The main difference between whole life insurance and term life insurance is that whole life provides coverage on the insured for their entire life as long as the premiums are paid and the owner does not cancel the policy. In contrast, term life insurance provides coverage for a predetermined period, which the policy stipulates in the contract.
It is important to understand that with a whole life policy, when the insured dies the beneficiary receives the amount of the face value. If the policy owner surrenders the policy, the owner receives the cash value of the policy. Whole life policies are often confused with universal life policies, the chief difference being that a universal policy pays the beneficiary both the face value and the cash values of the policy.
Whole life policies premiums are higher, as part of the premium pays for the insurance while the rest of the premium goes into a tax-deferred account that earns the policyholder money. These accounts vary depending upon the investment goals of the investor and their tolerance towards risk. Typically, risks are greater the higher the return on the investment.
Many financial advisers prefer to direct their clients towards term life insurance policies for a couple of reasons. First, term life insurance rates are generally cheaper. Second, whole life policies typically have high-cost commissions, especially during the first two years of the policy. They argue that the client can earn more by taking the extra money left over after paying the term life insurance premiums and investing in a no front-end load mutual fund, thereby having more money going to work for them at the beginning of the investment. The third reason financial advisors recommend term life insurance is that they believe that if the client lives long enough and is successful with their careers and their investments, they may not need to have insurance coverage in their golden years.
However, there are also some advantages to having a whole life insurance policy. As previously stated, earnings from the policy are tax deferred until the time that the money is withdrawn. While this may also apply to accounts set up as a retirement accounts, withdrawing funds from a whole life insurance policy early does not carry a tax penalty. Policy owners are also able to borrow money from the company, using the policy's cash value as collateral.
When the cash value reaches maturity, the insured may stop paying premiums, allowing the cash value to continue the payments for them. This depends upon the amount of the face value and the amount of the cash value, less any outstanding loans against the policy. If the insured decides to discontinue paying premiums, the cash value will begin getting smaller. The fact that the premium is constant no matter what age the insured reaches is another feature that makes whole life policies attractive. However, one other drawback to whole life policies is that they are more complex.
Term life insurance has the advantages of being less complicated and less expensive. The same amount of term life coverage costs two and a half to four times as much as whole life. Because of its simplicity, it is easier to find the best deal for purchasing. One only needs to determine the amount and for how long before comparing companies.
The main drawback of term life insurance is that the policy eventually expires and if the individual needs further coverage, it will most likely be more expensive. The older a person gets, the more money coverage will cost. If the individual is not in good health, he or she may no longer be eligible for coverage.
Term life does not acquire a cash value so when the insured's policy expires there will not be any money coming. However, if the insured has invested the money saved by purchasing term life insurance rather than whole life, they should be significantly better off financially than had they purchased a whole life policy instead. One has to exercise discipline in saving and investing the money so that in later life he or she has a comfortable nest egg that is significantly greater than the individual who elected to go with a whole life policy.