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Buying a life insurance policy provides a much needed financial safety net for family members in case of a loved one’s passing. Yes, it can be a bit morbid but picking the right coverage is key in ensuring your family’s financial future.
When shopping around for life insurance, policies will usually fall into one of two categories Term Life or Whole Life. Depending on your individual circumstances, the number of expenses you want to be covered, and factors like age; either whole life or term life insurance can be the right fit for you.
Let’s break down the differences:
Whole Life is a form of permanent life insurance. It is usually more costly and includes components like cash value that increase your types of benefits. These insurance policies can be customized to your needs and more than often require you to sit down with an insurance expert to discuss your financial responsibilities, and specific policy details.
Term Life is a simpler policy acquired by most individuals. Its structure is straightforward with level premium payments. The policy is paid out to one or several beneficiaries in the event of the policyholder’s death. This simpler coverage is a more affordable option, without the bells and whistle that come with an investment component.
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How does Whole Life Insurance Work
Whole life insurance guarantees coverage for a lifetime with level premiums. This is especially important if you are of an older age. Whole life insurance doesn’t have the age limitation term life insurance can have on coverage.
Like other permanent forms of insurance, whole life includes cash-value which accumulate over the duration of your policy and interest is paid towards it by your carrier. With each insurance payment, a percentage goes toward the cash-value, increasing the overall benefits.
Think of cash value as an investment account. In some cases, depending on how long you’ve been paying a premium, the cash-value can exceed the death benefit. You can also withdraw money from the cash value or use it as collateral for a loan.
How does cash value grow in a whole life policy?
In essence, when your insurance company does well, you do well. When your carrier makes more than needed to run the business some of that profit is paid back to you in the form of a dividend. So, in addition to the percentage of the money you’re paying to your cash-value, the carrier can contribute interest based on their performance and the size of your existing cash-value.
Policies with a cash-value component can either be participating or non participating. Non-practicing types of coverage like universal life are paid fixed market interest rates, as determined by the policy. Policyholders of participating policies like whole life act as partial owners of the life insurance company and are therefore entitled to the dividends of surplus earnings.
How can you use the cash value to your advantage?
There are several ways you can take advantage of cash-value components. As your cash-value grows larger more of these benefits become a great option. You can use cash-value to pay your premium, take out a life insurance policy loan, withdraw partial funds, or even sell your policy for an insurance settlement.
Policies with cash-value are also referred to as 7702 life insurance. This simply means that they are compliant with section 7702 of tax regulation. There are a number of tax benefits to cash-value as well. For instance, if you chose to partially withdraw money from cash-value, the money you take out would be tax-free. One of the biggest tax benefits in life insurance is that death benefits paid out to beneficiaries are free of income tax – with most eventually being paid out to whole life beneficiaries.
Here are the pros and cons of whole life insurance:
|Build Cash Value
||Moderate Return of Investment
|Fixed Return of Investment
||Higher Cost of Insurance
How does Term Life Insurance Work
Term life insurance offers coverage for a specific period of time. Most carriers offer term level insurance for periods of 10, 20, or 30 years and non-level insurance. Unlike whole life, term life insurance does not build cash-value.
With term life insurance the longer your policy term the higher your premium. Essentially term life insurance is great for policyholders who only require temporary coverage. For instance, young families with co-dependent incomes or individuals in their working years who plan on accumulating a significant amount of wealth as they get older. If you’re in the market for lifelong insurance or guaranteed coverage, term life may not be the right fit for you.
Here are the pros and cons of term life insurance:
||No Cash Value
Why is the cost difference so much?
Like most insurance policies, the cost of life insurance depends on a lot of things, none being more important than the type of policy you choose and the rate class you qualify for. The high premium of whole life is reflective of the guaranteed payout of its death benefit.
Term life has a lower premium because the chances of the death benefit getting paid out are much lower. The cost difference between term and whole life can be substantial for those reasons.
Buying vs Renting
Similar to renting or buying a home, term and whole life policies are reflective of the level of investment you want in your coverage. As you are essentially ‘buying’ coverage, whole life allows policyholders to build ‘equity’ in the form of cash-value. When you ‘rent’ property you have no equity or interest in it so your payments are cheaper.
Like the chart below breaks down, ‘renting’ coverage for 20 years for $23/monthly or 30 years for $40/monthly is going to be substantially cheaper than ‘buying’ it for a lifetime with a $430/monthly mortgage payment. Whether you rent or buy, make sure to pick the coverage that alines with the type of investment you want to make.
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What does converting from term life to whole life mean?
As your life changes your policy may need to change with it. Whether you’re becoming an empty nester or moving into retirement, converting a term life policy to whole life policy could be the right move for you. Most term life insurance plans are convertible, which means you would have continuous coverage. This also means not having to take another medical examine or answer a long list of questions as long as meet certain age requires.
Policyholders also have to option to convert to a hybrid policy like universal life insurance. This kind of coverage combines components of term life insurance with an investment option.
Choosing between the two.
When choosing between the two types of coverage there are several factors that your life insurance advisor will consider in order to help you get the right policy for your life needs. Some of these include affordability, the amount of coverage needed and age. Take the time to consider your current and future financial responsibilities. If you can no longer provide for your loved ones, what type of coverage would best support their needs at a reasonable cost?
Local Life Agents can help you answer important questions like these in order to find the best coverage for you and your family. Call us today to get information on policies that fit you.