The difference between Term and Permanent insurance

What's the difference between term and whole life insurance?

All life insurance policies are designed to pay a benefit when someone dies, but there are different types of policies to meet different needs. Two of the most common categories are “term” life insurance which provides protection for a specific period of time, and “whole life” insurance which includes a cash value account to build funds within the policy.

One way to illustrate the differences between term and cash value life insurance is the analogy of renting vs. owning a home. Term insurance is like renting your home, while cash value insurance is like owning your home.

There are definite advantages to renting a home. Rent can be cheaper than a mortgage payment, you don't have the responsibility of keeping the property in good repair and you can leave when your lease is up. On the other hand, you have very little control. The landlord can raise the rent or cancel your lease, and you have no financial benefit to show at the end of your lease, even after paying rent for years and years.

Term insurance, like renting, gives you the use of an asset – the insurance company's promise to pay a benefit – for a period of time. It pays a benefit only if you die during the term. When the coverage ends, you may or may not qualify for new coverage (depending on your health) or because of your age the cost of continued coverage may not be affordable.

By comparison, when you own your home, much of the control shifts to you. Your monthly mortgage payment might be more than a rent payment, but you have the opportunity to build equity as you pay your mortgage down. Equity is the difference between the market value of your home and any amount you owe on a mortgage loan. This equity is a financial asset you can use as collateral on loans to meet other needs.

In a whole life policy, premiums paid beyond the cost of the insurance protection are invested by the insurance company and grow tax deferred. This means money can grow faster than in a taxable investment with the same return and expenses.

Cash value life insurance, like owning a home, may require a larger payment but you have the opportunity to build “equity” – cash value – in the policy. You control the asset and can keep it even if your health changes and as you grow older. You can take withdrawals from cash value or borrow against these funds. Loans and withdrawals will reduce both the policy cash value and death benefit.

Click here for more information on how cash value works. Please keep in mind the primary reason to purchase a life insurance product is the death benefit.