Term life vs. whole life insurance: Which is better for me?

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Which policy will provide protection for your loved ones?

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If you’re looking to purchase life insurance, you may be wondering whether to get a term insurance policy—which covers you for a set period—or permanent life, which typically provides lifetime coverage and a cash value that builds over time.

Although both types offer a payout should you die within the coverage period, there are significant differences, and they may be used in different ways for different goals. There’s no one-size-fits-all answer here; it all depends on how much coverage you need, how much you can afford, and how long you want it to last.

It sounds simple, but there are nuances to consider. First, let’s look at the differences between term life and whole life (and other “permanent” life) insurance types.

Term life insurance is basic coverage, similar to other insurance you purchase in which you pay a monthly premium for a stated benefit, for a specified period of time (the term). Costs will vary based on the age and health of the insured individual, but term life insurance is considerably less expensive than permanent policies.

There are two basic types of term life insurance:

Permanent life insurance differs from term in two key ways. First off, as the name implies, a permanent policy will not expire; the coverage remains intact as long as premiums are paid. Second, permanent insurance also adds the component of a cash value, which acts as an investment and savings tool in addition to the death benefit.

The cash value component adds layers of complexity and flexibility to permanent policies, which also have premiums that are significantly higher than term insurance. Here are four popular permanent life policy types:

1. Why are you buying insurance in the first place?

This may seem like a simple question with a simple answer along the lines of: “Because I want to provide my family with income should I meet an untimely end.”

But you’ll have to break it down a little further than that.

A young family will want to provide coverage that addresses things such as future college expenses, mortgage liabilities, and income replacement for working parents.

You may be concerned with obtaining guaranteed coverage for life. The younger and healthier you are, the easier and less expensive it is to get coverage. Although many term policies are renewable, the renewal rates will be significantly higher than the original premiums.

More mature families with significant wealth will often use insurance as part of an estate plan to leave wealth to heirs and minimize estate tax liabilities.

2. What type of investment and savings plan do you have or are you comfortable with?

The cash value component of a permanent life insurance policy can act as an investment and savings mechanism. The policy owner may access the cash value through a loan, withdrawals, or by surrendering the policy (i.e., taking the cash value that’s built up in the policy, minus fees and expenses).

For some investors, this provides a disciplined and systematic approach to investing—a kind of “forced savings.”

On the other hand, you could be better off using a term life insurance policy (with lower premiums) and directly investing the money saved to build your nest egg.

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Here’s a simplified example. Suppose you are considering a $500,000 level-term policy at $30 per month versus a permanent life policy at $300 per month. If you were to buy the term coverage and be disciplined about investing an extra $270 per month over and above your regularly planned savings, would you come out ahead? Punch some numbers into the compounding calculator and see how you might fare.

3. How much coverage do you need, and how much can you afford?

As with most things in life, there’s often a trade-off between what you want and what you can afford. Although permanent policies provide cash value accumulation and guaranteed coverage for life, the higher premiums may prevent you from obtaining all the coverage you need.

The counterargument. Coverage only extends for a limited time. Renewal can be expensive, and if the policy doesn’t guarantee renewal, deteriorating health can make obtaining new coverage difficult.

The counterargument. Permanent policy premiums are expensive. The underlying fees of investments may be high. If you choose to surrender the policy for the cash value, the fees may be significant.

Plus, if you take out withdrawals from the cash value of the policy, and those withdrawals exceed the contribution basis (that is, the total you’ve paid in premiums over the years), the difference will be taxed as ordinary income rather than the more favorable capital gains rate.

Term life insurance policies work well if you have young family members who need higher coverage to address a mortgage, income replacement, and future college expenses, but you can’t afford the premiums to get all the coverage you need from a permanent policy.

Permanent life insurance policies can be a good solution if you want to guarantee coverage for the rest of an insured’s life, especially if you’re looking to use the investing and cash accumulation features of a permanent policy as part of your savings and/or estate plan.