According to data collected by the Insurance Information Institute, about 60% of all Americans were covered by some form of life insurance in 2018. About 20% of Americans believe they don’t have enough coverage and are in the market for more.
All life insurance policies take one of two forms:
- Term life insurance, which charges fixed premiums and pays a set death benefit to a named life insurance beneficiary or beneficiaries during a fixed term.
- Permanent life insurance, commonly known as whole life insurance, a more expensive product featuring a savings or investment component that grows in value over time and may offer a variable-premium option to control costs.
Life insurance shoppers keen to choose the right type of life insurance must understand the key differences between term and whole life insurance. This guide can help.
Key Features of Term Life Insurance and Whole Life Insurance
Whole or permanent and term life insurance both share a common purpose: to provide a tax-free windfall upon the death of the policyholder. While ensuring this windfall is effectively the sole purpose of term life insurance, the cash value component makes permanent life insurance a useful pre-death investment vehicle for higher-income policyholders as well.
Policy Premiums
Like all forms of insurance, term and permanent life both require policyholders to pay premiums as a condition of coverage. Failure to pay premiums eventually results in the policy’s cancellation and the attendant loss of any benefits or accumulated cash value.
Both types of life insurance charge fixed premiums by default. For term life policyholders, premiums remain “level” — fixed — for the full term, no matter what. (The proper name for term life insurance is “guaranteed level term life insurance.”)
Some permanent life insurance subtypes, such as variable universal life insurance, allow policyholders to pay lower premiums without interrupting coverage, although the death benefit and cash value may decline.
Even when premiums remain fixed for the full policy term, inflation all but assures they grow cheaper over time in real terms.
Term Life Insurance Premiums
A term policy’s premium remains fixed for the full duration of the initial term: 10 years on a 10-year policy, 20 years on a 20-year term, and so on. The premium is a function of term length, with longer terms generating higher premiums due to the policyholder’s greater likelihood of death while the policy is effective. Premiums on 30-year term policies are higher by a factor of two or more than premiums on 10-year policies of equal size.
Many term policies offer the option to extend coverage for a series of consecutive one-year terms after the initial end of the term. Each one-year term’s premium is higher than the last and extending coverage may well prove prohibitively expensive.
However, medical underwriting is generally not required to extend coverage. For policyholders in ill health, extension — rather than applying for a new policy for which approval is unlikely — may be the only option to continue coverage.
Permanent Life Insurance Premium
A permanent life policy’s premiums also remain fixed, or level, by default for the policy’s full duration: until the policyholder dies or reaches the age of 100, whichever occurs first. The premium doesn’t change due to age or health status, although a lapse in coverage that necessitates a fresh application will likely result in a higher premium once the new policy is issued.
Unlike level term policyholders, permanent life policyholders may have the option to pay reduced premiums. This option is available on variable universal life insurance policies, which allow policyholders to use their accrued cash value to pay part or all of their premiums once the cash value reaches a certain threshold.
Variable universal life policyholders can also front-load premium payments to accrue cash value faster, then use the stored balance to reduce out-of-pocket premiums.
Policy Term
A life insurance policy’s term is the length of time it remains effective — assuming timely, in-full premium payments as stipulated by the insurance contract — without requiring action by the policyholder or additional underwriting by the life insurance company.
Term Life Insurance Policy Terms
Term life insurance coverage through a company like Bestow is designed to be temporary, albeit relatively long in duration. Initial policy terms, during which the premium remains fixed regardless of health or age, typically range from five to 30 years. Some life insurance companies underwrite policies with initial terms as long as 40 years, but these aren’t as common.
Term life policyholders looking to continue coverage for 30 years or longer without paying the premium demanded by a single 30-year policy can instead create a life insurance ladder using multiple smaller policies that steps down the coverage amount over time.
For a 30-year-old applicant looking to replace $2 million in expected income over the subsequent 30 years, a suitable ladder might include:
- A 10-year policy with a $500,000 death benefit
- A 20-year policy with a $1 million death benefit
- A 30-year policy with a $500,000 death benefit
This ladder ensures $2 million in total coverage during the first 10 years, $1.5 million in coverage during the second decade, and $500,000 in coverage during the final decade. This gradual decline in coverage accounts for the policyholder’s likely accumulation of wealth and the corresponding decrease in remaining lifetime income and expenses.
Permanent Life Insurance Policy Terms
A permanent life insurance policy is designed to provide lifetime coverage. That is, the term usually lasts the entire life of the policyholder and ends with the policyholder’s death. Life insurers generally cancel permanent policies, go ahead and pay the death benefit, and return the cash value if the policyholder reaches the age of 100.
