Doing the Math on Whole vs Term Life

The difference between whole and term life insurance may seem simple. Either your plan lasts a lifetime or has a specified timeframe - but there are some financial aspects to each that are important to consider when doing the math on whole vs term life insurance.
By Stephanie L.
Updated Mar 15, 2022
whole and term life math
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Making the decision to purchase life insurance is just one piece of the process. There is a whole list of decisions to make to get the life insurance policy that is best for you.

The first decision worth tackling? Whether to invest in term or whole life insurance. As the two most popular life insurance options, these plans possess a few similarities while differing in numerous respects. Each option holds notable benefits as well as potential challenges worth considering. 

No single life insurance strategy benefits every policyholder to an equal extent. Ultimately, this difficult decision comes down to a variety of specific life circumstances, including your current budget to future tax ramifications. While health considerations can come into play, the driving factors in life-insurance decision-making often prove strictly financial.

There are a few main considerations to take into account as you select a policy but first, it's important to understand the difference between whole and term life insurance and how each of them impacts your finances.

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Whole Life and Term Life: The Basics

In general, term life insurance provides the most straightforward solution. As with car or home insurance, this plan kicks in after a qualifying event occurs. With life insurance, the policy's face value becomes available to the beneficiary in the event of the policyholder's death.

With whole life insurance, it's possible to make active use of the plan prior to the policyholder's death. Your plan could accumulate cash value over time, allowing you to secure dividends, reduce premiums, or otherwise handle your policy as you see fit.

Choosing Between Whole and Term Life Insurance: Top Financial Considerations

The primary differences between whole and term life insurance may initially seem simple. Either your plan lasts a lifetime and is accessible—or it's limited to a specific timeframe in which you cannot access funds set aside. If you dig a little deeper, however, you'll find a variety of specific financial implications that warrant careful consideration. Key factors include:

Upfront Cost

Many people focus on current budgetary concerns above all else. In that case, term life may be the most favorable approach. With term policies, participants pay premiums on an annual or monthly basis.

Term life insurance premiums are often reasonable, making this an ideal option for those with minimal wiggle room in their budgets. Many policyholders with modest incomes seek plans with low premiums and invest the difference elsewhere. Others simply rely on employers to cover term life insurance.

Whole life insurance is typically more expensive, although many policyholders are willing to pay higher premiums in exchange for the unique financial benefits these plans impart.

Lifelong or Temporary Coverage

Term life insurance involves an inherent element of risk. At the plan's outset, you may choose a preferred term of ten, twenty, or thirty years. If you pass away within this selected term, your beneficiaries will be paid accordingly. Otherwise, the policy holds no value.

Due to their built-in limitations, term life plans often cater to those worried about protecting dependents in the event of early or unexpected death. As personal plans, however, they may prove less than ideal, as they could end years or even decades before benefits come into play.

As its name implies, whole life insurance offers extensive coverage spanning the policyholder's full life. There's no need to worry about the policy ending after a specific number of years. On the flip side, however, policyholders take on the risk of maintaining higher premium levels over the course of several years or even decades—and all without knowing whether their budgets will change significantly in the future.

Cash Value

Beyond lifelong terms, the primary benefit of whole life insurance lies in the opportunity for accumulating cash value.

Many whole life policies involve annual dividends. Although not guaranteed, this portion of the plan's surplus can be used in several ways. Examples include:

  • Taking the value of the dividends in cash.

  • Using dividends to reduce premiums.

  • Using them to generate additional interest.

  • Purchasing further life insurance coverage.

  • Repaying policy loans.

Equalizing Inheritances

Many policyholders look at whole life as an option for keeping inheritances equal between several beneficiaries. This approach often comes into play for business owners or those with significant real estate. Under this strategy, such individuals can leave business interests or specific property to one beneficiary, while compensating others via whole life insurance plans.

Tax Ramifications

Taxes can play a huge role in the long-term financial viability of various life insurance policies. Both whole life and term life offer tax-free death benefits. When the policyholder passes away, the account's value is distributed among beneficiaries on a tax-free basis.

Whole life insurance allows policyholders to avoid taxes not only when distributing benefits, but also, for making loans while they're still alive. These tax-free loans come from the funds that would otherwise be distributed to beneficiaries. With proper management, such funds can prove a valuable source of cash for everything from college to retirement.

While whole life typically delivers the greatest tax advantages, it can also come accompanied by a few notable pitfalls. The greatest risks involve lapsed or surrendered plans. These often occur when the policyholder becomes unable to cover the cost of premiums, which, as mentioned previously, tend to be far higher for whole life than for term life plans. Upon lapsing, such plans become taxable.

High net worth policyholders are less likely to struggle with premiums over time. As a result, whole life often represents the most viable option for those who already possess significant financial resources but desire an additional option for building wealth.

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No matter your current circumstances or plans for the future, you can find an insurance policy that fits your personal and financial priorities. Steer clear of your impulse to automatically assume that a specific plan represents the better fit. Analyze your options to determine which actually delivers the best financial outcome—you'll never regret making the effort to secure the best possible insurance plan for your situation.