When it comes to life insurance, there are two main types: term and whole.
Both have their pros and cons, so which is right for you?
Here's a look at the differences between term and whole life insurance policies.
Where do I start when considering life insurance?
When you start to think about life insurance, it’s important to understand what it is and how it works. Life insurance is a contract between you and a life insurance company. You pay premiums, and the insurance company agrees to pay a death benefit to your beneficiaries if you die while the policy is in force.
There are two main types: term life insurance and whole life insurance.
What is Term Life Insurance?
A term life insurance policy is the simplest, purest form of life insurance. Term life insurance is also the cheapest, often costing less than buying a cup of coffee per day.
Term life provides protection for a required number of years. The most common policies are for 10, 20, and 30 years, or till you reach a specific age, like 65. Your beneficiaries receive a death benefit if you pass away during the policy term. Your family is free to use the payout as they like, for everyday living expenses, mortgage (or mortgages), other debts, or college tuition fees.
If you let the life insurance policy expire or stop paying premiums, the coverage ends.
As your policy approaches the end of its term, you can renew the life policy without a medical exam. However, you’ll have to pay higher premiums at each renewal since the cost of insurance goes up as you get older. Some policies allow conversion riders meaning that you can convert your term life insurance into a whole life insurance policy.
All term life insurance policies have a guaranteed death benefit. That means the death benefit amount will remain the same throughout the contract. Most policies have level premiums, meaning your premiums will neither increase nor decrease during the term.
Pros and cons of term life insurance
Easy to understand: A term life policy is a simple contract. The insurer promises to pay your family a specified amount if you die within a set period in exchange for premium payments.
Affordable: Term life insurance can be five to 15 times cheaper than comparable whole life policies.
Flexibility: You can cancel a term life policy at any time without cancellation fees.
Adaptability: You select the time period frame for you policy for a set number of years based on your needs. Once the policy expires you can re-evaluate your situation a commit to a new policy which meets your new needs.
Expiration: Term life policies have an expiry date — hence the name. However, the good news is most term life policies include a feature called guaranteed renewability. This provision obligates the insurer to renew your coverage without a medical exam. So even if your health has deteriorated significantly since you first bought the policy, you can rest assured knowing you can renew your same coverage (though for a higher premium rate).
No cash value: It does not build up a cash value component, which you can access to borrow funds from in the future.
A term life policy is considerably cheaper than a comparable whole life policy. That’s because it neither builds up a cash value component nor offers lifelong protection. Premiums for term life insurance can be five to 15 times lower than those for a whole life policy with the same death benefits.
What Is Whole Life Insurance?
Whole life insurance or permanent life insurance doesn’t have an end date. Unlike term life insurance, whole life coverage lasts for your lifetime and builds cash value. Your family will receive a payout, whether you die 10 years from now or 30. A permanent life insurance policy is sometimes referred to as permanent life insurance.
In addition to providing specified death benefits amount upon your death, a whole life policy also includes an investment account. The insurer uses part of your premiums to cover the cost of insuring you. The remainder gets funnelled into the in-built savings account, which grows on a tax-deferred basis. This means it will grow tax free, and you only pay income taxes on it once you withdraw funds from the investment.
As the policy’s cash value component grows, you can take withdrawals or borrow money from it. If the insurance policy has built enough cash value, you can even surrender it and take out the cash value.
Permanent life insurance features guaranteed level premiums and a guaranteed death benefit. This basically means your premium and death benefit amount will remain the same throughout.
Pros and cons of whole life insurance
- Lifelong protection: A whole policy doesn’t have an expiry date, provided you pay the premiums on time.
- Accumulates cash value: Permanent insurance policies include a savings account and acash value account.
- Potential to earn dividends: Some of these policies give you a chance to earn annual dividends. You can take out dividends as cash, use them to pay future premiums, or reinvest them in your policy.
- More expensive: Whole life premiums can cost 5 to 15 times more than comparable term policies.
- More complex: A whole life policy is more complex than term insurance. That’s because it is a combination of two financial components — life insurance and investments.
- Little control over how the cash value grows: You have no control over how the insurer invests your cash value. Also, the rate of return on a permanent life insurance policy is typically lower than what you can get with other investment options, like TFSAs and RRSPs.
- Higher fees: Fees for whole life investments can exceed 3%.
- Inflexible: You may have to pay a high cancellation fee if you terminate the policy within a few years.
As a rule of thumb, a permanent life insurance policy is more expensive than a term life insurance policy. That’s because it provides lifelong coverage and accumulates cash value. Cost is definitely something to keep in mind when considering term vs permanent life insurance.
Term Life vs. Whole Life: Policy Features
Which insurance plan has better policy features?
