Retirement and Annuity Advisor Jennifer Lang
Term Life Insurance, Whole Life Insurance Life Insurance: What's the Difference?
When shopping around for a life insurance policy, you have many choices. From monthly low-cost term insurance, to more expensive but long-term coverage benefits of whole life and universal life insurance, there’s a wide landscape of options.
As you consider different selections, it’s important to understand how these types of insurance differ from another. Among permanent life insurance, two widely-purchased options are whole life insurance and indexed universal life insurance.
While term life insurance is the most straightforward, it covers you only for a short-term period. Conversely, whole life and indexed universal life policies give lifelong coverage, so long as a policy remains active.
But they are more complex, tend to cost more than term coverage, and can be better-suited for long-term objectives. With that said, the cash value component of permanent insurance may be attractive for a number of reasons, including for efficient legacy planning, tax-advantaged wealth building, and tax-deferred retirement saving.
If you’re exploring term life insurance versus whole life insurance and indexed universal life insurance, it’s prudent to be diligent. You will want to research and consider your options carefully, and to help you get started, here's a quick guide on the differences between these life insurance types.
What to Consider When Buying Life Insurance
When it comes to life insurance, people often focus on two things: length of coverage and price. Chances are you have heard of trendy sayings like “term over perm” or “buy term and invest the difference.” But the question of what life insurance someone needs isn’t an “either-or” situation. Nor is term insurance the “best” option by default.
Sure, term coverage may be purchased at the lowest initial cost. But when you need to renew your policy, term rates often increase substantially. You may also find that you actually need more than one type of life insurance policy.
So, any life insurance purchasing decision should include a vigorous fact-finding and analysis of your personal and household financial needs. In fact, some other variables to consider are:
Your risk tolerance
How your number of dependents might change
Your health status
Your time horizon before retirement
Whether your needs extend beyond just protection
Depending on your circumstances, you may want to consider permanent as well as term life insurance for your portfolio. Now, let’s go back to the overview of term and permanent life insurance options.
Term Life Insurance
Compared to whole life and indexed universal life, term insurance provides the simplest coverage. The policy owner holds the guarantee of a death benefit for a certain period. That can last anywhere from 10-30 years, with most term policies lasting for 20 years.
When a term policy expires, that’s it. Your loved ones won’t receive any payouts since the policy has ended. You may be able to renew your term policy, but your new rates will be based on your current age and the actuarial risks that come with it (for example, heightened health risks, shorter life expectancy, so on).
The benefits of term life insurance are:
Premiums stay fixed
Simplest form of life insurance coverage you can purchase
Available at lower cost than whole life and IUL, at least initially
Provides a straightforward, guaranteed death benefit for a preset duration
May come with ability to convert to a permanent policy
Some policies include riders for healthcare and long-term care costs
Flexible, short-term protection when people need it
Some downsides tied to term life insurance are:
Policy may lapse if premium payments are late or missed
No death benefit provided upon expiration
Renewal rates can be far more costly than your initial rates
No cash value included in the policy
For some people, no “return benefit” for potentially decades of premium payments can be hard to stomach.
Because its coverage is temporary, term life insurance can be a better option for those with temporary financial needs. People who find themselves in the following situations may want to consider this type of coverage:
Creating protection for households in high-need years, such as when they first have children
Providing immediate financial resources if a primary income earner dies unexpectedly
Covering the economic value of a homemaker should they pass away
Giving coverage for debts or expenses, like a mortgage, if an income earner deceases
In short, term insurance is a short-term, economical way to insure a large amount of money, or the income stream that a wage earner brings home. Those looking for lifelong coverage or needing efficient legacy planning vehicles may be better-served by permanent insurance options.
Whole Life Insurance
Whole life insurance has been around for decades. It is the most basic form of cash value life insurance. A whole life insurance policy comes with predictable premiums that don’t rise with age. It also confers guaranteed benefits.
Whole life insurance comes with a cash value, which can be accessed in later years. When comparing whole life – and other cash value insurance for that matter – to term life, it’s similar to buying versus renting a home. Sure, renting will be less expensive in the short run. But over the long term, it may prove to be the most costly. In contrast, buying a home enables someone to build up home equity over time – not to mention it may be potentially lower cost over time.
