Term vs. Whole Life Insurance: Which Is Best for You?

Which of the two main types of life insurance meets your needs?

Matthew Frankel, CFP
Matthew Frankel, CFP
Jul 16, 2015 at 12:39PM
Investment Planning

Many people want life insurance for the peace of mind it provides, but shopping for policies can get confusing. While there are more specialized types of life insurance than I could name here, the two main varieties you'll find are term and whole life -- and there are many differences between the two. Here's what you need to know, so you can make an informed decision for you and your family.

Term life insurance can protect your family -- for now
You can think of term life insurance as temporary coverage, while whole life is permanent.

Essentially, your premiums stay fixed for a set number of years (the "term"), during which time your beneficiaries will receive a lump sum of money in the event of your death. If the policy runs out and you're still alive, you have the option to continue coverage, but the premiums can increase rapidly. Many people find that continuing a policy beyond its term can become unaffordable quickly, so don't plan on being able to keep it forever.

Wooden tiles on a notebook spelling out life insurance with laptop, pen, pair of glasses, smartphone, and coffee cup in the background

Image source: Getty Images.

Perhaps the most attractive aspect of term life insurance is the cost. Term life policies usually come with much lower premiums than whole life. I ran a quote for myself (mid-30s, non-smoker) through State Farm's website. For a 20-year term life policy with $250,000 in coverage, my premium would be just $22.85 per month. A whole life policy would cost $261.65 per month, or more than 10 times that amount.

For this reason, term life policies are a popular option for younger individuals and families, who may not have much savings yet but want to make sure their loved ones are financially secure. In fact, 85% of the life insurance policies TIAA-CREF issues are term life.

Whole life insurance protects you forever and builds cash value
As the name implies, a whole life policy protects you for your entire life. It's also much more expensive for a number of reasons.

For starters, whole life premiums stay the same forever -- even if you're 100 years old. Unlike a term policy's premium that can increase dramatically after the initial term runs out, a whole life premium is guaranteed for life. The premiums may seem steep to insure a 35-year-old (and they are), but they'll seem like a bargain for $250,000 in coverage on an 80-year-old.

Don't forget about inflation, either. While the $261.65 premium in the previous example may sound ridiculously expensive when compared with that of a term life policy, a dollar when you're 80 won't be worth the same as a dollar today, so your premiums will seem cheaper as time goes on.

Plus, whole life provides a living benefit. That is, as you pay your premiums, your whole-life policy accumulates cash value. Your premiums are invested and grow and earn dividends as time goes on, and this value builds on a tax-deferred basis, similar to an IRA or 401(k). You can also borrow against your policy if you choose to do so, or you can cash out some or all of its value.

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To recap, here's a summary of the reasons you might want each type of life insurance:

Term Life Insurance Whole life insurance
Cheaper Builds cash value
Straightforward, easy to understand Premiums will never increase
Just provides a death benefit; no extras You can borrow against the policy
  Eligible to be paid dividends

An alternative to whole life
Before you decide which is best for you, consider whether you'll need life insurance in 20 or 30 years after a term policy expires. After all, the main attraction of a term life policy is that it's an inexpensive way of providing financial security before you have enough savings and other assets. Well, if you're saving and investing responsibly, this may not be the case in 20 or 30 years from now.

Looking at my example once more, you'll notice that the monthly difference in premiums between the whole and term life policies is $238.80. If I simply buy the term life option and invest the difference, it could build up quickly. Based on the S&P 500's historical average returns, after 20 years my investment could be worth nearly $155,000. After 30 years, it could grow to $428,000. Bear in mind, this would be on top of whatever other investment accounts I have, such as a 401(k) or IRA.

The point is that if you have $428,000 or more in savings, do you really need a $250,000 life insurance policy? I tend to lean in favor of carrying a term life policy and maximizing my investments, and this is in fact what I do for myself and my own family. The goal is that by the time my term life insurance policy expires when I'm 55, the death benefit won't be nearly as necessary as it is now.

It's all about your peace of mind
While I completely agree with the assertion that term life insurance is sufficient for most people, it's still important to do what makes you comfortable. If you like the idea of having a fixed premium for your entire life and the ability to borrow from or cash in your policy, there's nothing wrong with shopping around for whole life if it'll help you sleep more soundly at night. However, I believe those extra dollars could be put to work elsewhere.