Death Benefit
Both term and permanent life insurance policies guarantee death benefits to the named life insurance beneficiary or beneficiaries.
A policy’s death benefit is generally payable upon the insured party’s death, although a portion may be paid out to terminally ill policyholders as part of an accelerated death benefit rider. When the named beneficiary is an individual, death benefits are not subject to income tax.
Term Life Insurance Death Benefit
A term life death benefit remains fixed for the entire policy term. Absent certain rare extenuating circumstances, such as provable fraud during the application process — like failure to disclose a serious medical condition — or suicide during the first two years of the term, the death benefit is paid to named beneficiaries upon the policyholder’s death.
Permanent Life Insurance Death Benefit
The rules governing permanent life insurance death benefits vary by policy subtype:
- Whole Life Insurance. The death benefit generally remains fixed for the life of the policy, regardless of the policy’s accrued cash value.
- Universal Life Insurance. Universal life policyholders offer more flexibility around death benefits. Policyholders generally have two options: a level death benefit that remains fixed until death or an increasing death benefit that combines a level death benefit with the steadily increasing cash value component and pays the combined sum at the policyholder’s death. Loans against cash value or withdrawals of cash value may decrease the death benefit, however.
- Variable Universal Life Insurance. A variable universal policy’s death benefit can increase or decrease, depending on the performance of the investment instruments underlying the policy’s cash value. The risks and potential rewards are greater for policyholders and beneficiaries alike.
Cash Value (Surrender Value)
Cash value, sometimes known as surrender value, is a key distinction between term and permanent life insurance. Permanent policies build cash value over time; term policies don’t.
Term Life Insurance Cash Value
A term life insurance policy has no cash value component. The death benefit is paid in cash, of course, but there’s no value to borrow against or cash out before the policyholder’s death. If the policyholder outlives the initial term and doesn’t renew, the policy expires worthless.
Life insurance companies do offer optional “return of premium” riders to would-be policyholders. In exchange for a higher fixed premium, return of premium riders guarantee the tax-free return of all premiums paid over the life of the policy to policyholders who outlive the term.
However, policyholders can’t withdraw or borrow against premiums paid before the term expires.
Permanent Life Insurance Cash Value
All permanent life insurance policies have a cash value component that exists separately from — but can sometimes be combined with, depending on policy subtype — the death benefit:
- Whole Life Insurance. Whole life insurance policies offer guaranteed rates of return that increase the cash value by predictable increments over time. These returns typically come as dividends that can be reinvested in the cash value, delivered to the policyholder as income, or used to reduce premiums.
- Universal Life Insurance. Universal life insurance policies index the cash value component to an underlying benchmark — such as the S&P 500 — that can gain or lose value. Like whole life, universal life pays dividends that can reduce premiums or supply income.
- Variable Universal Life Insurance. The cash component of variable life is also invested in market instruments. While the upside is usually higher, so are the management fees, and the dividends and returns can vary as a result.
The cash component’s value remains low during the policy’s early years but steadily builds over time and eventually represents a considerable sum available for withdrawal (surrender) or as collateral for a low-interest loan.
During the policy’s first number of years, usually 10 to 15, surrender fees — fees designed to dissuade early withdrawals — keep the surrender value substantially lower than the full cash value. Eventually, surrender fees no longer apply and the full cash value is available for withdrawal.
Medical Exam Requirements
Most term and permanent life insurance policies require applicants to undergo medical exams as a condition of approval. These exams are thorough but not invasive and typically involve checking the applicant’s vital signs, asking a battery of personal health questions, and running basic metabolic labs.
Term Life Insurance Medical Exam Requirements
Virtually any applicant, regardless of age or health status, can qualify for a term life insurance policy without undergoing a medical exam. The catch is that no-exam policies invariably carry higher premiums and lower maximum death benefits than otherwise identical policies that include medical exams.
For older applicants past retirement age, no-exam coverage is limited to a policy subtype known as “guaranteed issue” — a no-questions-asked product with high premiums and a low coverage limit meant to defray final expenses without much left over.
Permanent Life Insurance Medical Exam Requirements
Most permanent life insurance policies require a medical exam as a condition of coverage, but high-premium, low-value guaranteed issue whole life insurance policies do exist.
These are mainly appropriate for older policyholders looking to defray final expenses while building modest cash value over time. However, because they’re less costly overall, guaranteed issue term policies generally offer better value than guaranteed issue permanent policies.
The Verdict: Should You Choose Term Life Insurance or Whole Life Insurance?
