Whole or Term Life Insurance: Which Is Better?

The right choice between whole and term life insurance depends in large part on the circumstances of the person making the decision. Term life policies are ideal for people who want a lot of coverage but do not want to pay a lot for premiums each month. Whole life customers pay more in premiums for less coverage, but they have the security of knowing they are covered for life at a set premium, assuming they keep up with their monthly payments. Some customers prefer whole life insurance because these policies accumulate cash value and can be used as investment vehicles. As many financial advisers point out, however, the growth rate of a cash value life insurance policy is often paltry compared to other financial instruments, such as mutual funds and exchange-traded funds (ETFs).
Term Life Insurance

Term life insurance, as its name indicates, provides a policyholder with coverage for a fixed term, or period of time. Common terms for these policies are 10 and 20 years. Because the majority of term life policies never pay a death benefit, insurance companies can offer them much more cheaply than whole life policies, every one of which eventually pays, and still make money.

The younger a person is when he takes out a term life policy, the cheaper his premiums. The reason is an obvious one. A person is statistically less likely to die between the ages of 25 and 35 than between the ages of 50 and 60.

A popular time to take out a term life insurance policy, particularly one with a 20-year term, is upon having children. The cost of child-rearing is steep for food, toys, clothing, and doctor and dentist appointments, not to mention saving for college, an expense that, when charted over time, bears the trajectory of a space shuttle launch.

When a child loses a parent, especially one who is the household’s sole or primary breadwinner, the financial consequences can be grave. For this reason, parents often choose life insurance policies with hefty death benefits, sometimes in excess of $1 million, during the years their children are financial dependents.

Purchasing a whole life policy with a $1 million death benefit costs thousands per month. The average person who can afford that amount probably is not in dire need of life insurance. Moreover, most people find a death benefit that high unnecessary when their children are grown and able to support themselves. At that point, the purpose of life insurance generally shifts to simply covering burial and funeral expenses.

Term life insurance makes the most sense for someone who needs a large death benefit but only temporarily. A term life policyholder pays a small fraction of what a whole life policyholder pays for the same benefit amount. He can take the excess each month and invest it in stocks or bonds, a technique typically much more effective at creating long-term wealth than buying cash value life insurance.
Whole Life Insurance

Whole life insurance gives policyholders the security of knowing they are covered for the rest of their lives and their premiums, as long as they pay them on time each month, are never going to rise. The trade-off, however, is the death benefit these policyholders receive for their premium dollars is far less than what their peers with term life insurance receive.

While many people strongly favor term life insurance and its lower premiums and higher death benefits, others cannot stomach the idea of paying a life insurance premium every month for 10 or 20 years and then, assuming they are still alive, which is the most likely scenario, having nothing to show for it at the end of the term. Financial planners stress that the small premium for term life insurance purchases security and peace of mind, while leaving plenty of money left over, funds they would need for insurance premiums if they had a whole life policy with the same death benefit, to invest in other instruments, such as mutual funds or ETFs, and accrue wealth.

However, many people are incapable of looking at it that way. They want to know their money is going toward something permanent. For these people, whole life insurance is the better buy, despite their financial advisers likely trying to talk them out of it.

Another type of whole life insurance is final expense. Marketed to people age 65 and up, final expense policies offer a modest death benefit but one that is usually sufficient to pay funeral and burial costs. The typical final expense customer is not wealthy; many live on fixed incomes, such as Social Security. They purchase final expense insurance to keep their next of kin from having to pay out of pocket for their funeral and burial costs.
Whole Life Insurance as an Investment

One advantage of whole life insurance, at least in the eyes of some, is it can be used as an investment vehicle in addition to providing the security of life insurance. Most whole life policies build cash value; as the policyholder pays his premiums month after month, the value of the policy grows, similar to an investment portfolio. If the policyholder reaches a point in life at which he no longer needs life insurance protection, he can redeem his policy and claim its cash value. However, financial advisors often recommend against purchasing whole life insurance as an investment vehicle. Instead, for their clients seeking life insurance protection and wealth creation, they recommend buying term life insurance and using the monthly savings to invest in mutual funds.
Convertible Term Life

Convertible term life insurance offers the best of both worlds. This is a term life policy at the end of which the policyholder has the option to convert it to a whole life policy and receive guaranteed approval. If he elects this option, his premiums increase significantly, since whole life insurance is much more expensive than term life insurance. The advantage is he does not have to undergo a medical exam like new customers. Any long-term medical conditions he develops during the term life period cannot be used to adjust his premiums upward.


