Term insurance vs. whole insurance has been the subject of an ongoing debate in the financial services community. There are a wide variety of insurance products from which to choose. Each has features that may or may not meet your objectives for protecting your families’ financial future. To determine which type of insurance is right for you and your family, it is important to understand the basics of life insurance and the difference between the two instruments.
People purchase life insurance for a variety of reasons, including paying for funeral expenses, enhancing the financial security of one’s family in case of death, providing the funds necessary to pay obligations of an estate, such as estate taxes, or compensating an organization for the death of a key employee. The choice between term and whole life becomes clearer once the reasons for purchasing insurance coverage are understood.
Term life insurance policies pay the family of the deceased death benefits if the insured person dies before the policy’s term expires. The money received by the beneficiaries upon the death of the insured is limited to the face value of the policy. Generally, term insurance can be purchased in periods of 10, 20 or 30 years. Younger people usually can purchase term insurance for very reasonable rates.
One risk that must be considered when comparing term insurance with a whole life policy is the possibility that the insured might become ill or suffer a serious disease during coverage, which can make the individual “uninsurable” when the term insurance policy concludes. One solution to this is to purchase renewable term coverage. However, the premium for these policies generally increases each year.
The lack of a cash-investment component attached to term insurance is often a key argument in favor of whole life insurance, but people who choose term insurance can invest the difference between their term insurance premium and what it would cost to purchase whole life insurance. This strategy offers more flexibility and control over your resources and might also offer a better return on investment in the long run.
One of the newest products on the market is return-of-premium life insurance (ROP). Like traditional term policies, ROP policies pay beneficiaries the face amount of the policy upon the death of the insured, but ROP an additional feature designed to eliminate the major argument against term insurance. If the insured lives out the policy’s term, 100 percent of the premium is returned.
Another enhancement is the return of a portion of the premium if the policy is canceled. The longer the coverage stays in effect, the more money returned to the insured.
Whole life insurance provides permanent insurance coverage. Premiums are usually fixed and must be paid on a periodic basis, and this policy has an investment component that builds the cash value over time. The funds are invested by the insurance company, and any accumulation in the account is tax-deferred and can be borrowed against. Generally, the insurance company guarantees a minimum rate of growth.
The cash value feature is the main difference to consider if you’re evaluating term vs. whole life insurance. Whole life policies pay out a death benefit, which is capped at the face amount as expressed in the terms of the policy. When the face value amount is paid to the insured, the insurance company keeps all the cash value that has accumulated in the policy.
A variation on the whole life policy is universal life (UL) insurance. Like traditional whole life insurance, UL is a category of permanent insurance policy. However, UL policies permit the owner to change death benefits and offers flexibility regarding the timing and amount of the premium paid. The owner of the policy can focus on accumulating cash value or pay fewer premiums and build the guaranteed benefit protection.
Any payment that exceeds the stated premium goes into the cash value account. The account is credited with interest every month; the rate of interest is usually tied to a financial instrument, such as an index fund. If a premium payment is not made a particular month, the cash value account is debited for charges and fees.
Variable Universal Life
Variable universal life insurance (VUL) is a variant of whole life insurance. It offers permanent coverage and includes a cash accumulation element. The policy is referred to as “variable” coverage because the owner has the choice of investing in select accounts. The accounts function like mutual funds. They may have varying values because the funds are usually invested in the bond or stock market, which are inherently volatile.
The policy owner can make flexible payments on this type of policy, which means she can elect not to pay premiums in some months or to pay the maximum allowed in other months. VUL policies pay the beneficiary the face amount of the policy in addition to any cash value minus the current insurance premium. Cash value growth is based on declared fixed interest rates made at certain intervals. Altering the VUL’s premium or the death benefit, can cause performance to suffer, which may require an increase in premiums.