Whole life is like owning a home that has a corresponding equity component. Over time, this equity component, or the cash value grows tax-deferred, and your premiums don’t increase. With that said, whole life insurance does come with more costs to cover, including management fees.
The benefits of whole life insurance are:
Premiums stay fixed, don’t rise with age
Comes with guaranteed benefits
Simplest form of cash value life insurance
Ability to pay up policy face value in 10-20 years, or at age 65
Can access cash value via loans or withdrawals later on
No age 59.5 withdrawal rules, so long as the policy doesn’t become a Modified Endowment Contract
Cash value grows on tax-deferred basis and money can be taken out on a potentially tax-free basis
Insurance company may pay dividends to policy owner
Some downsides of whole life insurance are:
Often the interest rate is not guaranteed
Comes with more costs to pay than term insurance
Premium payments aren’t flexible
Premiums must be paid consistently or policy will lapse
Likely to earn lower interest
Policy lapse may trigger taxable event
Most whole life policies don’t build cash value early on
Whole life insurance may be a good option for those wanting lifelong coverage and more straightforward cost of insurance than with other cash value insurance products. It can also be a better fit for retirement savers looking for alternatives to the meager interest rates of CDs or bank saving accounts.
Indexed Universal Life Insurance
Index universal life insurance, or “IUL,” can enjoy stronger opportunities for cash value growth than whole life insurance. Its interest-earning potential is tied to an index, like the S&P 500 price index. Unlike whole life insurance, IUL does offer flexibility in premium payments, with certain conditions. The cash inside an IUL policy grows tax-deferred, just like with whole life, and the cash value can be tapped for premium payments.
While the growth potential may be more substantial, indexed universal life insurance is a newer innovation in the insurance marketplace. Your premiums may increase over time, as the cost of insurance may rise. Insurance carriers may hold derivatives as underlying investments in IUL policies, which can make these policies even more complex.
While IUL does let you enjoy growth potential tied to an index, it comes with limits. IUL insurance carriers “cap” the growth potential at certain predetermined rates, and likewise they may protect against negative index changes with a “floor.” While many IUL policies have a floor of 0%, or your cash value doesn’t drop in value when the index goes down, this applies to when the insurance carrier credits interest to your policy. In fact, your policy may lose value due to policy costs you have to pay, should you earn no or low interest at a given point.
If a policy owner relied on high interest-earning years to fund the cash value, it could lead to a policy lapse in later years, should the policy get low interest in later times. Likewise, taking policy loans and paying loan interest can be risky if earned interest doesn’t surpass the costs of the loan.
Some of the benefits of indexed universal life insurance are:
Guaranteed benefits, though fewer than whole life insurance
Ability to obtain a bigger death benefit than with whole life
Flexible payments for premiums possible
Potential to receive more interest than whole life insurance
Cash value can be accessed via loans or withdrawals
No age 59.5 withdrawal rules
Tax-deferred retirement money growth potential
Ideal vehicle for supplementing income or maximizing an estate for beneficiaries
Some drawbacks of IUL can include:
Premiums may increase over time
Opportunity to earn interest depends on index performance
Interest-earning potential “capped” by insurers
Policy may lose value when costs outpace low interest
Overall, people looking for safer alternatives to stock market volatility may want to consider indexed universal life. Likewise, individuals looking to maximize legacy assets for heirs or provide a tax-efficient estate transfer to their loved ones may look into this insurance type. IUL can also offer another vehicle for supplemental retirement income when retirement savers have maximized contributions to IRAs, 401(k)s, and other savings plans.
While indexed universal life insurance may be a solid retirement planning vehicle, it is more complex than other cash value life insurance. Working with a qualified financial professional to properly structure a policy, according to your needs and goals, is a prudent strategy.
While this overview showcases some of the critical differences of IUL, whole life, and term life insurance, it’s by no means exhaustive. If you are considering life insurance as part of your financial strategy, especially permanent insurance, be prudent.
Conduct a careful due diligence and consider guidance from a financial professional who acts in your best interest. And when planned and implemented properly, a life insurance policy can go a long ways to bringing you more financial security and peace of mind.
Ready for personal attention as you consider different insurance options? A financial professional at JenniferLangFinancialServices.com can assist you. Click here to connect with someone directly.