Understanding Taxes on Life Insurance Premiums

Tax implications are important to consider when buying life insurance. The Internal Revenue Service (IRS) imposes different tax rules on different plans, and sometimes the distinctions are arbitrary. The following guide is meant to elucidate some of the tax implications surrounding life insurance premiums.

A person shopping for life insurance has many things to consider before making a decision. First, there is the distinction between term life insurance and whole life insurance. Term life provides coverage for a set number of years, while a whole life policy is effective for life. A policyholder also must calculate how much coverage he needs. This depends largely on why he is buying life insurance.

A person who is only concerned with covering burial and funeral costs for his next of kin may opt for a death benefit of $20,000 or less. By contrast, someone with several dependent children, all of whom he hopes to send to college, often desires $500,000 or more in coverage. Further complicating the buying process is the sheer number of life insurance companies from which to choose. The Internet has made this process somewhat easier, with several sites dedicated exclusively to comparing quotes from dozens of life insurance companies side by side.

Paying Taxes on Life Insurance Premiums

Unlike buying a car or a television set, buying life insurance does not require the payment of sales tax. This means the premium amount a policyholder is quoted when he obtains coverage is the amount he pays, with no percentage amount added to cover taxes. With that said, certain situations exist in which a policyholder is required to pay taxes on insurance premiums.

Employer-Paid Life Insurance

When a person’s employer provides life insurance as part of an overall compensation plan, the IRS considers it income, which means the employee is subject to taxes. However, these taxes only apply when the employer pays for more than $50,000 in life insurance coverage. Even in those cases, the premium cost for the first $50,000 in coverage is exempt from taxation.

For example, a person whose employer provides him, for the duration of employment, with $50,000 in life insurance coverage in addition to his salary, health benefits and retirement savings plan, does not have to pay taxes on his life insurance benefit because it does not exceed the threshold set by the IRS.

A person whose employer provides him with $100,000 in life insurance coverage, by contrast, has to pay taxes on part of it. The premium dollars that pay for the $50,000 in coverage he receives in excess of the IRS threshold count as taxable income. Therefore, if the monthly premium amount is $100, the amount that is taxable is the amount that pays for the additional $50,000 in coverage, or $50.

Prepaid Life Insurance

Some life insurance plans allow the policyholder to pay a lump sum premium up front. That money gets applied to the plan’s premiums throughout the plan’s duration. The lump sum payment also grows in value because of interest. The growth of that money is considered interest income by the IRS, which means it can be subject to taxation when it is applied for a premium payment or when the policyholder withdraws some or all of the money he has earned.

Cash Value Plans

Many whole life insurance plans, in addition to providing the insured with fixed death benefits, also accumulate cash value as policyholders pay into the plans with their premium dollars. A portion of the premium dollars enter a fund that accumulates interest. It is common, particularly with plans that have been in force for many years, for the cash value to exceed the amount the policyholder has paid in premiums. Therefore, people use this type of life insurance as an investment vehicle along with taking advantage of the protection it provides their families in the event of an untimely death.

While many financial advisers remain steadfast against using life insurance for investment purposes, claiming the returns, historically, have been extremely weak compared to mutual funds and other investments, the fact remains the cash value of most whole life insurance policies grows over time. Because this is considered income to the policy holder, it has income tax implications.

The good news for a whole life policyholder is he does not have to pay income taxes each year on the growth in his plan’s cash value. Similar to retirement accounts, such as 401(k) plans and IRAs, the accumulation of cash value on a whole life insurance policy is tax-deferred. Even though this money qualifies as income, the IRS does not require the policyholder to pay taxes on it until he cashes out the policy.

If and when a policyholder elects to take the cash value of his whole life insurance policy, the amount he is required to pay taxes on is the difference between the cash value he receives and the total he paid in premiums during the time the policy was in force. For example, if he pays $100 per month for 20 years, or $24,000, and then cashes out the policy and receives $30,000, the amount subject to taxes is $6,000.

