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Whole Life vs. Term Life

The two main forms of life insurance you should understand are whole life and term life insurance. (It's also good to learn about universal and variable, which are variations of whole life insurance.)

But what's the difference between the two? With term insurance, you're covered only during the life of the policy, while you're paying the premiums. If you carry a term life insurance policy for 50 years, regularly pay the premiums, and then quit paying and die a year later, you're out of luck. (Well, you'd be out of luck regardless -- but in this case, your beneficiaries are out of luck, too.)

There are several forms of term insurance:

  • Level term -- you pay a fixed premium for up to 20 years. This can be a good deal, since it protects you against the effects of inflation and unexpected changes in your health that would warrant higher premiums.
  • Annual renewable term -- gives you the option of renewing your policy regularly, but at increasing premium rates.
  • Decreasing term -- features a steadily decreasing death benefit. This might seem undesirable, but it can be sensible for many people. You may need a bigger benefit when you're a young breadwinner with a family to support than when you're a retiree with grown children and a nice nest egg.

Whole life insurance, meanwhile, is designed to cover you for your entire life. These policies charge you a fixed premium each year, one that's typically higher than term insurance. The advantage touted by insurance companies for whole life insurance is that, while part of the premium covers what term insurance would cost, the surplus resides in an account that pays interest and accumulates a cash value. As this "accumulation account" grows, your premiums can decrease over time. Eventually, in some cases, the interest earned can pay the premiums for you. So you won't be paying any more premiums, but you'll still be covered for the rest of your life.

The problem with whole life insurance is that insurance companies tend to offer low interest rates to policyholders, while the companies typically earn much greater returns because they invest the money in stocks and bonds. Policyholders are indeed earning a bit of money through the policy, but as an "investment," it leaves a lot to be desired.

Enter "universal" life insurance, a form of whole life insurance. With universal life, in years when the insurance company earns more on policyholders' accumulation accounts than they promised, they pass along the extra gain. This sounds good, but in some situations, because of overly optimistic assumptions insurers make about customers' returns, customers can end up paying more than they expected to. "Variable" life insurance policies, which invest in sub-accounts that look like (but legally are not and cannot be) mutual funds, carry the same danger.

With universal and variable insurance, the higher the initial assumed rate of return, the lower the annual payments will be. This is how some unscrupulous agents can sign you up -- through very attractive policies based on unreasonable assumptions. Since most insurers invest to a great degree in bonds, be skeptical of any promised universal rates much higher than the 30-year Treasury rate. With variable insurance, since most mutual funds have trouble beating the S&P 500's average historical return of 10%-12% per year, we'd be skeptical of any projected rates in that neighborhood.

Learn more about the less-exciting-but-still-critical topic of insurance in our Insurance Center or our 60-Second Guide to Insurance. You may not have thought about some kinds of insurance, such as disability or long-term care insurance, but they're vital for many people. And, of course, properly insuring your property is crucial, too. Take a little time to learn more, and you may be very happy you did, especially if some calamity occurs in the future.

And if you're in the market for insurance, another way to inform yourself about options is to spend some time at the websites of insurance companies. According to SNL Financial, the 10 largest insurance companies (as of 9/30/05) are:

  • American International Group (NYSE: AIG  )
  • BerkshireHathaway (NYSE: BRKa  ) (NYSE: BRKb  )
  • UnitedHealth Group (NYSE: UNH  )
  • WellPoint (NYSE: WLP  )
  • MetLife (NYSE: MET  )
  • Allstate (NYSE: ALL  )
  • Prudential Financial
  • St. PaulTravelers
  • Aetna
  • HartfordFinancial Services

UnitedHealth is a Motley Fool Stock Advisor recommendation.Take the newsletter dedicated to the very best of David and Tom Gardner's selections for a30-day free spin.

Read/Post Comments (7) | Recommend This Article (41)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 05, 2009, at 11:37 AM, fleemarkets wrote:

    Great article…here is another good article I came across:

  • Report this Comment On May 08, 2011, at 11:36 AM, jamesrcooper wrote:

    This is a great article. As a Licensed professional in the industry, I feel a strong obligation to educate families about which option is best for them. I believe firmly that a family need the proper amount of protection (10 to 20 yrs. income) first and foremost, and that the type of insurance they buy is secondary to that. Therefore, I almost always recommend 20-35 year fixed-level term. It is the most cost effective way to put the proper amount of coverage in place. The biggest problem with whole-life, or any cash value life insurance for that matter, is that it is so expensive, that many families who own it are drastically under-insured. They are paying out the nose for life insurance that will do their family little or no good if something were to happen to them. Also, the savings aspect of whole life is really not all that great, neither is the "tax benefits" if you really stop to think about how much you have lost through these policies. The only real advantage is that it is permanent

    insurance, but if a person starts planning early enough, they really don't need that either.

    I recently wrote an article which shows a person how to compare whole life vs. term on an individual basis, you can find it @

  • Report this Comment On December 25, 2012, at 6:19 PM, RobbieStrong wrote:

    I thought these videos might be of interest to you . Just click on the link below to watch them.

    "Safe Money Learning Center"

    PS: these videos will require authentication with your name and email address - but only to let me know when you've watched them.

  • Report this Comment On January 16, 2014, at 10:32 AM, akbarsheikh wrote:

    Great article. You actually went in dept further disecting the types within term and whole life insurance for better understanding. This shows the intent. Co-incidently, I also explored this topic in my article and if you want you can use the infographics which I created in your article above if you feel it adds value.

  • Report this Comment On January 21, 2014, at 11:13 PM, ThomasRockford wrote:

    I'm a financial advisor who sells a lot of life insurance. You have to go into each case with an open mind and not be looking to sell any one type of coverage. I'm currently not making an enormous income nor am I close to retirement with estate tax issues, but I bought mostly whole life insurance for myself and my wife along with some term which we will eventually convert to whole life. The BIGGEST ADVANTAGE of whole life is if you'd eventually like to leave something to your kids/grandkids/church/charity etc., let's say this is what you want to do If you were able to buy term and invest the difference and lets say you retire with $500,000. Your term would be expiring around retirement because you "don't need" it anymore. So you live on a safe withdrawal rate of 4% so that you will never run out of income and so you can leave money to your kids.

    For the cheapest whole life quotes, check out ... I think you'd be smart to get a whole life estimate as soon as you possibly can. Don't wait on it!

  • Report this Comment On September 02, 2014, at 2:04 AM, CodyHarry wrote:

    HI, I am Cody Harry. This is very informative and useful article for people. The people have received very huge information about whole life and term life insurance. This is very important and gainful article. The Whole Life Insurance is a kind of perpetual (as opposed to term) protection that gives deep rooted scope. I agree your all points and appreciate you to share me very informative article. I am also running a big company in the named of Desjardins in Toronto. I am providing a great service of best whole life insurance at a cheaper price. The people very like my service and recognized him. Do, you more detail about whole life and term life. So, visit it and get it information.

  • Report this Comment On October 24, 2015, at 10:42 AM, vronyca65 wrote:

    Most informative; feel better but I am age 70.5, paying $164.00 quarterly for $7,500.00 insurance policy (CIGNA) as a retiree from local college; am feeling kind of stupid because as a widow, I had no idea what this was all about, other than to cover funeral expenses. The question is do I now at this late date, make any changes

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