Thursday, March 1, 2012

Term vs Whole Life Insurance - Basics

Term: You pay a fixed schedule of premiums for a one-time death benefit. The future value, with interest compounded at the insurance company's rate of return, is equal to the death benefit (at your actuarial life expectancy). Minus profit to the insurance company and commissions to the selling broker. Whole Life: You pay much larger premiums which go into an account earning the insurance company's rate of return, profit and commissions being subtracted from that. Out of the account, premiums are paid for a term life policy to provide the actuarial death benefit; the rest accumulates for a cash value. So theoretically, whole = term + investment account. Universal is a variation on the whole life theme where the rate of return in the account is up to you and not the insurance company. Considerations: 1. Can you earn an after-tax rate of return on investment that is higher than of the insurance company? Most people think yes, but the trick is to compare apples to apples risk-wise. The insurance company's return is likely to be a stable bond-like return since that is what they do with your money. 2. Do you like the credit rating of the insurance company, because that is the risk of your investment fund? If the company is AA-rated and pays 4% interest, that is pretty good. 3. The whole / universal life policies are more complicated allowing the insurer to hide mulitple layers of fees (admin, investment management, insurance, etc.), and the borker commissions come out in the first few years. If you understand compounding, having money come out at the beginning reduces fures values a lot. 4. The good side of whole life is the forced savings mechanism. If you buy term, are going to commit to save extra and to invest it? 5. If you plan to die tomorrow, buy term, pay little and have your loving wife cash out early. If you plan to die much later, the whole policy may give you the option of cashing out vs your estranged ex-wife cash out on your policy..
Did I miss anything? Comments please.


  1. I worked for a company for years that taught (and still teaches) about an infinite banking concept where you become your own bank by using the forced savings of whole life and using it overtime when you need to borrow so you pay yourself back. I've done this with my children using the whole life policy as the safe return, easy access fund for future costs such as college. I'm wondering how you feel about these strategies. The insurer is a trust company with an A or A- rating.

    1. Whole life insurance is perfect for those who can afford a higher premium and want to avail of guaranteed death benefits and cash values. If you're young, have a limited budget and only looking for temporary protection then term life insurance is probably best for you.

      Laura from