Danielle's contributions to the MoneyGeek article "Term vs. Whole Life Insurance" are below. For the full post from MoneyGeek, check out the article here.
Expert Insights on Term Life vs. Whole Life Insurance
Danielle Seurkamp, MS, MPAS®, FBS®, CFP®
Founder at Well Spent Wealth Planning
What are the main differences between term and whole life insurance?
Term insurance is very straightforward. You buy a policy with a death benefit or an amount paid to your beneficiaries at your death. The policy will be in place for whatever term you select, typically 10 to 30 years, and if you pass away during that time, your heirs receive the death benefit tax-free.
Whole life insurance is a type of permanent insurance that will stay in force as long as you continue to pay the premiums. Like term, the policy has a death benefit, but unlike term, it also has an investment component. Part of your premiums accumulate a cash value, on which life insurance companies typically pay a dividend. The cash value can be borrowed, which some retirees use as a source of cash in retirement. Because of the permanent nature of the policies and their cash value, whole-life premiums are much higher than those of a term policy with the same death benefit.
“Buy term and invest the difference” is a common phrase used to talk about why term insurance is a better strategy than permanent insurance. Is this good advice?
This is good advice for most people. The primary reason most people carry life insurance is to replace income. For example, if you are the primary income earner in your family and your loved ones would struggle to maintain their standard of living without your income, the death benefit of a life insurance policy can replace that lost income.
Over time, as you save, your need for life insurance typically dwindles because your own savings can help your survivors maintain their standard of living if they lose your income. When you retire and voluntarily give up your income, you and your family will unlikely need life insurance. This means the need for insurance is usually temporary, which aligns better with the way a term policy is designed.
Furthermore, the premiums for term insurance are so much less expensive that you can pay to protect your income and use any other available money to invest on your own. Investing outside a life insurance policy is usually less expensive and gives you a wider range of investments from which to choose.
From a behavioral finance perspective, is there a case to be made for buying whole life insurance instead of “buy term and invest the difference”?
A whole life insurance policy forces you to save money by paying the premiums each year; as you do that, the cash value will accumulate. If you know you are someone who would have difficulty maintaining the discipline to save, a whole-life policy voluntarily could be beneficial.
What are appropriate situations where whole life or other permanent insurance is more appropriate than term?
There are a few instances when permanent insurance would be more appropriate. Employment income isn’t the only type of income to protect. Sometimes, when one partner has a large pension that will go away when they die, it makes sense to maintain insurance to protect against losing that retirement income. If the survivor cannot maintain their standard of living in retirement without that pension income, a permanent life insurance policy can help. To be fair, you could also buy a term policy to protect this income, though the cost of the term typically increases significantly as you age.
People may also consider converting their term insurance to a permanent policy. Let’s say you’ve reached the final year of your term policy, and you find out you have a terminal diagnosis. You could simply let the insurance expire, giving up the death benefit. You could also go out and try to get a new term policy, but you would likely get turned down by the insurance company due to your health. A better option could be to turn your term policy into a permanent policy. If your policy allows it, you can likely convert it without going through medical underwriting, preserving some death benefit for your heirs.
Finally, there are instances for high-income self-employed individuals to maintain permanent insurance inside a cash balance plan. If owned in a cash balance plan, life insurance premiums can be a deductible business expense, which is typically not allowed.
As originally published on MoneyGeek: https://www.moneygeek.com/insurance/life/types/term-vs-whole/#expert=danielle-seurkamp-ms-mpas-fbs-cfp
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