Both term and whole life ask applicants to commit to many years — decades, in most cases — of timely premium payments. Given the time spans and dollar values involved, the stakes for choosing the correct type of insurance are high.
You Should Apply for Term Life Insurance If…
A term life policy is a better fit if:
- You Want to Minimize Premium Payments. Term life insurance premiums are invariably lower as a share of face value than permanent life insurance premiums. If you aim to minimize premium payments over the life of the policy while maximizing the policy’s death benefit, term life insurance is the clear choice.
- You Don’t Need Coverage Forever. A finite term is not necessarily a drawback. As you age out of obligations like your mortgage and college tuition for your kids, you’ll also build wealth, assuming you’re saving diligently for retirement. This combination of lower future expenses and higher net worth, along with an inexorable decline in your future expected income as you realize an ever-greater share of your lifetime income potential, will reduce and eventually eliminate your need for life insurance coverage.
- You Want to Customize a Multipolicy “Ladder” That Steps Down Coverage Over Time. Although certain types of permanent life insurance allow policyholders to customize premiums and death benefits, it’s simpler and cleaner to do so with a multipolicy term life insurance ladder, especially for policyholders who expect not to need as much coverage as they approach retirement.
- Your Family Won’t Rely on Life Insurance to Supplement Savings or Investments Later in Life. A key advantage of permanent life insurance is the promise of guaranteed cash value in perpetuity. If you expect your family to have adequate liquid savings and investments not to need that backstop after your death, whole life likely isn’t worth the significant added cost.
- You Want to Skip the Medical Exam. Permanent life insurance policies invariably require medical exams, making term life the de facto choice for applicants who’d prefer to avoid that part of the underwriting process.
You Should Apply for Permanent Life Insurance If…
A whole life policy is a better fit if:
- You Want Your Policy to Last Indefinitely. If you want the peace of mind that comes with ensuring truly long-term, tax-free financial protection for your survivors and don’t want to roll the dice on another round of underwriting when you’re much older, whole life insurance is the clear choice.
- You Expect to Borrow Against (Or Cash Out) Your Policy’s Cash Value. If you expect to need a ready source of low-cost leverage later in life instead of or in addition to home equity products, permanent life insurance provides it. Term doesn’t.
- You Need Help Saving for the Future. Even if it’s not used or thought of as such by many policyholders, permanent life insurance effectively forces policyholders to save a portion of their monthly income for the far future. This is a key selling point for policyholders who worry about their capacity or diligence to save consistently for their later years.
- Your Income Can Support Higher Premiums. Permanent life insurance is not always the superior choice for higher-income policyholders. Indeed, term life insurance is a better fit for many affluent families that don’t need the tax or cash value benefits of permanent life insurance. But whole life is useful for high earners who consistently max out contributions to other tax-deferred savings vehicles, such as employer-sponsored retirement plans, 529 education savings plans, and IRAs.
- You Want the Option to Vary Your Premiums Over Time. By definition, level term life insurance premiums remain fixed for the duration of the initial term. That’s not the case with certain subtypes of permanent life insurance. Variable universal life insurance, for example, allows policyholders to pay higher or lower premiums as their needs dictate — salving the sting of higher overall policy costs.
Both Are Great If…
Both term and permanent life insurance are excellent options if…
- You Need to Shield Your Family From Medium- or Long-Term Expenses Resulting From Your Death. Assuming timely and consistent premium payments, both term and permanent life coverage provide tax-free benefits to policyholders’ survivors, mitigating the financial fallout that would otherwise result from their deaths.
- You Can’t Afford to Cover Expected Future Expenses From Savings Alone. If you expect your future expenses to exceed the capacity of your survivors’ future income and net worth, either type of life insurance provides a valuable and perhaps critical lifeline to maintaining their living standards and providing for dependents left behind.
Final Word
Most American adults have life insurance coverage. Some prefer the low cost and fixed, finite span of term life insurance through an online insurer like Bestow. Others happily pay more for peace of mind that lasts a lifetime. All agree that life insurance provides an important layer of financial protection for their loved ones.
It’s an important layer, but not the only one. A term or permanent life insurance policy is necessary but not sufficient to protect against the full range of setbacks that can sidetrack a long-range financial plan — or permanently knock it off course.
Other all-but-essential layers of protection include disability insurance, which helps replace income lost to chronic injury or illness, and health insurance, which helps defray the cost of lifesaving medical interventions — a significant cause of bankruptcy in the United States.
So, by all means, celebrate when you finally cross “get life insurance” off your long-term to-do list. Just don’t assume it’s the last insurance application you’ll need to make.
