On your way to financial independence, one of the terms you would hear is insurance. Insurance is a way for you to reduce the amount you would take out of your pocket to protect yourself, your family, or your valuables in exchange for a fixed amount.
One of the many types of insurance you would need to get is life insurance. As defined by Fidelity, it is a setup where you would pay a sizable amount to your insurance company, and they will return that amount to your beneficiaries after your death.
In this article, let us learn the two types of life insurance: term and whole. I will discuss their main differences, from features to pricing, and give you tips on how to choose which type to get.
Before that, do watch this short video about one crucial tip when it comes to buying life insurance:
What is Term Life Insurance?
This type of insurance is known as the easiest to understand compared to its counterpart. In summary, it is a time-limited form of life insurance that pays its beneficiaries once the policyholder dies within the period it is active or once it expires.
Let us explore what its policy contains and how much money you need to buy one.
Relevant: Read all about how to use life insurance policy to be debt free here
Once you get this type of life insurance, you have to choose how long you would want it to cover you. Usually, plans would ask you whether you wish to have it for 10, 20, or 30 years. Several companies also offer it in 1-year or 5-year increments.
With that in mind, if you ask for a term life insurance policy, you would require to submit information such as your health, age, and life expectancy.
As I have mentioned earlier, if you die while holding this type of life insurance, the company will pay your beneficiaries its expected value. Once your term life insurance expires, you wouldn’t be covered by it, nor will your recipients get a payout.
Unlike the other life insurance type, you wouldn’t be able to do several things. First, you wouldn’t be able to accumulate cash in the policy. The second reason is that you cannot pay for an extra benefit nor transfer money from other accounts into it. Finally, the company will not pay you for any interest for the amount you paid for it.
There are four types of term life insurance: convertible term, increasing term, mortgage term, and annual renewable.
Convertible term life insurance
This type of term life insurance allows you to upgrade it to a lifetime life insurance policy. When going through this change, the payout and coverage will be the same as the term insurance policy. However, it will require you to pay a higher premium.
A convertible term life insurance is an advantage since it can help you save time and money. This is because getting this will help you avoid an additional medical underwriting process when switching between life insurance types.
Increasing term life insurance
Meanwhile, an increasing term life insurance features a policy that increases the amount given as a death benefit over time. This also means an increase in the premium over time. However, it is an advantage to start with a death benefit plan early on in a person’s life.
Another advantage of this life insurance is that beneficiaries will be given a base amount with a percentage of the total amount of premiums paid. However, do take note that if you were to get this type of insurance, it would prevent you from qualifying for another later on in life.
Mortgage term life insurance
If the previous life insurance had something to do about increasing the benefit over time, this type does the opposite. This type introduces in its policy a decrease of coverage over time.
When you look up several policies of this type, it can span between 1 and 30 years. This type was created to adjust to the remaining mortgage of the policyholder’s home. It can also cover other expenses, such as business operations and startup costs.
Annual renewable term life insurance
The final type of term life insurance involves a policy whose premiums increase every year and ensures lifetime coverage. Its idea revolves around the fact that the policyholder doesn’t have to reapply to continue the coverage.
However, this plan only lasts for a year every time you renew it. Take note that the premium will increase based on the policyholder’s risk of dying during the term.
This type of life insurance is known for having lower premiums over time compared to whole life insurance. However, the premium amount differs depending on the policyholder’s situation and the term they choose for the policy.
Let’s take a life insurance policy that pays out $250,000. Here is how the annual premiums would cost, according to NerdWallet:
- 30-year old male, 30-year term insurance – $223
- 30-year old male, 20-year term insurance – $150
- 30-year old female, 30-year term insurance – $191
- 30-year old female, 20-year term insurance – $133
What is Whole Life Insurance?
Getting whole life insurance is another type of insurance where a policyholder can get a cash benefit for the listed beneficiaries. However, the main difference here is that it offers cash value, and it covers the policyholder for as long as they live.
