When you buy life insurance, you have many choices to make. The most basic choice you must make is whether to purchase term life insurance or whole life insurance. Each type of policy has its own uses and advantages as well as disadvantages. Make sure you understand the nature of what you're buying before you sign a contract.
A term life insurance policy provides basic death benefit protection. In exchange, you pay premiums to the insurance company. As long as you pay premiums to the insurer, your insurance policy remains in force. The insurer guarantees the coverage. At the end of the term, your policy premium increases. Term for these policies range from one year up to 30 years.
Whole life insurance has higher premiums than term life insurance, but a whole life policy extends death benefit coverage out to age 100. The policy also builds a cash reserve against the death benefit. This cash reserve is a saved amount you use during your lifetime for any reason.
The main advantage to term life insurance is cost. Term premiums are low relative to death benefits. The low cost means you may buy more death benefit for the same amount of money when compared to whole life. Term life is ideal for insuring mortgages and short-term loans. It's also an ideal solution for times when you have high debt or financial obligations but low cash flow.
Whole life insurance is a long-term solution for insurance. As the cash value builds up in the policy, the actual amount of death benefit you are purchasing decreases. Because of this, whole life becomes more efficient over time. Policy loans allow you to access the cash reserve during your lifetime. On top of this, all elements of the policy are guaranteed so that you can't lose your death benefit or cash value unless you stop paying your premiums. Even if you do stop paying premiums, some insurers will automatically borrow money from your cash value account to pay for the premiums to keep your policy in force for you. Whole life is ideal when you want a permanent life insurance policy with a savings component.
When considering whether to buy whole life or term, analyze your needs and financial goals. Term life is, essentially, a short-term contract made for short-term needs. Whole life is a long-term contract that is designed to allow you to buy the policy and never worry about increasing insurance costs or whether you are insurable in the future.
With both types of policies, the general idea is that you will buy insurance and then accumulate a savings at the same time. With term insurance, you must accumulate the savings yourself. With whole life, the savings element is built into the policy.
- "Life Insurance"; Kenneth Black, Jr., et al.; 1994
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, et al.; 2007