The argument about whether to purchase term insurance or permanent insurance (e.g., whole life) has been around for years. So, we thought it would be a good time to review some of the key aspects of both. Keep in mind that there are other types of life insurance policies available, but these are two of the most commonly owned.

Term insurance provides protection for a specified period of time. Generally, there are two types of term life insurance: annually renewable term (where the premium increases each year) and level premium term (where the premium remains constant for a specified period of years). For example, if the policy is written for 10 years, it provides protection equal to the face amount of the policy for that period. At the end of the period, the coverage terminates, and the policy generally has no value. The principal appeal of term insurance is the low cost.

Term insurance is particularly useful for providing maximum protection for young families at low premium costs. It is also used to provide for the liquidation of a debt, such as a home mortgage, with the insurance amount decreasing as the mortgage gets smaller. Another use of a limited period policy would be to provide a college fund for children in case of the untimely death of the family wage earner. Once the children graduate from college, the policy will have served its purpose and can be canceled.

Some disadvantages of term insurance include higher premiums if the insured needs to renew the policy; the potential inability of the insured to renew the policy at the end of the term because of poor health; the fact that many term insurance policies never pay a death benefit because term policies frequently are allowed to expire; and the policy generally has no cash value.

Whole life is one of the three types of permanent or cash value life insurance (the others are universal and variable life). Whole life is the combination of a savings account (cash value) with insurance. The savings feature arises because, in the early years of a whole life policy, the annual level premium is more than enough to pay the current cost of the insurance protection. The excess premiums in early years and the effect of compound interest make up for the deficiency of premiums in later years when the annual level premium is no longer sufficient to pay for the cost of insurance. The funds accumulated in the early years are held by the insurer for the policyholder and provide the cash value aspect of the policy. Because the earnings being compounded inside the policy are not taxed to the owner of the policy, part of the premium is being paid with pretax dollars.

Whole life premiums are fixed and usually invested in long-term bonds and mortgages as determined by the insurance company. A common axiom is, “buy term and save the difference.” This may be a sound strategy; however, some folks are not good savers, although they do pay their bills. Since, in a whole life policy, the savings occurs through paying a bill, this is a means of forced savings. Also, the life insurance cash value grows on a tax-deferred basis.

Whole life is more expensive than term insurance, but the advantage of a whole life policy include guaranteed premiums, death benefits, and cash values; future uninsurability, old age, or other contingencies cannot terminate the policy; when the policyholder is older and no longer needs a large face amount of insurance protection, the policy can be cashed in; and the policyholder can borrow against the accumulated cash value at the interest rate indicated in the policy.

This information can be used to make a careful decision about life insurance based on your own personal needs and goals.

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