If you pass away unexpectedly, life insurance can protect your loved ones financially.
However, the type of insurance you get is just as important as the amount of coverage, if not more so.
Term life insurance and whole life insurance are the two most common types of life insurance. Which one you choose is important.
Understanding term insurance
A term life insurance policy is exactly what the name implies: It is a policy that provides coverage for a specific term or period of time, often 10, 15, 20, 25, 30, 35, or even 40 years.
After that, you can usually continue the policy on a year-to-year basis up to age 95, which is the term life insurance age limit, but at a much higher cost.
Term policies are sometimes called “pure life insurance” because, unlike whole life insurance, there is no cash value component to the policy.
You pay your premiums as scheduled and in return, your insurer agrees to pay a death benefit should you die within that term. Term life premiums are based on a person’s age, health, and life expectancy.
A major benefit of term life insurance is the low, fixed cost. Term insurance can be purchased in large amounts for relatively small premiums.
Most term policies can be converted (age limitations typically apply) to a whole life policy if your temporary needs evolve into lifetime needs.
The disadvantage of term life insurance is that the policy is temporary. Term insurance is designed to last for a specific amount of time (the term).
After the term period is over, many policies are guaranteed to renew on an annual basis but at a higher premium that may become unaffordable.
Understanding whole life insurance
Whole life insurance is one type of permanent life insurance that can provide lifelong coverage. It provides a variety of guarantees, which can be appealing to someone who does not want any guesswork after buying life insurance.
Whole life insurance combines an investment account called “cash value” and an insurance product. As long as you pay the premiums, your beneficiaries can claim the policy’s death benefit when you pass away.
Unlike term, it is not a “pure life insurance” product because it includes a cash value component.
A policy has cash value if a portion of your premium dollars are invested and this sum grows over time on a tax-deferred basis.
The benefit of whole life insurance is that the costs are guaranteed to stay the same. The premiums you pay the insurance company each month will never go up.
Cash value grows on a tax-deferred basis and your heirs can receive tax-free assets. Some insurance policies offer dividends as well.
Comparing the two
The disadvantage of whole life insurance is you will pay higher initial premiums compared to term life insurance
When you submit your application, you’ll also typically need to undergo a medical exam. There are ways to get around the exam with no-exam insurance. But opting out of an exam causes the insurance company to take on more risk, so those policies typically are more expensive.
Once you’ve completed the application and the medical exam, the insurer will notify you that you’ve been approved or denied. It will also provide a final rate, and you’ll have the option to accept or decline.
If you accept it, be sure to make all of your insurance payments on time. Otherwise, you may lose the coverage.