Another feature of whole life insurance is that, in many cases, the policyholder is allowed to take out a loan against the cash value of his policy. There is a misconception that the proceeds from this kind of loan are taxable. That is not the case, even when the loan amount exceeds the total premiums paid into the policy. Taking out a loan simply reduces the cash value of the policy and, if applicable, reduces the death benefit paid.

5 Ways to Lower Life Insurance Premiums

Life insurance companies use a variety of factors to arrive at a policyholder’s premium cost. The customer’s age, geographic location, existing health conditions, desired benefit amount and lifestyle are common criteria that companies plug into the algorithms they use to determine premiums. The most subjective of this criteria is lifestyle. Life insurance companies look at several aspects of a policyholder’s mode of living and may consider any number of them as evidence the client presents a higher risk factor. A client who represents a high risk factor, meaning the insurance company’s actuaries determine there is an elevated probability he will die sooner rather than later, invariably pays higher premiums than a client deemed lower risk.

Lifestyle factors that often affect life insurance premiums include smoking, obesity, occupation and even hobbies. Enthusiasts of such activities as sky diving, bungee jumping, scuba diving and extreme sports, the kinds of things you see at the X-Games, can expect higher life insurance premiums, all other variables being equal, than someone who fishes and plays golf in his spare time.

Obtaining lower life insurance premiums is a simple and effective way to free up money in a monthly budget. Because everyone likes the idea of paying less for the same thing, the following five tips can lead to lower life insurance premiums.
Stop Smoking

Avoiding tobacco products is the simplest way to pay less for life insurance. Note the word used was simplest, not easiest. The difficulty of quitting smoking, once addicted, is extensively documented. Most would-be quitters try and fail several times before successfully giving up tobacco for good.

In addition to better health, smokers thinking of quitting have an incentive to do it now rather than later. Life insurance is more expensive for tobacco users and often by a huge margin. A sample quote for a $500,000, 20-year term life insurance policy for a 30-year-old male has a monthly premium of $20.88 per month for a nonsmoker and $77 per month for a smoker. For a 50-year-old, the dollar amount difference is even starker: $81.35 for a nonsmoker and $337.75 for a smoker.

A person who obtains life insurance as a smoker and subsequently quits does not have to apply for a new policy to receive lower premiums. Almost all life insurance companies lower a former smoker’s premiums once he has been tobacco-free for a set amount of time.
Lose Weight

Apart from smoking, maintaining an unhealthy body weight is one of the biggest reasons people pay more than they should for life insurance. Obesity is linked to a variety of diseases that can lead to an early death, and therefore constitute risk factors to an insurance company. These diseases include diabetes, heart disease, stroke and cardiovascular ailments.

Insurance companies generally use body mass index, or BMI, to determine whether an applicant’s body weight falls within a healthy range. The BMI formula considers only two factors: height and weight. It ignores bone structure, body composition, or ratio of muscle to fat, and other variables that might increase a person’s weight without contributing to ill health. The calculation does not even distinguish between males and females. In short, it is a flawed measure of health. Nevertheless, a life insurance policyholder needs to be mindful of his BMI if he wants to pay the lowest premium amount.

For a male of average height, which is roughly 5 foot 10 inches in the United States as of 2015, the healthy weight range, as determined by the BMI calculation, is 132 pounds to 173 pounds. Drawing a quick mental picture of this male adult who weighs 132 pounds, and then realizing the BMI metric considers this healthy, provides a good indication of why it is flawed. Once again, however, insurance companies use BMI despite its shortcomings, which means anyone wanting to save on premiums should be aware of it.
Be Safe Behind the Wheel

It is common knowledge that moving violations and at-fault traffic accidents lead to higher auto insurance rates. Many people fail to realize, however, that a poor driving record can raise a person’s life insurance rates as well.

Not unlike smoking and carrying excess weight, racking up speeding tickets and demonstrating a propensity to get in fender-benders represent risk factors to an insurance company. A policyholder who is careless behind the wheel is statistically more likely to suffer a serious car accident than someone who drives defensively and carefully. Because a percentage of car accidents are fatal, life insurance companies take this into consideration when setting premiums.

