Understand the basics and significant differences of term life insurance and whole life insurance.

Confused about the benefits and differences between term life insurance and whole life insurance? You’re not alone. Here’s what you need to know to make an informed decision that works best for you and your family.

Benefits of Life Insurance

The biggest benefit of life insurance is the peace of mind you have knowing that if you die prematurely, your spouse, partner, children, or other loved ones will have financial security. The financial benefits from a life insurance policy are paid out upon your death. The person or people you choose to receive these benefits are your beneficiaries. They can use the funds to pay funeral expenses, pay off debt, pay tuition, or cover any other relevant expenses. Perhaps most importantly, the death benefit can be used to replace the income you would have earned.

The most common types of life insurance are term life insurance and whole life insurance. You’ll want to learn about both types of life insurance to decide which is best for you.

Term Life Insurance

Term life insurance offers a guaranteed payout if the insured person dies while the policy is in effect. The most common term life insurance policies cover a 10- or 20-year period. At the end of the term, you may be able to renew your policy for a new term, but the premium will likely be higher. Some polices also allow you to convert your term life insurance policy to a whole life policy.

Term life insurance often makes sense for people who want to ensure that family financial obligations are met. So, a parent may purchase a term life insurance policy to make sure that if they die, there will be money to support the children through graduation. Or, a dual-income couple may purchase term life insurance policies to provide funds to pay off a mortgage if one of them dies, so the survivor does not have to sell the house.

Whole Life Insurance

A whole life insurance policy lasts for your whole life. It is a combination of an insurance and investment product rolled into one. Whole life insurance pays a death benefit, and, just like term life insurance, allows you to choose one or more beneficiaries to receive the payout after you die.

Because it is also an investment product, whole life insurance can pay a living benefit, called cash value, as well. A portion of each premium paid goes toward building up the cash value, similar to an investment account. You can borrow against the policy or withdraw funds. You don’t have to die to benefit from a whole life insurance policy.

Whole life insurance might be the right option for a parent of a child with special needs who will never become financially self-sufficient. Whole life can also be a good investment strategy for people who want to leave money to their heirs. The death benefit goes directly to the insured person’s beneficiaries when they die without passing through their estate. This method of inheritance may have tax advantages because the death benefit is tax-free.

Differences Between Term and Whole Life Insurance

Though both types of life insurance accomplish the primary goal of paying a death benefit, term and whole life have some significant differences.

Cost

The cost of the policies is the most obvious difference between term life insurance and whole life insurance. While each typically charges a consistent amount – or premium – for the life of the policy, a term life insurance policy is much less expensive. That’s because term life insurance covers a specific period of time (not your entire life) and does not build cash value.

All life insurance premiums are based on the amount of the death benefit, the age of the insured, and other health and life expectancy criteria. Term life insurance premiums also factor in the length or term of the policy.

The average annual cost for a $500,000 20-year term life insurance policy for a 30-year-old woman is in the hundreds of dollars, while the same size policy for whole life insurance is in the thousands. For example, over the course of the 20-year term, you might pay $5,000 in premiums for the term life insurance policy. If you died during that period, your beneficiaries would get a $500,000 payout. With the whole life insurance policy, you would pay closer to $80,000 in premiums over the same 20-year period. If you died after 20 years, your beneficiaries would still get the same $500,000 death benefit.

Cash Value

A term life insurance policy has no cash value. The only way you get any money from it is if you die and your beneficiaries collect the death benefit. If you outlive the policy, all the money you paid in premiums is gone. You cannot cash out of a term life insurance policy after the term expires. It may be possible to recoup some of your premiums by converting the term life policy into whole life, but the premiums would go up substantially.

A whole life insurance policy builds cash value over time at a fixed interest rate. You can borrow against it (likely at a lower rate than a personal loan), using the cash value as collateral, and you can also withdraw money from your policy – but any money not paid back will reduce the death benefit. When you die, any cash value left in your whole life insurance policy after the death benefit is paid reverts to the insurance company.

Death Benefits

Both term and whole life insurance offer a death benefit. The death benefit for a term life insurance policy is valid only if you die during the term of the policy. No death benefit will be paid if you die after the expiration of a term life policy.

With a whole life insurance policy, a death benefit is guaranteed. Because a whole life policy does not expire, the death benefit will be paid no matter when you die. As long as the premiums are paid, a whole life insurance policy will pay your beneficiaries the value of the policy.

Simplicity

Compared to whole life, term life insurance is fairly simple. Deciding on the length of coverage you need is probably the most difficult part. You can choose the term, usually 10 or 20 years, to coincide with a life event like paying off your mortgage or your children reaching maturity. You then make your premium payments for the term of the policy. If you die during that term, your beneficiaries receive a death benefit. When the term expires, you no longer have life insurance coverage.

Undoubtedly, a term life insurance policy is easier to understand than a whole life policy. Whole life insurance presents different ways to grow your investment, but you may need a financial advisor to help you understand and take advantage of the features that are right for you. Whole life insurance could be a good investment, but if you are unable to keep up the premium payments for any reason, you could lose any cash value your policy has accrued.

Life insurance can be an important safeguard for your family’s financial future. To learn more, especially if you are considering whole life insurance, speak with a qualified financial advisor.

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