Wlife insurance policies are a lot like Rodney Dangerfield, they don’t get respect. Spend five minutes researching term life versus whole life and you’ll soon discover that everyone but life insurance sellers recommends term life insurance. The reason for this is simple:term life insurance is almost always the better option.
But as with most financial choices we face, there are exceptions. So instead of accepting a general statement that whole life insurance is always the bad choice, let’s take a look at the pros and cons so you can decide for yourself which type of life insurance to buy.
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Term versus whole life
As a quick refresher, term life insurance is as simple and inexpensive as it gets. You get life insurance for a certain period at a fixed premium. If the insured dies during the term of the policy, his or her beneficiaries receive the death benefits. When the term expires, the policy ends. The policy has no cash value. It’s the kind of life insurance my wife and I have had since we adopted our children 17 years ago.
In contrast, full life insurance includes not only death benefits, but also an investment component. In fact, the insurance company charges significantly more than the cost of the actual insurance and invests the extra premium in stocks, bonds, or both. Unlike term life insurance, whole life has no fixed term; the insured can keep the insurance for life. And lifetime policies have a cash value that is returned to the insured if the policy is ever canceled. Life insurance, also known as permanent insurance, includes universal and variable life insurance.
At first glance, life insurance seems very attractive. But there are some significant drawbacks that should be weighed up before purchasing a lifetime policy.
Without a doubt, the cost is the biggest drawback. The actual cost of life insurance varies based on a number of factors. These include your age, whether you smoke, the duration of a term policy, the amount of insurance and your health. But the cost of full life insurance can easily be thousands of dollars a year higher than a term policy with the same death benefit. As a general rule, whole-life policies cost five to ten times more than a similar-term policy.
Because of the excess premium funds, the investment component to a whole life insurance policy, it may seem worth the cost. There may be some tax breaks, and some see it as a forced way to save for retirement. Some insurance agents sell whole life insurance to customers by emphasizing that a portion of the premium is invested in bonds, money market products, stocks and other financial products that collectively serve primarily as a pension fund. Again, this may sound great, because forced saving takes the responsibility for saving off your hands. But there are two major drawbacks to keep in mind.
Firstly, you have little control over the investment choices made by the life insurer. It’s not like a 401(k) or IRA where you can choose where to invest your money. And second, the fees that are deducted from the premiums you pay are extremely high. While I like my investment costs below 0.5%, the cost of investing in whole life insurance policies can sometimes exceed 3%. So if you’re considering life insurance, make sure you understand the cost structure first.
Assuming you pay your monthly premiums, a whole life insurance will cover you all your life. The idea of incessant life insurance coverage comforts many customers. Typically, term life insurance will not cover you after age 65. And once the term ends on a term policy, the premiums typically rise significantly.
Life insurance differs from term life insurance in providing both a death benefit and a savings account. A portion of your life insurance policy is set aside in a savings account often intended to fund your retirement. Insurance agents call this “forced savings.” You can withdraw or borrow against the cash value of your savings portion of your insurance policy. In addition, if you survive the life of the policy, you can get a refund, which acts as another security feature to ease the mind of the consumer.
Buyer pay attention
The most important thing to understand about permanent life insurance is that it is not an investment. You will often hear universal life insurance described to you as “comparable to an IRA” or as a “guaranteed return” investment. This couldn’t be further from the truth.
Permanent life insurance comes at a high cost and your higher premiums can hurt your returns. Dave Ramsey said it best: “Cash value life insurance is one of the worst financial products out there.” You should max out your 401(k) and an IRA before you even start considering whole life insurance, and even then it probably isn’t the best choice for you.
“Permanent” life insurance is just what it sounds like, and you will be severely penalized if you withdraw from your policy early. This is a policy that you take out for life, so compare it with other common insurance products such as auto insurance. You change your auto insurance policy as your car ages, drops coverages, or changes deductibles. Do you want to lock yourself in a policy that will last until you turn 100?
Be sure to weigh all your options before choosing life insurance. And remember that the best option for you today may not be the best option for you ten years from now.
Sproutt can help you compare life insurance policies and term life insurance policies
If you’re hesitating between full life insurance and term life insurance, you may want some help comparing them and figuring out which one is best for you.
Sprout is an innovative life insurance company that offers insurance over the internet. Unlike most life insurers, it uses its Quality of Life Index to focus on positives in your life, such as frequent exercise and a good diet, rather than negatives such as smoking.
You can complete the company’s QL Index questionnaire to get a QL Index score. You can then use that score to meet with one of Sproutt’s advisors to discuss which policy is best for you.
If you want, you can also skip the QL index and request a subscription right away. The online application is quick and easy and you have the option to adjust some aspects of your policy to get a premium that suits your budget.
For more information, see our full Sproutt review.
Life insurance has both advantages and disadvantages:
- Whole life costs much more than term life insurance
- The investment portion of the policy typically charges significant fees
- The insured often has limited control over investment choices
- Ideal if you need insurance for the rest of your life
If you’re still on the fence, maybe the first step is to compare the costs of different life insurance policies. And if you do need advice, ask a fee-based advisor, rather than someone who can earn a nice commission if you buy an expensive policy.
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