Term VS Whole Life Insurance - Which Will Work Better For You?

Understand which type of life insurance you really need can be difficult. Here's the difference between term and whole life insurance, and which is better for you.

When it's time to get life insurance, how do you know which to get - term or whole life?

This question is a true ongoing debate. The reality is that both term and whole life insurance have their virtues. It's just a matter of which will work best for you.

Here'e what you need to ask yourself when trying to decide between the two.

How much life insurance do you need?

A single person who has no dependents probably only needs a small life insurance policy. $50,000 or even $25,000 may be enough. Since there is no one else who will rely on the income, it's basically a matter of having enough insurance to pay for final expenses and any lingering obligations.

Given that the amount of coverage is relatively small, a single person may be well served by a whole life policy. The benefit will be a permanent policy, with a fixed annual premium - two qualities that term life doesn't offer.

At the opposite end of the spectrum is a young family. If you have very young children, your need for life insurance is probably greater right now than it will be at any other time in your life.

Were you to suddenly die, there would have to be sufficient funds available, not only to cover final expenses, but also to provide sufficient support for your children until they reach adulthood. In addition, you will want to make some sort of provision to pay for their college educations.

In this situation, a $500,000 life insurance policy might be the absolute minimum. For example, it would provide $20,000 for final expenses, $300,000 to provide $20,000 a year for support for the next 15 years, and the remaining $180,000 to be used for their educations.

Naturally, it will be much more expensive to have a larger amount of life insurance coverage. In that situation, the young family would likely favor term life insurance.

How long do you need coverage?

Covering final expenses is a permanent insurance need. If final expenses are all that you need, a small whole life policy will get the job done.

Raising a family, on the other, creates a large temporary need. You may need a large amount of coverage for 20 to 25 years, and after that, final expenses may be all that needs to be covered.

If the need for life insurance is temporary, term life is usually the better option. You can take a policy that has a term running from five to 30 years, which can be used to cover the higher need. After the initial term expires, you'll have the option to either.

1. Continue coverage at a higher premium,
2. Lower the death benefit and therefore the premium, or
3. Cancel the policy completely

How much life insurance can you afford?

This is always the controlling question when it comes to life insurance. Obviously, you cannot have more life insurance than you can afford. 

This is typically a problem for the people who need the most life insurance coverage, which is people with dependent children. Unfortunately, the cost of raising children consumes a lot of income. That can leave little left over for a contingent benefit, like life insurance.

In most situations, where affordability is a major factor, term life insurance is the preferred policy. That's simply because you can buy the most coverage for the lowest premium.

Is a specific need temporary or permanent?

There are many reasons, other than having a family, that would require additional life insurance, either on a temporary or permanent basis.

For example, you might want to have additional insurance coverage while you owe a mortgage on your house. The policy will pay off your mortgage in the event of your death, enabling your spouse or your family to continue living in the home mortgage-free.

You might also want to have additional coverage for other types of debts. One prominent example is debt you owe jointly with your spouse, such as credit cards or car loans.

Another type of debt is business-related. If you took on debt to start a business, or to either expand a business or sustain it during a rough patch, you might want to have additional life insurance that will pay off those debts.

Term life insurance policy will be the more cost effective solution, since you can match the term of the policy with the length of time it will take you to pay off your debt.

Term life insurance will be the most cost effective solution, since you can match the term of the policy with the length of time it will take you to pay off your debt.

On the permanent side, if you set up a trust for your spouse or children, you may want to fund it with the whole life insurance - that's a very common practice. A term policy would not be appropriate for this purpose, since the policy will either terminate or renewals will become expensive as you move into old age. 

Do you also need (or want) an investment provision?

Both term and whole life insurance provide a death benefit. But only one - whole life - also provides an investment provision.

The main reason why whole life is so much expensive than term life is the investment provision. Most of the difference in price between the two goes into the cash value of the policy.

The cash value represents an account value that you can borrow against, or liquidate by canceling the policy.

That means that a whole life insurance policy, besides providing a death benefit, will also provide an investment benefit. And that benefit can be substantial after 20 or 30 years, even to the point of representing an additional retirement resource.

It is often said that the best strategy is to buy term, and invest the difference. This refers to buying an inexpensive term life insurance policy, then investing the savings (versus a whole life policy premium) in an index fund. You will generally have more money at the end of many years using that strategy, simply because the index fund is highly likely to outperform the whole life insurance investment. 

If you don't have an orientation toward saving money, you'll want to take out a whole life policy instead, so you don't just blow through the savings intended for your investment. 

When you're considering buying life insurance, avoid the which is better debate entirely. Instead, focus on your own needs, circumstances, and financial habits - this is what will really help you determine which is the right type of policy for you.

Going with a very simple summary - a large family should probably opt for term life insurance and a single person, with no dependents, might want to stick with whole life. However, this can vary depending on a range of factors.