Term Vs Whole Life Insurance

Which is best for your situation? It depends on your reason for buying.

Term Insurance is useful for providing short term protection and is always the least expensive option because you are simply paying to insure against death occurring in the next year. At the end of the term ( year ) if you choose to renew the policy, it will be at a higher rate. If you have an upcoming expense that you would like to insure against such as putting your kids through college, then you have a short time horizon and it makes sense to use term insurance.

Single year term starts out as the cheapest option but as the policy ages, the rates escalate at an increasingly fast rate. In order to secure lower rates again you will need to reapply and retake your medical exams proving insurability. Once you have done this, you will start the process over again. This is why many people will move to a Level Term product that stays level for a specific period of time.

Level Term Insurance is much more commonly used today than single year term insurance. You pay more in the first few years, but the premiums are guaranteed not to change for a defined period of time such as 10 or 20 years.

Here are a couple examples of Term Insurance for a 45 yr old male non-smoker with health profile that qualifies for Preferred Plus Rates. For illustration purposes we chose the company that had the lowest overall rates from 10 major insurance companies surveyed. These rates are for illustrative purposes only.

Level Term Insurance Rates:

$500,000 - 10 Yr Level Term: $31.85/mo.

$500,000 - 20 Yr Level Term: $53.23/mo.

$500,000 - 30 Yr Level Term: $87.41/mo.

As you can see the longer the term you wish to maintain "guaranteed rates and coverage" the more you will pay in monthly premiums. This makes sense because the odds of death occurring between the ages of 45-75 are much higher than a death occurring between 45-55.

Using Level Term Insurance For College Planning

Let's say you have 2 children that you would like to put through college. If the youngest child is currently 12 years old, it is approximately 10 years until they both will be completing 4 years of college. If you estimate the total cost of putting both kids through college is $60,000 you could purchase a simple 10 year level term policy. You would probably want to look at a $100,000 face value policy since it's normally much cheaper per thousand than trying to buy an odd number like $60,000. Most companies wouldn't even offer a policy for $60,000.

Using 20 Year Level Term To Replace Your Income

One reason people purchase life insurance is to provide income for their family in case of an untimely death. If you are the primary income earner and you have others depending upon you, it's a wise thing to do.

If you are currently 45 years old and plan on retiring at age 65 you have 20 years until retirement. If you take home $40,000 after taxes and the current interest rates on Inflation Protected Government Bonds is 4% you would want to divide your salary by .04 to come up with the level of insurance coverage needed to replace your income without using the principal.

$40,000 / .04 = $1,000,000 policy

Using this example the beneficiary would receive $1,000,000 tax free at the time of death and could invest them in Inflation Protected Government Securities ( TIPS ) at 4%. This would provide $40,000 of income per year without reducing the principal. Since the investment is in TIPS, it's protected against being reduced by inflation.

Using a quote from the same company as above with the same age and health characteristics it would cost just under $125 /mo for this policy.

Generally you want to use Term Insurance to protect against and untimely or premature death. People who want to make sure they die with the coverage in place should not purchase term insurance.

When To Use Whole Life Insurance

Whole Life is most commonly used to describe "Permanent Life Insurance" that is designed to keep the premium level over your entire lifetime. Permanent life insurance is used when you want to make sure it is inforce at the time of your death regardless of whether or not it's a pre-mature death. It's commonly used for Estate Planning, Business Buyout Agreements and as a means of Forced Savings. The younger you are when you purchase whole life insurance, the lower your premiums will be since there are more years for the funds to accumulate within your policy.

Using Whole Life Insurance For Estate Planning:

If your estate is going to have to pay $250,000 in taxes upon your death, many people will choose to purchase $250,000 worth of whole life insurance to avoid the need to liquidate assets. The fact that the insurance proceeds will be tax free to the beneficiary makes it a good vehicle to use in this situation. If someone had died in late 2008 and the primary asset in their estate plan was stock holdings, it would've been very undesireable to liquidate stocks at 10 year lows in order to pay estate taxes.

Whole Life To Fund A Business Buyout Agreement:

If you own a business with other partners, whole life insurance can be a good way to buy the business from the surviving spouse in case one of the partners dies. Without this type of planning it may be difficult for the other partners to raisde the capital needed to buy out the deceased partner. This can lead to being in business with an unproductive surviving spouse or taking on additional debt to buy out the spouse.

Level term is also used for business buyouts especially if a partner plans on exiting the business at a specific time such as age 65. If the partner is currently 45 years old a simple 20 yr level term would take care of the issue.

Whole Life As Forced Savings:

People are often told to "Buy Term and Invest the Difference" but that is usually easier said than done. Many people do not have the disipline required to invest the difference on a consistent basis or they choose poor investments. In all permanent life insurance products, the amount of the payment above the actual cost of insurance & administrative fees goes into the savings portion of the policy. In traditional "Whole Life" insurance this money will earn dividends based on the profitabiltiy of the insurer. In Universal Life ( UL) products the savings portion typically earns interest similar to a deferred annuity. In a Variable Life product the excess goes into a stock based mutual fund. The type of policy you choose should be based upon your objectives and risk tolerance. If you already have significant stock market exposure, it's probably foolish to subject yourself to additional risk.

Tax Deferred Growth and tax free death benefits are the primary benefits of having money accumulate within permanent life insurance products. If you have already maximized IRA and 401k contributions this can be an additional way to accumulate wealth on a tax deferred basis.

Fees and Expenses are the primary drawback of investing your money into an insurance product, make sure you understand all the fees and surrender charges that may be involved.

An Underlying Insurance Need is also important. In order for a variable life product to make sense there should be a need for carrying the insurance. Otherwise it would be wiser to use a variable annuity instead of life insurance. Additionally, 401k and IRA contributions should be maxed out prior to using tax deferred financial products. IRA contributions are Tax Deductible and Roth IRA contributions (which are not tax deductible) grow on a tax deferred basis and are subject to "Tax Free Withdrawls" after age 59 1/2.

Whole Life Insurance Rates Vs Term Rates:

When you look at a "Whole Life" type product this same company offered a No Lapse Universal Life Policy to age 121. This appears to be the most commonly offered whole life ( No Lapse ) product on the market today.

$500,000 - Level to age 121: $3611 /yr or approx. $300 /mo.

As you can see, this premium is considerably higher than even the $87.41/mo premium for the 30 year level term product. That's because there is almost a 100% chance that a male will die by age 121. Therefore, the premium is determined primarily by how much would have to be set aside to accumulate $500,000 by the time of death.

Summary Of Term VS Whole Life Insurance:

To summarize, there are several factors that determine which type of insurance is best for you:

- The purpose for purchasing the insurance. Is it designated to solve a short term or long term problem? Short term problems such as college planning can best be solved with term or level term insurance. Estate planning or other long term issues are best solved with whole life or permanent life insurance.

- If you are protecting against pre-mature death ( before age 65 for example ) then it makes sense to purchase term insurance. If you are planning to keep the insurance past age 65 it makes more sense to purchase permanent insurance. Insurance becomes increasingly unaffordable over age 65 especially for males.

- Most people may actually find they have a combination of short term and long term issues that would be best solved by having both types of coverage. For example someone 55 decides they need $100,000 of whole life coverage for estate planning purposes and an extra $250,000 of 10 year level term as income replacement.

If in doubt, consult a qualified insurance professional. If you look for the CLU (Chartered Life Underwriter) or CHFC (Chartered Financial Consultant) designation it should be a well trained agent who can assist you in determining your individual needs.

Side Note

When looking at Term vs Whole Life Insurance, it's not a question of which is better but which is right for your situation.