term life insurance as 'renting' and whole life insurance as 'buying'. I say this because you build no equity in the form of cash value in a term policy. When the term is over (and the policy holder is still living), the coverage ends and there is nothing to show for the premiums paid into the policy. But, in a whole life insurance policy, you build equity in the form of cash value that can become a valuable asset in your overall financial plan. It takes a while to build up cash value however whole life policies can build cash values greater than the amount of premiums put into the policy over time.

    You want to think about how long you will need the coverage. Term means the insurance will have fixed premiums for only as long as the period of time you select. After that period of time, the guaranteed premiums will likely increase significantly. Getting a new term policy afterwards will generally result in higher premiums as you will be older when getting that new policy.

    Whole life premiums will be higher than term premiums at inception because it is designed to last until death. The higher premiums paid will build cash value in a whole life policy. Cash value can be very useful in a number of ways. It can be accessed via withdrawals or through policy loans. Accessing the cash value can be done on a tax free basis when properly structured.

    So if you have a specific amount of time that you want the coverage, want it at the lowest possible cost, and don't wish to build cash values over time, a term policy is likely the better choice for you. If you want coverage to last as long as you live, you can afford to put more into your life insurance policy, and you see the value in building cash values, a whole life policy is likely a better option for you.

    Age is not a determining factor when considering term or whole life - both young and old can get either kinds of coverage. Premiums will be lower for both term and whole life when young and will be higher for both kinds of coverage when older. By obtaining whole life insurance when young, you are able to secure your life insurance needs and lock in those costs at your best rates. Getting a whole life policy when young allows more time to build up cash values resulting in a bigger benefit. As mentioned above, getting term life insurance while young, allowing the policy to last for the term specified, then attempting to get another term policy can result in much higher costs than by simply buying a whole life policy in the first place.

    An option that exists for some life insurance policies is to convert it into a permanent (cash value) policy. You can obtain a term policy at a lower cost relative to whole life at inception, and later, should your insurance needs change so that you need permanent coverage, you can contact your insurance broker or the company directly to convert all or part of your policy into permanent coverage. Your premiums will increase for the amount you select to become permanent coverage but you will have locked in something that will be there as long as you are.

    To close, I want to briefly say that there are other types of cash value building life insurance policies than just whole life. Those other types include universal life, indexed universal life, variable life, and variable universal life to name a few.  Each of these other kinds of permanent policies are differently structured and have different features and benefits. I suggest that you consult a life insurance professional to assist you in determining which option is best for you.

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  • 2 out of 2 people found this answer helpful

    CFP®, MSFS San Luis Obispo, CA

    The best way to "think" about life insurance is to try to match the coverage you are buying for the need it might have to fill.

    As Roger suggests, ask yourself the question, "if I die (tomorrow / next year / 10 years from now / 40 years from now), what do I want to have happen for my family / loved-ones / business partners?"

    The answer to this question will define the scope of the coverage. If money is needed for 25 years to pay off debt, then a term policy of that length and the amount of debt does the job. If money would be needed to replace the income lost when your life is cut short, then an additional term policy would be appropriate.

    If 40 or 50 years from now, your death would create a financial hardship for your spouse or family, then a permanent policy (and whole life is one type of permanent life insurance, but not the only type) would be more cost effective and efficient because a permanent policy is designed not to run out before your run out of life.

    As with all my answers, it is best to consult with a professional. On life insurance issues, the most qualified individuals are a CLU, ChFC or a CFP® professional (with the understanding of how each gets paid and the fact that only the CFP® has an ethical duty to do what is in your best interests).

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    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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  • 3 out of 4 people found this answer helpful

    CFA, CPA San Francisco, CA

    I suggest that you think about it like this:  term life insurance is like an option ~ you pay an an up-front premium and receive a benefit payment if the person dies during the coverage period.   Whole life is like an option packaged with a series of zero coupon bonds, with some embedded tax benefits.  

    The economics of most whole life policies can be replicated using a combination of term life and financial instruments, at less substantially less cost.

    For most people, term life is a much better deal.  Pricing is transparent, commissions are reasonable, and the overall return is greater.

    Another certainty about term life insurance --- brokers will probably try to convince you that whole life is a better product, and most of them probably believe that it is, notwithstanding the fact that commissions and insurers' profit margins on whole life are substantially higher than on term life. 

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  • 1 out of 1 person found this answer helpful

    CDFA Mystic, CT

    If you are young, and/or are looking at life insurance as a means to replace your income in the event of a premature death, then term life insurance will be the most effective and inexpensive way to do that.

    Whole life has a couple of issues:

    First, the "returns" you get can be muted because of the current investment/interest rate environment. And second, it is going to take much higher premiums to see the same level of death benefit.

    Permanent insurance (such as whole life) is better suited for estate planning applications where you need to keep the policy in force until death (for example, to pay the cost of estate taxes on a large estate, or to create a legacy for your children).

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