Choosing Life Insurance: Term or Permanent?
What’s better: buying life insurance at a low price that lasts for a certain term (typically, the income-generating part of the insured’s life) or purchasing a permanent policy for a substantially greater amount that lasts forever (from now until the insured dies or cashes in the policy)?
Please note that although there are many variants of permanent or cash value policies (for example, whole life, universal life, and variable life products), I am going to focus my discussion on term life vs. whole life.
Here is the basic argument:
Term Life Insurance
Pro: Inexpensive way to get insurance
Con: Lasts for a limited time (for example, 10 years or 30 years)
Whole Life Insurance
Pro: Is permanent (provides lifetime coverage)
Con: Very expensive
Nuance: Bundles insurance coverage with an investment product
What is the difference in cost between term life and whole life insurance?
It depends. But I’ve done some investigating to give you a rough idea of the price differential. State Farm gives you a peek at whole life rates and its term life rates without getting an agent involved. There are many sites that offer term life quotes and I’ve used QuickQuote.com to get a second term life quote. Price quotes are offered for site users who provide information on state of residence, age, gender, and tobacco habits. Actual prices, which may vary depending on your health status and insurance company's underwriting guidelines, should be obtained from an insurance agent.
To give you an illustration of the price differences, I’ve made some assumptions about a potential insured. She is a 30-year-old, non-tobacco-using female resident of Delaware who wants $500,000 in life insurance coverage for 30 years. Here are the annual rates based on quotes gathered on August 21, 2007:
State Farm Whole-Life Insurance: $5060.00
State Farm Select Term 30: $820.00
AIG Select-A-Term 30 (via QuickQuote): $360.00
If you purchased term life insurance and your investments earned 5% or 10% per year, you would have no insurance coverage but the following investment value at the end of your 30-year term:
State Farm Select Term 30 @ 5%: $281,700.71
State Farm Select Term 30 @ 10%: $697,454.66
AIG Select-A-Term 30 @ 5%:$312,262.58
AIG Select-A-Term 30 @10%: $712,121.91
What you have in 30 years with a whole life policy is $500,000 insurance coverage and an investment value that depends on your insurance policy or contract.
Please note that you (or your insured) will need to die for you to collect the insurance benefit but the investment amount if you bought term is all yours.
The argument in favor of term life, then, is that you can purchase affordable insurance and make investments that will deliver a return that may be comparable (often higher) to the value of the death benefit and you can have access to these funds while (hopefully) the insured is alive to enjoy spending the money.
The case for whole life is that, despite your good intentions, you wouldn’t really end up saving, investing, and earning a good return so that buying a policy that combines insurance with a savings or investment component protects you from lack of discipline.
I would love to hear that insurance agents, some of whom have financial planning designations, give consumers the pros and cons of each type of policy so that the consumer can make an informed choice. And, in fact, such discussions may be taking place every day. However, the insurance agents who I've encountered seem to think that term is bad, permanent is good; that purchasing term is foolish and buying permanent (no matter the cost) is wise. They seem unaware that reliable sources (the Federal Trade Commission (FTC), for example, mentioned by The Motley Fool) recommend term life for insurance protection. From 66 Ways to Save Money, the FTC advises “If you want insurance protection only, and not a savings and investment product, buy a term life insurance policy.” And, contrary to the advice to try out a policy, "If you want to buy a whole life, universal life, or other cash value policy, plan to hold it for at least 15 years. Canceling these policies after only a few years can more than double your life insurance costs."
As for me, I spoke with three agents before I found one who was willing to sell me a term policy.