What is the difference between whole life insurance and term life insurance?
Answer:
Whole life
1) Whole Life is a form of permanent insurance. Permanent insurance comes in a variety of forms, e.g., universal, variable universal, equity-indexed, etc. All have unique attributes, advantages and disadvantages.
2) Premiums remain fixed until a predetermined age, until the policy matures or "endows" (typically age 100), or when you die. If you live to endowment age, the company will pay the face amount of the policy to you, tax-free.
3) There will typically be a "surrender period", often 10 years. The surrender charges decrease over time, thus, it may appear that in the early years, all premiums go to the insurance company as the surrender charges may equal the accumulated value. At the end of the surrender period the surrender value will equal the cash value.
4) Cash value typically accumulates at an annual interest of around 3%.
5) You may access money from the policy be either withdrawing from or by borrowing from the cash value. Withdrawals above basis will be treated as income and taxed accordingly. Loans from the policy do not incur taxes. Interest will be assessed on a loan, typically between 3% and 6%, sometimes as high as 8%, depending on the policy.
6) If there is a loan balance at death, it will be deducted from the face amount of the policy. If you cancel the policy while there's a loan balance, you may be responsible for income taxes on the gains.
7) When you die, the face amount (less any loans, loan interest due, and missed premiums) will be paid to your beneficiary.
8) Because cash value is accumulating in the policy, you are actually only paying for the difference between the face value and the accumulated value.
9) Properly designed, the cost of insurance will decrease over time to the point no money is required out of pocket - any insurance costs are taken directly from the cash value (and therefore paid with tax-free money).
Term Insurance
1) Does not build cash value. This allows you to save money elsewhere - possibly with better returns.
2) While premiums appear to be considerably lower than whole life insurance - the actual cost of the insurance itself is not substantially different. This is because
3) Provides coverage for a limited time, then expires (like home-owner's or auto insurance).
4) At the end of the term, some companies may renew without proof of insurability. However, most will require underwriting. If you are still insurable, the premiums will be considerably higher as you are now that much older. (To get an idea of how much more, get quotes for both your current age and 20 years older.)
5) Keep in mind that term insurance only pays about 3% of the time. The other 97% outlive their policies. (Just like home-owner's or auto insurance, we hope to never have to use it!)
The original author said:
Some may argue that it will get more expensive when it is time to renew your term insurance. While that is true, you should put together a plan so that you don't need life insurance forever. I think 20 year level term is long enough for most people. If not, a 30 year level term. Lets say you got a 30 year level term and pay about $600/year for $500,0000 coverage. And you invest $400/month into a Roth IRA for the next 30 years. The investments I own have an average rate of return of 12% in the past 30 years. To be conservative, lets say you get a 8% return in the next 30 years. In 30 years, you will have about $600k saved for retirement. If you get 12%, it will be $1.4 million.
I add:
Renewal of term insurance will absolutely be more expensive. Guaranteed.
Will you need life insurance forever? Who knows?
Life insurance isn't necessarily just about the people you leave behind though, it can also be about you:
Do you own a business? There are few (if any) better methods to transfer money from the business to the owner tax-efficiently. Likewise, there are few, if any, better methods to sell or transfer ownership of a business than through the use of life insurance.
As far as investments are concerned, anyone making 12% per year for 30 years deserves huge kudos. (While the stock market has averaged 12%, the individual investor has averaged closer to 6%. Sad but true statistic.)
I'm glad the original author said "Roth IRA" - tax-free income trumps taxable income.
So, give me the bottom line!!! Is whole life or term better?
Neither is better than the other. But one will offer a better solution than the other for your particular needs, goals, and abilities.
No one in this forum - or on the web - can answer that for your situation. We can only help educate you about the products, their differences, pros and cons, and even offer our own opinions or biases.
Talk to your financial advisors - knowing the facts first will keep them honest!
1) Whole Life is a form of permanent insurance. Permanent insurance comes in a variety of forms, e.g., universal, variable universal, equity-indexed, etc. All have unique attributes, advantages and disadvantages.
2) Premiums remain fixed until a predetermined age, until the policy matures or "endows" (typically age 100), or when you die. If you live to endowment age, the company will pay the face amount of the policy to you, tax-free.
3) There will typically be a "surrender period", often 10 years. The surrender charges decrease over time, thus, it may appear that in the early years, all premiums go to the insurance company as the surrender charges may equal the accumulated value. At the end of the surrender period the surrender value will equal the cash value.
