Why Term Life Insurance is the Smart Life Insurance

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When making financial decisions, we like to stress that circumstances matter.  Your wants and needs make a decision good for you, even though it might not be the best choice for me.  This is less true, though, in deciding whether to purchase term or whole life insurance.

Term life insurance is almost always the better option.  First, let’s get an understanding of each type of insurance, and then we’ll look at why term life insurance is usually a smarter choice.

What is whole life insurance?

As the name implies, whole life insurance is a life insurance policy that covers you for your entire life, assuming you are paying the premiums.  The idea that the policy has no end date is appealing to some customers.

Whole life insurance differs from term life insurance because it provides both a death benefit and a savings account.  Insurance agents like to refer to these “forced savings” as a form of retirement savings.  You can withdraw or borrow against this cash value savings account portion of the policy.

In addition, insurers sell this policy by emphasizing that the cash value grows over time.  Eventually, you could cash out the savings portion of your policy.  Since a portion of your premiums is going towards this savings account, whole life premiums typically cost 5 to 10 times more than term life premiums.

What is term life insurance?

Term life insurance is life insurance that covers you during the life, or term, of the policy.  Terms range in length from 1 to 20 years.

There is no forced savings associated with term life insurance.  For this reason, term life policies tend to be less confusing and more convenient for policy holders than whole life policies.

Term life premiums are also significantly cheaper than whole life premiums, particularly if you are under age 50.  The premiums for some policies rise a little bit every year, but level term life insurance policies have steady premiums for the entire term. Either way, though, your premiums are likely to be much less expensive than premiums on a whole life policy with a similar death benefit.

Why is term life insurance better?

Whole life insurance is usually significantly more expensive than term life insurance.  You would assume this means your whole life policy provides a noticeable extra benefit.  One purported benefit is that you can receive life insurance beyond age 65.  Term life policies typically won’t cover you beyond age 65.

On the surface this might seem attractive, but it doesn’t actually matter.  The idea of life insurance is that it provides for the people who depend on you and won’t be able to care for themselves in the case of your death.  For example, life insurance is designed to help provide for young children if their parents pass away.  By the time your term policy expires—likely around age 65—your kids will be old enough to care for themselves.  In addition, most liabilities, like loans, will be repaid by that age.

So how else do insurers justify the much higher premiums for whole life policies?  They say a portion of your premiums goes towards an investment—it might be bonds, money-market instruments, stocks, etc.

You can borrow against this savings account, or you can use it as a retirement account.  This might seem like a good idea, except these policies typically come with large commissions and high fees.  In addition, there are much better ways to invest for retirement.

So with whole life insurance you’re essentially paying a higher premium in order to put money into a bad retirement investment.  Typically, you’ll come out on top by investing that extra money in a mutual fund or another solid investment.

Is whole life insurance ever a good idea?

To be clear, buying whole life insurance is not always a bad idea, as the high premiums are suited for wealthier people.  Whole life policy holders might benefit from using the whole life policy in their estate planning or by setting up an insurance trust to pay estate taxes.  Borrowing or withdrawing from the cash value could be a useful investment strategy, as well.  However, in the vast majority of cases, choosing term life instead of whole life insurance is the smart decision.

Published or Updated: March 20, 2013
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Jamie says:

    In my experience it is cheaper getting quotes online. Some of the bigger companies offer discounts when ordering online, because it is less work for them. But to be safe you could compare quotes online, pick the best offer and try a local agency to see if they can match it or do better.

    I recommend this site for online comparing:
    http://www.quotes-center.com/term-life-insurance-calculator

    • Rob Drury says:

      Sounds like SPAM to me. First of all, it is ILLEGAL to offer cheaper quotes through one venue versus another, so your first statement is either a mistake or a lie (I tend to believe the latter). All premiums are approved by each state’s insurance commission and are identical for a particular product regardless of how that product is marketed. No agent or entity is able to “haggle” the price. Some companies do offer certain products which can only be obtained online so they can sell them at a lower premium than competing products, but those products usually lack features in order to lower that premium. More importantly, in order to save that insignificant amount, one misses out on the very most important element in purchasing life insurance; the assistance of a professional advisor.

  2. David Crandall says:

    Term life is the dumbest life insurance because statistics show that only about 2 percent of those who take it out actually collect on it. This is a shocking statistic. You can only take it out if you prove your are healthy and are not a risk taker so the insurance company wins every time. Whole life insurance is the way to go because it builds a cash value and you will have it regardless of how old you have become. Term life is very stupid.

  3. jim says:

    David, Term life is not an investment. Its insurance. The goal is to not collect on it. Collecting on it means you die, (which is to be avoided as long as possible). I certainly hope I don’t get a pay out on my term life insurance. But again, its not an investment it is insurance. Insurance is not something you want to use, it is something you buy “just in case” to mitigate risks. If I don’t get in a car accident then does that mean that my auto insurance is stupid? Is my home owners insurance stupid if my house doesn’t burn down?

