Term life versus whole life, without the sales pitch

Life insurance answers one question: if you die, does anyone suffer financially?

If the answer is yes, you need cover. What kind is a separate question, and it is where the industry's incentives diverge from most buyers' interests.

Term life

Cover for a defined period — ten, twenty or thirty years. If you die during the term, the death benefit is paid. If you do not, the policy expires with no value.

It is pure insurance. No investment component, no cash value.

It is also inexpensive. A healthy person in their thirties can typically obtain a substantial death benefit for a modest monthly premium, because the probability of dying during the term is low.

Level term keeps the premium fixed for the term, which is the standard product.

Annual renewable term reprices each year, rising steeply with age.

Convertibility — the right to convert to permanent cover without new underwriting — is a valuable feature worth checking for, since it protects against becoming uninsurable.

Whole life and other permanent cover

Cover for life, provided premiums are paid, with a cash value component that accumulates.

Premiums are substantially higher than term — commonly many times higher for the same death benefit — because part of the premium funds the cash value and because the policy will certainly pay out eventually.

Whole life has guaranteed premiums, a guaranteed death benefit and guaranteed minimum cash value growth, often with non-guaranteed dividends on participating policies.

Universal life is more flexible, with adjustable premiums and death benefits, and cash value crediting that varies.

Indexed universal life credits interest linked to a market index, subject to caps, floors and participation rates that the insurer can generally adjust.

Variable universal life invests cash value in subaccounts, with market risk borne by the policyholder.

The case for term

The need for life insurance is usually temporary.

You need it while children are dependent, while a mortgage is outstanding, while a spouse depends on your income. Twenty or thirty years, typically.

By the end of that period, the mortgage is paid, the children are independent, and retirement savings have accumulated. The need has largely gone.

Term cover matches that shape exactly, at a small fraction of the cost, which frees the difference for saving and investing in vehicles with lower costs and more flexibility.

This is the reasoning behind the standard advice, and it is sound for the majority of buyers.

The legitimate case for permanent

Overstated in sales presentations and not zero.

A genuinely permanent need. A dependent with a disability who will require support indefinitely. An estate with illiquid assets and a tax liability at death. A business needing funding for a buy-sell agreement.

Estate liquidity where the estate consists of assets that cannot easily be sold — a business, farmland, property — and cash is needed for taxes and administration.

Certainty of insurability, for someone whose health may deteriorate.

Behavioral forced saving, for someone who genuinely will not save otherwise. This is a real consideration even though it is an expensive way to solve the problem.

Why permanent policies are sold so heavily

Worth stating plainly because it explains the market.

Commissions on permanent policies are typically a large percentage of the first year's premium, and first-year premiums on permanent policies are much larger than on term.

The commission on a permanent policy can therefore be many times that on a term policy providing similar death benefit.

This does not mean every agent recommending permanent cover is acting badly. It does mean the recommendation should be examined, and that a second opinion from a fee-only advisor with no product commission is worth obtaining.

Reading a permanent illustration

The projections shown are the main source of misunderstanding.

Illustrations typically show guaranteed and non-guaranteed columns. Only the guaranteed column is a promise.

Non-guaranteed projections assume current dividend scales or crediting rates continue indefinitely, which is not a commitment and historically has not held.

Look specifically at: the guaranteed cash value in early years, which is frequently zero or near zero for several years because of front-loaded costs; the surrender charge schedule; and the internal cost of insurance, which rises with age.

Ask directly what happens if you stop paying in year six. The answer is frequently that you receive very little.

The practical approach

Determine how much cover you need and for how long.

Buy level term for that amount and that period, from a financially strong insurer, with convertibility if available.

Invest the premium difference deliberately.

Then, if a genuinely permanent need exists — estate liquidity, a lifelong dependent, business succession — address it specifically, with advice from someone not paid by commission.

General information about insurance products, not insurance, financial or tax advice. Policy terms, costs and suitability vary by individual circumstance. Consult a licensed advisor, preferably one without a product commission interest.