4) Cash value typically accumulates at an annual interest of around 3%.
5) You may access money from the policy be either withdrawing from or by borrowing from the cash value. Withdrawals above basis will be treated as income and taxed accordingly. Loans from the policy do not incur taxes. Interest will be assessed on a loan, typically between 3% and 6%, sometimes as high as 8%, depending on the policy.
6) If there is a loan balance at death, it will be deducted from the face amount of the policy. If you cancel the policy while there's a loan balance, you may be responsible for income taxes on the gains.
7) When you die, the face amount (less any loans, loan interest due, and missed premiums) will be paid to your beneficiary.
8) Because cash value is accumulating in the policy, you are actually only paying for the difference between the face value and the accumulated value.
For example, if you have cash value of $250, 000 in a $1,000,000 policy, you are only purchasing $750,000 of insurance. This is how much the insurance company must come up with to add to your cash value to pay your beneficiary the full $1,000,000.
9) Properly designed, the cost of insurance will decrease over time to the point no money is required out of pocket - any insurance costs are taken directly from the cash value (and therefore paid with tax-free money).
Term Insurance
1) Does not build cash value. This allows you to save money elsewhere - possibly with better returns.
2) While premiums appear to be considerably lower than whole life insurance - the actual cost of the insurance itself is not substantially different. This is because
a) whole life has an investment component (i.e., only a portion of your deposit goes to the insurance cost), and
b) the insurance company is obligating themselves to take on the added risk that comes with aging.
3) Provides coverage for a limited time, then expires (like home-owner's or auto insurance).
4) At the end of the term, some companies may renew without proof of insurability. However, most will require underwriting. If you are still insurable, the premiums will be considerably higher as you are now that much older. (To get an idea of how much more, get quotes for both your current age and 20 years older.)
5) Keep in mind that term insurance only pays about 3% of the time. The other 97% outlive their policies. (Just like home-owner's or auto insurance, we hope to never have to use it!)
The original author said:
Some may argue that it will get more expensive when it is time to renew your term insurance. While that is true, you should put together a plan so that you don't need life insurance forever. I think 20 year level term is long enough for most people. If not, a 30 year level term. Lets say you got a 30 year level term and pay about $600/year for $500,0000 coverage. And you invest $400/month into a Roth IRA for the next 30 years. The investments I own have an average rate of return of 12% in the past 30 years. To be conservative, lets say you get a 8% return in the next 30 years. In 30 years, you will have about $600k saved for retirement. If you get 12%, it will be $1.4 million.
I add:
Renewal of term insurance will absolutely be more expensive. Guaranteed.
Will you need life insurance forever? Who knows?
If your child were diagnosed with multiple sclerosis at age 40, would you want to be able to provide for him/her well beyond your death?
If you died six months after Bernie Madoff cleaned you and your wife out 10 years into retirement, would you want her to regain her footing?
Will your heirs incur estate taxes? An $20M estate in 2011 may incur taxes of $8M or even more! (Do you really want to say "Sorry, kids, I chose to give the IRS half of your inheritance..."?)
Life insurance isn't necessarily just about the people you leave behind though, it can also be about you:
Do you own a business? There are few (if any) better methods to transfer money from the business to the owner tax-efficiently. Likewise, there are few, if any, better methods to sell or transfer ownership of a business than through the use of life insurance.
Do you want to pay for your children's college? Sure there are 529 plans, but what if your kid gets a full scholarship? Or doesn't go to college? You can give the plan to a niece or nephew or you can pay tax on the growth and pay a penalty.
As far as investments are concerned, anyone making 12% per year for 30 years deserves huge kudos. (While the stock market has averaged 12%, the individual investor has averaged closer to 6%. Sad but true statistic.)
I'm glad the original author said "Roth IRA" - tax-free income trumps taxable income.
But what if you make too much to qualify for a Roth IRA?
Do you have the means and desire to contribute more than $400 to a Roth IRA?
What if you want a Roth for yourself, a 529 plan for your children, and need life insurance?
So, give me the bottom line!!! Is whole life or term better?
Neither is better than the other. But one will offer a better solution than the other for your particular needs, goals, and abilities.
No one in this forum - or on the web - can answer that for your situation. We can only help educate you about the products, their differences, pros and cons, and even offer our own opinions or biases.
Talk to your financial advisors - knowing the facts first will keep them honest!
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