While the death benefits of whole life and term life insurance can be similar, there are significant differences between these two popular types of life insurance.

What is the difference between term and whole life insurance?

Term life insurance is the most affordable and easiest to understand. It protects you for a set period of time, such as 10, 20, or 30 years. If you do not die during the term, your coverage terminates and no money is paid out.

Whole life insurance is more complicated and typically costs more than term life insurance, but it provides additional benefits. Whole life insurance is the most well-known and basic type of permanent life insurance, and it covers you until you die. It also includes a cash-value account from which you can withdraw funds later in life.

What is term life insurance?

Term life insurance provides coverage for a set period of time. It is often referred to as "pure life insurance" because it is only intended to protect your dependents in the event that you die prematurely. If you have a term policy and die within the term, the payout is paid to your beneficiaries. Other than that, the policy is worthless.

When you purchase the policy, you select the term. The most commonly used terms are 10, 20, and 30 years. The payout — known as the death benefit — and the cost, or premium, of most policies remain constant throughout the term.

When looking for term life insurance:

• Select a term that covers the years you'll be paying bills and needing life insurance in case you die.
• Purchase an amount that your family would require if you were no longer able to provide for them. The payout could replace your income and assist your family in paying for services you currently provide, such as child care.

Your need for life insurance should ideally end around the time your term life policy expires: Your children will be on their own, your house will be paid off, and you will have plenty of money in savings to serve as a financial safety net.

Term life insurance is sold by all of the best life insurance companies, making it simple to find rates. Online life insurance quotes are available.

What is whole life insurance?

Whole life insurance provides coverage for the rest of one's life and includes an investment component known as the policy's cash value. In a tax-deferred account, the cash value grows slowly, which means you don't have to pay taxes on the gains as they accumulate.

You can borrow money against the account or cash out the policy. However, if you do not repay policy loans with interest, your death benefit will be reduced, and if you surrender the policy, you will no longer have coverage.

Although more complicated than term life insurance, whole life is the most basic type of permanent life insurance. This is why:

• The premium remains constant for the duration of your life.
• The death benefit is guaranteed.
• The cash value account grows at a guaranteed rate.

Some whole life policies also pay out annual dividends, which are a portion of the insurer's profit. Dividends can be taken in cash, left in your account to earn interest, or used to reduce your premium payments, repay policy loans, or purchase additional coverage. Dividend payments are not guaranteed.

Term vs. whole life: Policy features

Term vs. whole life: Cost comparison

Term life insurance is inexpensive because it is temporary and has no cash value; in most cases, your family will not receive a payout because you will survive the term. Whole life insurance premiums are much higher because the coverage is permanent and the policy has cash value, with a guaranteed rate of investment return on a portion of the money you pay.

The table below compares the annual costs of term life insurance and whole life insurance for a $500,000 policy. We used the most common term length, 20 years, because there is no way to compare the length of term life to whole life.

Term vs. whole life: Which to choose

Most families only need term life insurance, but whole life and other types of permanent coverage can be useful in certain situations.

Choose term life if you:

• Only need life insurance to replace your income over a certain period, such as the years you’re raising children or paying off your mortgage.
• You want the most affordable coverage possible.
• You're thinking about getting permanent life insurance but can't afford it. Most term life insurance policies can be converted to permanent coverage. The deadline for conversion varies depending on the policy.
• Think you can invest your money better. Buying a cheaper term life policy lets you invest what you would have paid for a whole life policy.

Choose whole life if you:

• Want to provide money for your heirs to pay inheritance or estate taxes. In 2021, estates worth more than $11.7 million per individual or $23.4 million per couple are subject to federal estate taxes. State inheritance and estate taxes vary.
• Have a lifelong dependent, such as a disabled child. Life insurance can be used to fund a trust that will care for your child after you die. To establish a trust, consult with an attorney and a financial advisor.
• Want to spend retirement savings and still leave an inheritance or money for final expenses, such as funeral costs.
• Want to make inheritances more equitable. If you intend to leave a business or property to one of your children, whole life insurance may be used to compensate other children.

Other life insurance options

Consider other types of permanent life insurance if you require lifelong coverage but want more investment options in your life insurance than whole life provides.

• Universal life insurance pays interest at market rates (like those that determine mortgage interest rates).
• Variable life insurance and variable universal life insurance both allow you to invest directly in the stock market.
• Indexed universal life insurance pays out interest based on the performance of stock indexes.

In addition to the investments they provide, all of these options may be less expensive than whole life insurance if the market cooperates. While the costs of whole life and term policies are fixed from the start, the costs of these other options will vary depending on the performance of your cash account and the policy choices you make. This can result in significant savings or unexpected expenses.

As always, speaking with a fee-only financial planner about your specific needs is a good place to start.