Each whole life insurance plan has a savings component. It works by letting the policyholder invest at least the monthly premium into a savings account. After a certain amount of time, the policyholder can withdraw from their savings account. They can also get a loan from life insurance.
Take note that every time the policyholder withdraws from this policy will reduce their cash value. Aside from that, any unpaid loan amount against their policy can lead to reduced coverage.
You can also opt to surrender the entire policy from your company. In exchange, you can get a sum equal to the amount you have paid for it through your premiums. This will end your coverage of the policy as well.
Several plans also offer you to increase the death benefit amount. With this type of plan, you would have to pay a certain dividend during your lifetime to help your beneficiaries in the future.
Some plans let you choose riders. According to Investopedia, a rider is a type of endorsement that is paid on top of the policy’s premium. The said endorsement is to help increase the savings contained in the current policy.
Here is the type of riders that can exist over the various plans offered:
- Long-term care rider – This type of rider can help address the policyholder’s long-term care issues. Adding this benefit in the policy will cover the expenses that the policy might not be able to cover.
- Term conversion rider – Meanwhile, investing in this rider would help the policyholder adjust their insurance plan from between 10 to 30 years only. The policyholder might not be able to hold the same coverage and terms once the policy with this rider expires.
- Waiver of premium rider – This is available in certain states and at the start of the life insurance policy. Having this in the policy means that if the policyholder becomes critically ill, injured, or disabled, they do not have to pay for any premium.
Compared to a term life insurance policy, whole life policies have annual premiums constant from the get-go. If the policy offers any riders, you would have to pay extra on top of those, as explained earlier.
For a policy that pays out $250,000, NerdWallet cites the following amounts:
- 30-year old male policyholder: $2,145
- 30-year old female policyholder: $1,904
How to Choose Between Term Life and Whole Life?
Simply put, term life insurance offers a flexible term length, a guaranteed payout, and a lower premium. Meanwhile, whole life insurance policies provide lifelong coverage, an increase of cash value, and annual dividends.
After learning what both life insurance policies are all about and their costs, I’ll now give you tips on how to choose which policy to get for you and your family.
You should be thinking about getting a term life insurance policy if you experience the following:
- A major loan has not been paid in full, such as a business loan or a mortgage
- Cover living expenses for your family after you die
- Let your business operate on their own without your help
- Receive the best coverage for the least amount of money
- Unable to afford whole life insurance
- Have extra money to afford a whole life insurance policy later on
If you are thinking about getting a whole life insurance policy, make sure it can provide for the following:
- Let your benefactors be able to pay for your future estate and inheritance taxes
- Protect a life-long benefactor, such as a disabled child
- Be prepared to spend your retirement money while being ready to leave enough for your inheritance
- Distribute your inheritance equally among your benefactors
- Guarantee a return on the cash value the policy holds
Aside from those, here are tips on how to choose the right life insurance policy for you:
- Apply at your earliest convenience to get lower premiums over time.
- Keep yourself healthy for lower premiums.
- Women will be charged lower than men for their premiums.
- Check your life insurance company’s financial strength through A.M Best or the National Association of Insurance Commissioners.
- Learn about the insurer’s reputation in customer service before applying.
- Look for the lowest prices for the coverage you need.
- Review the insurer’s life insurance application process.
- Talk to a financial adviser on which type of life insurance will fit your budget and needs.
In this article, I have talked about the differences between term and whole life insurance. We have explored what each insurance type offers in terms of coverage and compare their prices.
While each type of life insurance can help you and your loved ones have financial stability for the next generation, there are reasons why you should invest in one or another. Aside from that, you should also research how to choose which insurer to get it from.
I hope that this guide helps you in your path to a fulfilling life.
Did this article help you understand insurance better? Here are some of my items that can help you know the world of insurance and coverage:
- Understanding the Basics of Hospital Indemnity
- Your Guide to Hazard Insurance
- What is health insurance penalty?
Do leave a comment below on what topic I should cover next!