Term vs. Whole Life: Which Should I Get?

Term vs. Whole Life: Which Should I Get? article image.

Life insurance is one way to protect your loved ones financially if you pass away. But the type of insurance policy you get is just as important as the coverage amount, if not more so. Term life and whole life are two common forms of life insurance you'll come across when you start shopping for a policy.

Life insurance agents often get paid based on the cost of the policies they sell, so you may be encouraged to purchase whole life insurance instead of an inexpensive term policy. But each type has its pros and cons. Here's what you need to know about life insurance options and how to choose the right policy for you.

Term Life vs. Whole Life Insurance

Both term and whole life insurance provide protection in the event that you die—but for the most part, that's where the similarities end. Many have compared the two to buying a home versus renting one. Here's why:

With whole life insurance, you'll get a cash value account that grows over time. If you decide to cancel your policy at some point in the future, you may be able to access some or all of the cash that's built up. In contrast, term life insurance offers protection only, and once your policy's term ends, you don't get anything in return. This makes it more like auto or homeowners insurance, which doesn't build up value, but protects you when you need it.

Here's a deeper dive into both term and whole life insurance.

Term Life Insurance

Term life insurance can come in many forms, but the most popular is level term. With a level term policy, you purchase coverage for a set period of time, which can range from five to 40 years. During that time, your premiums stay the same (or level).

If you die during the policy's term, your beneficiaries receive the death benefit. If you outlive the policy, you'll lose coverage unless you renew it or purchase a new policy.

Term life insurance is less expensive than whole life insurance, especially if you're young and healthy. For example, a 25-year-old woman could purchase $500,000 worth of coverage for an average premium of $30.46 per month, according to Policygenius.

But while they're cheaper than whole life, term life policies don't offer a cash value component.

Whole Life Insurance

Whole life is a form of permanent insurance, which means that you're covered virtually your entire life as long as you keep up with your premiums. In addition to a death benefit, whole life also offers cash value, which acts like a savings account: A portion of your monthly premium goes into this account, and it grows over time.

The growth in a cash value account is relatively slow, with guaranteed rates hovering around 1% to 2%. As a result, it can take 10 years or longer just to break even on your premiums. But once your account balance has grown, you can use the cash for retirement, borrow from it for large purchases and more.

Cash value accounts grow on a tax-deferred basis. This means that you won't pay any taxes on the balance up to the amount you contribute to the policy, and you won't owe taxes on any of your gains until you withdraw it.

The catch is that the cost of whole life insurance can range from five to 15 times the cost of term insurance, making it unaffordable for many.

Insurance agents may also try to sell you universal life insurance. These policies function similarly to whole life policies as permanent insurance, but they give you a little more flexibility with your monthly payments. That said, universal life is also more expensive than term life, and its complexity makes it less appealing than whole life for most.

Which Type of Life of Insurance Should I Choose?

While there's no one-size-fits-all answer to this question, term life insurance is better suited for most consumers. This is primarily because term insurance is more budget-friendly, and it provides the coverage you need without the complication of a cash value account.

Also, because cash value growth rates are low, you'll likely get more long-term value by purchasing term insurance and then investing the difference between the cost of term and whole life (assuming you can afford both types of policies).

However, if you have a high net worth and you've exhausted all of your tax-advantaged retirement and health savings options and can afford a whole life policy, the tax-deferred growth and safe, guaranteed return can be appealing compared with riskier options.

How to Get Life Insurance

If you want to purchase term life insurance, you can typically start the process by getting a quote online, directly from an insurer or through a life insurance agent or comparison website.

You may also be able to purchase whole life insurance through a comparison website, but in most cases, you'll need to work directly with an agent.

During this process, it's best to work with an independent agent who doesn't work for any specific insurance company. Independent agents are able to shop around and compare features and rates from multiple companies to help you save as much as possible.

When you submit your application, you'll typically need to undergo a medical exam. There are ways to get around the exam with no-exam insurance. But because opting out of an exam causes the insurance company to take on more risk, those policies are typically 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 the offer.

If you accept it, be sure to make all of your insurance payments on time. Otherwise, you may lose the coverage.

Will the Insurance Company Check My Credit?

Historically, life insurance companies didn't require a credit check during the application process. But that's changing quickly.

For example, LIMRA, a global trade association for life insurance companies, found that the number of insurers who use credit checks increased from 18% in 2017 to 49% in 2019.

In general, though, insurance companies use what's called a credit-based insurance score rather than the traditional FICO® Score lenders use. A credit-based insurance score provides insurance companies with the information they need to determine the likelihood that you'll miss premium payments.

As a result, having a good credit score could improve your chances of scoring a low rate on your insurance policy.

Establish Good Credit to Save Money

A good credit score could not only save you money on life insurance but also other forms of insurance and, of course, loans and credit cards. Before you apply for a life insurance policy, check your credit score to get an idea of where you're at and to help you decide if you need to take steps to improve your credit.

Also, check your credit report to determine where you can start addressing potential issues that are hurting your credit score. This may include late payments, high credit card balances, frequent credit applications or even potential inaccuracies on your report.

Building credit isn't always easy, and it can take time to achieve your goal, especially if you have significant negative items on your reports. But the savings in several areas of your financial life are worth every ounce of effort it takes to achieve your goal.