To find out the answer, we did a term vs whole life insurance policy analysis.
|Term Life Insurance||Whole Life Insurance|
|Choice of Term Length||Yes||No|
|Level Death Benefit Amount||Yes||Yes|
|Builds Cash Value||No||Yes|
|Potential to Earn Dividends||No||Yes|
This should give a clear idea on the features that come with each policy.
Term Life Insurance vs Whole Life Insurance: Cost Comparison
Term life is more affordable because it comes with an expiry date and doesn’t build cash value. If you outlive the term, your family won’t receive a payout.
Below is the monthly price comparison between whole life insurance and term life insurance for a $250,000 policy. These rates are for, non-smoking and smoking males and females. We picked the most term length — 20 years — and calculated the coverage for a 40-year-old male in good health.
|Whole Life Insurance||Term life insurance|
Looking for a personalized quote for term policies or whole life insurance policies? We’ve got you covered. Simply answer a few questions, and our insurance calculator will find you the best coverage at the best price.
How Much Term Life Insurance Should You Purchase?
Experts recommend buying a term life policy for 10 to 15 times your annual income. While this method is better than coming up with a random number, it has certain obvious limitations.
The most obvious one is that it doesn’t take your current savings into account. Also, it doesn’t work for someone who is a homemaker.
A much better approach is to consider your annual income and then multiply it by the number of years for which you need protection. Next, to this number add all your current debts (mortgage, credit card bills, etc.) and future needs (college fee, funeral cost, etc.).
Finally, from this number subtract liquid assets (current savings, any other life insurance, etc.). The figure you get is a rough estimate of how much life insurance you need.
Find the best rates
Annual Income x Years you will require financial support + Current assets – Any expenses = Coverage amount requirement
For example: Let’s say your annual income is $50,000 and you're going to need 10 years of support. Also, you have a car that’s worth $10,000 and your annual expenses are $40,000.
$50,000 x 10 + $10,000 – 40,000 = $470,000 (Coverage amount requirement)
Keep in mind you should buy life insurance for both you and your partner.
That’s true even if your partner is not working. Think about the services your partner provides for free — caring for kids, cleaning the house, cooking meals, etc. If he or she dies suddenly, you may have to pay someone to perform those services. And that would mean a lot of extra expenditure.
Frequently Asked Questions
What are the key differences between whole life and term life insurance?
Whole life policies are permanent, meaning they do not expire and offer permanent coverage. As long as you continue to pay your premiums, your coverage will remain in force and build cash value. Term life insurance policies, on the other hand, only remain in force for a set period of time, typically 10, 20, or 30 years. After that, the policy expires and you are no longer covered.
Whole life policies also builds cash value over time.
Is term life insurance better than whole life?
No policy is better than the other, it all depends on a person needs. If someone is looking for cheaper coverage for a set number of working years then term life is more suitable. On the other hand, if someone is looking for more security, the more expensive nature of whole life is worth it as it provides additional benefits such as lifelong coverage, fixed premiums and cash value.
Which type of policy is right for me?
There is no one-size-fits-all answer to this question, as the type of policy that is right for you will depend on your specific circumstances. However, some general guidelines that you may want to consider include:
The amount of coverage you need: This will depend on factors such as the value of your assets, your income, your dependents, and if you require cash value in the future.
How does the premium for whole life insurance compare to the premium for term life insurance?
The whole life insurance premiums for a whole life insurance policy are generally higher than the premium for term life insurance because whole life insurance provides coverage for the policyholder's entire life, while term life insurance only provides coverage for a set period of time. The premium for whole life insurance is typically based on the policyholder's age, health, and life expectancy, while the premium for term life insurance is typically based on the policyholder's age and health.
When can you stop paying premiums on whole life insurance?
Most whole life policies require you to pay premiums for your entire life to keep the policy in force. There are some paid up options for whole life insurance policies where you only pay for a certain amount of time and still get life coverage after the cash value has built up overtime. That said, these policies are quite expensive and are not very popular choices for life insurance.
Can I convert my term life to a whole life policy?
In most cases, there are ways in which you can convert your term life to a whole life policy once a certain time period has passed. This is usually after a year since the policy has come into effect. These types of policy conversions are great for people who have certain health conditions which would make buying a new permanent policy more expensive. For more information on policy conversions book a call with a Dundas Life broker today.
Term life insurance provides sufficient coverage for most families, but a whole life plan can prove useful in certain situations where permanent coverage is needed.
The best way to understand which one of them is for you is to consider your financial needs and budget. If you want the most affordable coverage or life insurance to act as an income replacement over a certain period, consider term life.
By contrast, if your financial needs don’t have an expiry date, or if you want your life insurance policy to also act as a tool for investments, a whole life insurance policy could make sense for you.
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