Term Vs. Whole Life Insurance: The Eternal Debate

This is a guest post from Mindy Lamont, the Founder & CEO at The Insurist and participant in Bloggers Helping Bloggers. As a former sheepherder, she finds life insurance and financial planning just a bit more exciting.

Term vs. Whole Life insurance.

I sigh just typing those words. Several times.

People get all sorts of riled up on this topic. Cue the likes of Suze Orman and Dave Ramsey. It’s like the Vegan argument. Full of passion, idealism, emotion, and half truths. And no, I’m not calling Vegans liars. My diet comes close, without all the emotion. Same with my views on term vs. whole life.

I believe they’re both good. Depends on the client. Put into the wrong hands, a whole life policy can be like kryptonite for your finances. In the right hands, and much later down the road, a well designed whole life policy can be a diamond in the rough, just waiting to be harvested. This is where the confusion lies. The pundits like to portray this as an apples to apples comparison. It’s not. At all.

Let’s start with defining term coverage. Term is the most basic form of life insurance. At the time of underwriting your risk profile determines your premium. That premium is guaranteed for a certain number of years. 1, 5, 10, 15, 20, etc…usually in five year increments. At the end of the initial term, the premiums typically skyrocket. Why? Because term life insurance isn’t designed to go on forever.

Often times this increase in premium is described as a scam or another example of the insurance industry trying to take your money. It’s really not. It’s just that these products are not intended to go beyond their initial term. That is all. You might think someone who was uninsurable at the end of a term policy might have to continue and pay these enormous premiums. Likely not. Why? Because of something called a conversion privilege…one of the most important concepts when it comes to buying term like insurance.

What’s a conversion privilege you ask? The majority of term policies provide the ability to convert to another, usually permanent, product with no additional evidence of insurance. Huge, right? That means if during the duration of your term policy you decide you want life insurance for life you can get the same amount of coverage in a permanent product guaranteed. The devil’s in the fine print though, because some policies limit the number of years you can take advantage of this, so make sure you know what you’re getting into.

So the summary on term life: simple, affordable coverage that is intended to cover a temporary risk for a defined number of years.

Whole life isn’t so easy to explain. This is often part of the problem. Hard to explain and harder to understand if you’re not eating, drinking, and breathing life insurance every day. This is what leads to the product being SOLD instead of understood.

Whole life is best used as a savings product, not strictly for death benefit protection. And it’s a LONG TERM savings product when used this way. While there are many different uses for whole life products, I’m going to stick to its application as a safe money savings tool.

Treating it as an apples to apples comparison with term life products, the premium numbers immediately point out we’ve got big differences. For the healthiest 35 year old man, a $1 million 20 year term policy will run something in the neighborhood of $40 per month for 20 years. For the same guy, a $1 million dollar whole life policy will cost $820 per month through age 65. Say what?!? No that’s not a typo. $40 a month vs. $820 a month. Who in their right mind would pay $820 for something they can get for $40?

No one. Because it’s not the same policy.

The difference in this example is what happens INSIDE the policy and what you can do with it. Some call it a “living” benefit. If we look at the whole life policy at the end of twenty years (when the term policy expires), the whole life policy has a minimum guaranteed cash value of $231,360, where as the term policy has no cash value built up. If the client pays premium to age 65 and uses the cash value to supplement his retirement income, he has the potential of adding over $27,000 to his annual income from age 65 to 95. So for a total of $196,900 paid over 30 years, the client can potentially draw $834,600 (over the next 30 years) out of the policy on a tax free basis. Yep, you read that correctly. On a tax free basis.

The next argument against whole life typically comes in the form of “buy term and invest the difference.” Often times they’re right, particularly when the client doesn’t have 30 years to let their money accumulate. But rather than lose your attention completely, I’ll stop here and take a break. In a follow up post we’ll tackle that one, with numerical examples so you can see where this does and doesn’t make sense.

One thing to point out is while we are using the same theoretical client for this example, in real life, the two product examples I’ve used would be applied to two completely different clients. One with a need for basic life insurance protection (i.e. the term product) and one with a decent amount of discretionary cash available to contribute to a long term savings plan. The need for term insurance can be easily identified and solved. The suitability of a whole life policy should only be determined after a thorough discovery process. If someone’s trying to shove it down your throat, run fast.

Thanks for listening. I’m happy to take any questions, and I’ll be back with more on this topic in a future post (Jana’s note: and she will be. Soon. Because although I grew up in a house with an insurance broker for a father, I don’t understand this stuff at all. And it’s important).

**Please note: there are all sorts of disclosures about theoretical explanations of insurance products. Things like “this example is only for a 35 year old healthy male in California who’s never been skydiving, didn’t party like a rockstar, and doesn’t play with tigers.” You get the picture. The figures here are for explanation purposes only and represent no guarantees related to any specific person reading this. Play nice kids.