Though there are variations and insurance plans that try to mix elements of each, there are basically two types of life insurance plans to choose from: term life insurance or whole life insurance. So what is the difference?
Just as the names suggest, whole life insurance is a permanent plan that keeps you covered for your entire life while term life insurance is coverage for a term or a set period of time that you determine, when you start the policy. At face value, it may seem that the permanent option would be the way to go. However, there is much more to consider when deciding between whole life and term life insurance.
Whole Life Insurance
While whole life insurance offers coverage as long as you live without concern of expiration (as long as the premium payments remain up-to-date), you will end up paying a higher rate because it offers tax-deferred cash value accumulation. This means that the insurance company invests the money you pay into your life insurance policy and credits your account with a portion of the interest it accrues from these investments. If you decide to cancel your policy you can be paid the cash value of your account in a lump sum (you will only pay taxes if the lump sum is more than the amount of the premiums you have paid into the policy). If you need access to your cash value now, you can borrow against it with a policy loan, or even withdraw money from your account, minus the taxes, as long as the amount isn’t larger than the premiums you have paid into it.
Term Life Insurance
Unlike whole life insurance policies, term life insurance pays death benefits to the beneficiaries only if the policyholder dies within the set period of time that the insurance policy is in effect, generally ranging from 5 to 30 years, or up to age 65. The advantages of term life insurance include its simplicity and affordable rates. You choose the term length and coverage amount and pay a smaller, affordable premium thereby keeping more money in your pocket, unless you have special requirements like a no medical exam policy which could drive up the rates. Term life insurance does not provide you with cash value but allows you to purchase a higher death benefit than you could maintain under a whole life policy. It leaves you free to invest the difference in the premiums any way you see fit. These term life insurance policies are generally ideal for young families, new homeowners, or people with other financial responsibilities because the premiums are the lowest on the market, and you can buy policies offering higher levels of coverage during the time when you need the insurance coverage most. Also, you most often have the flexibility to renew your coverage (at a higher rate) once your policy expires and, as with other insurance policies, your beneficiaries will receive an income tax free payout.
It is true that whole life insurance has the advantage of being a permanent solution and offers cash value that can come in handy, later on down the road. However, when you evaluate the higher out-of-pocket expense and how that cash value in your account compares to other investment options, term life insurance makes more sense for nearly any family.