When looking at the financial needs you may have throughout your life, the subject of supporting your loved ones should the worst happen will likely come up. It’s a grim topic—and it’s natural to want to avoid talking about it. However, there are serious decisions you need to make with regard to your life insurance policy. Deciding between whole vs term life insurance is a big one.
If you have been in the working world for a while, you’ve possibly already encountered term life insurance. Also known as temporary insurance, many employers offer it as part of their basic benefits package.
However, term life insurance is not the only kind of life insurance. Depending on where you are in your life and career, it’s entirely possible that whole life insurance is a better option. This comes with some major risks and drawbacks, particularly if you are paying into a cash value account associated with your permanent plan. It does still have some major advantages on term contracts.
Sometimes, more options mean you need to be more careful. That is very much the case when you take the step to purchase your own life insurance policy.
Duration of Whole vs. Term Life Insurance
It’s right there in their names. Term life insurance expires after a set time period—typically 10, 20, or 30 years. Usually, this is long enough to carry most working adults into their retirement, but no further. This makes sense, as the risk for life insurance companies increases exponentially the older a person gets.
Whole life insurance is a kind of permanent life insurance, the idea being that this is a plan you can have until you, well, die. Whole plans usually come with other opportunities to invest in addition to your premium, but we advise against those unless you read your contract very carefully.
Price of Whole vs. Term Life Insurance
Term life insurance has the advantage in terms of price, at least if you’re younger, a nonsmoker, and in relatively good health. For example, a 35-year-old male could get a 20 year, $500,000 policy for $20 a month. You can also typically purchase term life insurance plans up until the age of 80. But premiums will get more expensive as time goes on, for obvious reasons.
On the flipside, whole life insurance premiums tend to be magnitudes more expensive. That same $500,000 policy would cost about $4,400 a year as opposed to $240. That’s a pretty significant difference if the primary thing you are worried about is cash flow.
Cash Value Accounts
Here is where you need to be very careful with whole life insurance plans—the cash value account. A part of them usually includes an investment account requiring you to deposit money other than your premium. This is money that you can withdraw at any time, and while the investments are extremely reliable, the percentages tend to be low.
Cash value accounts operate like low-yield savings accounts that might not go to beneficiaries if the policyholder dies. This arguably defeats the purpose of both savings accounts and life insurance.
It is possible your contract allows a portion of that account to go back towards your beneficiaries, but you would always have been better off putting that money into a high-yield savings account or investing it. In any event, read your contract very carefully so you know exactly what will happen with that money should the worst happen.
This is the biggest drawback to whole life insurance plans other than the higher premiums.
You Know Your Life
While the choice between whole vs term life insurance will come down to your needs in the end, for the majority of people, term life insurance will be a better option. Especially if you are young, that extra $4,000 a year is a major loss in terms of cash flow and savings or investment potential. Frankly, you probably couldn’t realistically afford it. But even if you can, whole life insurance plans come with some serious drawbacks. Chief among those drawbacks is the possible misuse or loss of that cash value interest account that we talked about earlier.
You know your life and needs better than strangers on the internet. That being said, our recommendation is to stick with term life insurance unless you have a very compelling reason to go with whole life insurance. Yes, it gives you more control over the money that you pay in, but you’re better off never losing control of that money in the first place.