    The insurance company wins overall with whole life insurance as well as term insurance. They aren’t giving away free money with whole life policies. Do you realize that over 1/4 of whole life policy holders lapse their policies within the first 3 years and most of those people lose their entire investment due to surrender fees??

    • Rob Drury says:

      Jim,

      You could not be more right or more wrong at the same time. In your opening statement, you claim that insurance is not an investment. You are incorrect, on either one or two counts depending on the scenario. First of all, insurance from a protection perspective is itself an investment. One is putting out money in order to ensure a more favorable situation than what otherwise might be the case. Second, the internal rate of return of the typical whole life policy is extremely favorable compared to the bond/fixed income portion of a properly allocated portfolio. Throw in the tremendous tax advantages, and it becomes a fine investment vehicle for the right individual; especially high net worth individuals who desire the sheltering of large amounts from taxation and potential creditors while having an easy tax-free venue for passing on assets at death.

      Of course, this article mentions only whole life and term; more evidence that the author is completely inept in his understand of life insurance. The use of variable insurance instruments offers the right individual advantages otherwise unavailable. If one suggests that buying term and investing the difference is the right way to go, that is precisely what happens within a variable universal life, with the added protections only a life insurance policy can offer.

      As far as the high lapse ratio of whole life, who’s to blame for that? There certainly are instances when WL is surrendered because it had been sold inappropriately, but more often the client was thinking rationally when he made the purchase decision and irrationally when he got in a financial bind or some idiot convinced him that he had made a bad choice.

      Finally, the understanding of WL as “life insurance with a savings plan attached” is a complete misnomer. Cash value within a WL is exactly the same thing as excess premium reserves within a level term; the product of averaging annual mortality costs over time. Basically, a WL is a level term policy written for one’s life expectancy.

    • ken says:

      In the last 15 years that I have been selling insurance, I have a 90 percent persistency rate (most of the 10 percent is because of divorce) and many own permanent insurance. If one buys what they need for their circumstances, they keep it; the same for their investments. But for that most need a “coach (agent/rep) to keep them on track.

    • ken says:

      In the last 15 years that I have been selling insurance, I have a 90 percent persistency rate (most of the 10 percent is because of divorce) and many own permanent insurance. If one buys what they need for their circumstances, they keep it; the same for their investments. But for that most need a “coach (agent/rep) to keep them on track.

    • ken says:

      In the last 15 years that I have been selling insurance, I have a 90 percent persistency rate (most of the 10 percent is because of divorce) and many own permanent insurance. If one buys what they need for their circumstances, they keep it; the same for their investments. But for that most need a “coach (agent/rep) to keep them on track.

  4. Hello Jim, you said that because Whole Life cost way more then you should expect receiving more benefits… and you do. The problem many people have with whole life is that they look at it as an investment in itself but later use and analysis has shown that it is more a financial platform.
    The fact that whole life can put you in control of a capital that is easy accessible to you without restrictions and barriers, provide you with those benefits.
    Once you have created that capital (this is one of the reasons the policy is over-funded, to enjoy the benefits of being capitalized) you are free to do everything you do with third people financing but with much better results to you since you will be receiving the interest and fees that third parties make such a good life off.
    Some people say but you have to pay interest to use your money! Yes but the reason for that is IRS regulations and the fact that the use of money has a cost.
    There is plenty of documentation to support what I state here: “Becoming your own banker” by Nelson Nash.
    “How Privatized Banking Really Works” by Carlos Lara and Robert P. Murphy Ph.D.
    “The Pirates of Manhattan” by Barry J, Dyke
    P.S. The more your cash value grows the higher your death benefit becomes; different from term that the $250,000 insurance you took 20 years ago will be the same but depreciated dollars your family will receive if you die within the contracted term. Otherwise “puff” all the money and the opportunity cost of that money paid in your term premiums is gone.

  5. Rob Drury says:

    Term insurance is temporary insurance appropriate only for temporary needs. For most people, most of the time, mostly term insurance is appropriate. For some, protection for the family until the children leave is definitely the only potential life insurance need. For these households, term is appropriate. Such households are a small minority. There are many reasons and scenarios where the need is permanent, or where some type of permanent coverage is more cost effective. Because no one reading this could possible have the time to read all the possible reasons, and because many of those reasons are beyond most people’s comprehension, it suffices to say that one should simply consult with a properly qualified financial planner or comprehensive advisor in order to determine one’s life insurance need. BTW, an insurance agent is typically NOT a qualified life insurance advisor. Done properly, most households have a need for some level of permanent coverage.

  6. Interesting post, Dr Writer. You bring up some great points, but people use life insurance for a variety of reasons. Even though a 65 year old’s kids can likely take care of themselves, many people take out a policy to cover funeral expenses. Like Rob said, there could be any number of reasons why someone would take out a policy, so I’d have to agree that consulting a qualified adviser or planner for your particular needs is the right course of action. Thanks for taking the time to show your perspective though

  7. Wilson Courtney says:

    For me, there’s advantages and disadvantages for both policies, but base on this article, I rather choose Term life insurance because it is more affordable compared to whole life. Are there any insurance policy aside from the two to choose from?

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