By Peter Mastrantuono
Life insurance is an essential risk management tool that can help protect families and surviving spouses, as well as address estate planning objectives. While popular financial media pundits like to frame the comparison in terms of “which is better”, the reality is that the most appropriate choice will depend on an individual’s circumstances and goals.
Setting the Table
Before discussing the relative merits and drawbacks of both types of life insurance, a short explanation of whole life and term life insurance may be helpful.
Term life insurance provides coverage for a defined period of time, e.g., 10, 15 or 20 years. After the term expires, the individual is no longer covered and there is “nothing to show” for all those years of premium payments (other than, of course, the good sleep that comes with knowing loved ones are protected). Every dollar in premium goes toward funding a death benefit.
Whole life insurance, on the other hand, is permanent life insurance, which means that as long as the premiums are paid, coverage will remain in effect. Unlike term insurance, a portion of the premium is deposited into a tax-deferred savings account called the policy’s cash value.
Advantages and Disadvantages of Each Life Insurance Type
The advantages to term life insurance are that it’s inexpensive, simple to understand and it can be canceled at any time.
Term insurance’s primary disadvantage is that the protection is temporary. If there is a need for coverage after the term expires, it is possible that a health condition may make renewing insurance impossible or too expensive. Aging is another issue that can lead to coverage challenges once a term policy expires.
Term policies may have a renewable term option that allows policy renewal without re-qualifying for coverage, though this provision typically comes at a higher premium. Of course, the renewal rate for subsequent terms may also rise.
Whole life insurance can be costly, which may mean that individuals are unable to buy all the protection they need. However, as a permanent policy, it can never be canceled due to age or changing health conditions.
Though most individuals do not like to combine insurance and investing, whole life offers a disciplined way to save and earn policy dividends on the accumulating cash value, though the rates earned on that cash are very low.
Deciding Which Is Best for You
Young families usually need substantial life insurance protection since their future liabilities (e.g., mortgage, children’s college funding, etc.) are quite high. Consequently, term insurance is often their best choice as it allows them to obtain full financial protection at a very reasonable cost.
In later years (e.g., 50s, 60s and 70s), insurance needs may center on creating an estate for heirs, estate equalization or estate liquidity. However, with advancing age and declining health, term insurance can become very expensive, provided you are even insurable at that time.
Consequently, many financial advisors recommend that their clients begin to complement their term insurance with permanent life insurance around the ages of 40-45 when their health is still good and rates are still reasonable. In this way, they are assured of coverage that can’t be canceled should their health decline in later years.
Despite what the financial media pundits may say, the right amount and type of coverage isn’t answered with some universal rule of thumb. The right solution will differ with each person, which is why it’s important to sit down with your advisor to discuss what’s right for you, not some hypothetical everyman.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.