Whole vs. Term Life Insurance

When I rank the most annoying (excuse me, persistent) salesmen, some life insurance salesmen are at the top of the list. But what is it that they’re selling, and do you need it?

To start, what is life insurance?

Life insurance is a contract between an individual and a life insurance company, where the life insurance company pays a sum of money (called a death benefit) to one or more beneficiaries when the insured person dies, in exchange for a monthly payment (called a premium) to the company. In short, you make small, frequent payments now to potentially receive a large amount of money later.

Life insurance isn’t a Ponzi scheme (or at least not all life insurance is a Ponzi scheme). Life insurance is designed to help your family pay for end of life expenses, funeral costs, and replace your income to stay afloat in your absence. A 2021 study found that over half of households rely on a dual income to maintain their lifestyle, with 42% reporting that they would struggle financially within 6 months of losing an income. If I were to die tomorrow, Emily would be sad (I hope), but a sack full of money would at least alleviate any financial concerns she has. If someone depends on your income for their livelihood, getting life insurance isn’t a bad idea. But which kind should you get?

There are two major umbrellas of life insurance, term life insurance and permanent life insurance. Term life insurance only provides coverage for a specific number of years, while permanent life insurance lasts until you die or until you stop making payments.

Permanent life insurance comes in many variations, the most popular being whole life insurance. The people you lost touch with from high school and college who randomly hit you up about an incredible insurance “investment opportunity” with no downside are probably trying to sell you some form of permanent life insurance.

Let’s compare the two so you can see which, if either, is best suited for you.

Policy Length

Term life insurance allows you to choose a policy length that typically lasts for 5, 10, 15, 20, 25, or 30 years. The most popular term lengths are 20 or 30 years. The longer the policy term you select, the more it’ll cost you each month (because of the increased odds that you’ll die at some point).

If I’m 30 now and want life insurance coverage until I’m 60, I’d purchase a 30-year term life insurance policy. Under term life insurance, if you die at 61, you don’t receive a penny from the life insurance company because the policy is no longer active. With whole life insurance, your policy remains active throughout the rest of your life, or until you stop making payments.

Point for whole life insurance.

Cash Value

Both term and whole life insurance pay a death benefit in exchange for monthly payments, but only whole life insurance policies involve a cash value component.

With term life insurance, your beneficiaries only get money if you die. If you don’t die, they don’t get money. It’s a win-lose situation (as weird as that is to say). Whole life insurance operates differently.

When you pay your monthly whole life insurance premium, the majority of your payment goes to the company, similar to term life insurance, but a portion of it goes toward your cash value. This is an account of money that grows over time (often with a small amount of interest) and is yours to claim if you surrender your policy.

Some whole life insurance companies even offer dividends based on the company’s performance, which can further build your cash value balance.

For these reasons, some people see whole life insurance policies as a win-win, as both an investment account and a life insurance policy.

So cased closed - whole life insurance wins over term, right?

Not quite. With great promises come great downsides.

Cost

Life insurance companies are practitioners of dark magic that ensure they always charge more for life insurance than they pay out in benefits. If they didn’t, they’d go out of business. Life insurance costs are driven by a few key factors, including your gender, your age, your lifestyle, your family medical history, and your current health. The better your odds of dying, the more you’ll be charged. These factors are similar between both term and whole life insurance.

Term life insurance is immensely cheaper than whole life insurance. As of January 2023, the average 40-year-old male will pay $1,085 a year for a $1 million dollar 30-year term life insurance policy, or $13,887 a year for a $1 million whole life insurance policy. Pretty significant difference.

The reason for this staggering difference in cost is the cash value that whole life insurance provides and term life insurance doesn’t. “Well of course whole life is more expensive, it’s a guaranteed death benefit, dummy!” True, but what you’re sacrificing can negate the benefits.

Due to the enormous costs, many people who start whole life policies give them up before they die. And when they do, they’re only left with a cash value that’s a fraction of what they contributed into the policy.

Despite what your boomer grandparents may have told you, whole life insurance is not a good investment, in the literal sense. It may suit your needs for insurance, but it’ll give you peanuts as an investment. For those wanting the security of life insurance, buying term life insurance and investing your premium savings in index funds within a tax-advantaged retirement account is the best bang for your buck.

Now, that’s not to say that there aren’t other uses for whole life insurance. Some savvy high-net worth individuals purchase whole life insurance as a tax shelter for a chunk of their money. But for the average guy/gal looking for basic insurance, term life insurance is generally the better option.

How Big of a Policy Do I Need?

If you decide you need life insurance, it’s generally advised to take out a policy that covers the sum of your annual salary times however many years you want to replace it, your mortgage balance, any other debts, and the cost of any other necessary services (like childcare).

Few people are more persistent and persuasive than whole life insurance salesmen. And debating them can be like debating a wall at times. But don’t get me wrong, there are plenty of fine men and women working in the insurance field who have your best interests in mind. I’m not denying that. But this doesn’t mean that what they’re selling you is in your best interest.

Life insurance salesmen are usually paid in a percentage of your first year premiums. With whole life insurance policies, the salesman can receive as much as 100% of your policy premiums. This goes down significantly to around 70% with term life insurance policies. Whole life insurance might be the right choice for some people, and it is always the right choice for the salesman.

“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” - Upton Sinclair (- Michael Scott)

Call to Action

Determine if you need life insurance. If you do, calculate how much you think you need and research policies that fit your needs.

What We’re Reading/Listening To:

Elmo’s playlist on Spotify. My life is run by a tyrant toddler (that I love) whose current obsession is Elmo. I barely have room in my brain for anything other than Elmo lyrics at this point. My best Elmo song recommendation is Number of the Day: 10, by Count Von Count. Thank me later.

Debrief on Deck

Next week, Wilson is going to consult the robots, seeing how ChatGPT would invest $10,000. I haven’t asked it myself, but I’d be willing to bet it wouldn’t “invest” it in whole life insurance.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

Disclaimer