Obeying posted speed limits and all traffic laws, looking out for other drivers and keeping a clean moving vehicle record, or MVR, can save big money on life insurance premiums.
Lock It In Early

As of 2015, life expectancy in the United States is about 79 years. The closer a person is to this age when he purchases life insurance, the higher his premiums. It is simple math: when an older person buys a policy, the life insurance company expects to have fewer years to collect premiums before it has to pay a death benefit. Term life insurance policies, which only provide coverage for a fixed number of years, are also less expensive when purchased at a young age. This is because a person is statistically less likely to die in his 30s than in his 50s.

Young people often act as if they are going to live forever, and they are loath to consider their own mortality. For these reasons, many of them neglect to secure life insurance at an early age while premiums are still cheap. This is a mistake. The younger a person is when he buys life insurance, the less he pays in premiums for the duration of the policy.
Purchase Term Life Insurance

Life insurance comes in two types: term life insurance and whole life insurance. Their names describe them very accurately. Term life insurance covers a person for a fixed term, usually 10 or 20 years, though some companies offer term policies in one-year increments from three to 30 years. Whole life insurance, by contrast, provides coverage from the day a person takes out the policy until the day he dies.

Because most term life insurance policies never pay a death benefit, as the policyholder is usually still alive when the term comes to an end, the insurance company can charge much less in premiums and remain profitable. A young person who maintains a healthy weight and does not smoke or skydive can often obtain $500,000 or more in term life coverage for a monthly premium of under $50.


How to Shop for Life Insurance

You’d do anything to protect your family. Yet many heads-of-household neglect the most commonplace thing they can do: Get life insurance. Of course, buying a policy may seem pretty daunting (adequately provide for your spouse and kids if you’re gone? No pressure there), but the experience becomes much easier when you know some of the basic questions to ask. The following are some of the most important things to know before signing on with an insurer.
Term or Permanent Coverage?

Life insurance comes in two basic categories: term policies and permanent policies.

Term policies are the easiest to understand. You pay a premium at regular intervals and, in return, get a guarantee that, if you die within a certain period or term – say, 10 or 20 years – your beneficiaries will receive a predetermined death benefit. Conversely, permanent policies offer protection for an indefinite period – as long as the owner continues to pay premiums, basically.

But that’s not the only distinction. Unlike the more straightforward term coverage, permanent policies also include a savings component.The insurer essentially takes part of your premium payment and diverts it to a separate cash account. Once the value in your account builds, you can make withdrawals or even borrow against your policy. As you might have guessed, you pay higher premiums to receive this benefit.

The permanent life category itself consists of two major types: whole life and universal life (read more about the distinction in Permanent Life Policies: Whole Vs. Universal). And within those subcategories are several variations. For example, variable universal life policies allow you to put the investable portion of your premiums into professionally managed investments, rather than relying on the fairly conservative dividends and accruals afforded by a whole life policy.
What Do You Need?

But let’s return to the first, fundamental question: whether to go with term or permanent coverage. Basically, the decision boils down to whether it’s better for you to build a nest egg within a life insurance plan (as a permanent policy offers) or to just pay for the bare-bones life coverage offered by a term policy, and make other savings plans.

A lot of advisors plump for the latter, quoting an old personal finance adage: “Buy term and invest the rest.” Here’s why. Permanent life insurance has significantly higher fees – and more restrictions – than your basic term coverage. The sales commission on a whole life policy can easily exceed half of your premiums for year one. So after paying into your policy for a year, you may find that its accrued cash value is still tiny. (See How Cash Value Builds In A Life Insurance Policy.)

What’s more, annual renewal fees can cost you around 7% over the next decade, further cutting into the savings portion of your policy. That makes no-load stock or bond funds look much more affordable by comparison, and their rates of return better too.

And what if you let the policy lapse within the first few years, as a sizable segment of consumers do? It’s doubtful the cash surrender value will ever match the added premiums you’ve paid in.

Still, permanent life has its points. One of them is the fact that funds within your cash account grow tax-deferred. That’s always a plus, especially if you’ve already maxed out your 401(k) plan and IRA contributions. Lump-sum death benefit payouts are not subject to income tax or, in certain cases, to estate tax, either. In fact, well-heeled families sometimes use these policies as part of a complex estate-planning strategy to reduce the impact of taxes. See Cut Your Tax Bill With Permanent Life Insurance.

Another reason for sticking with a permanent life insurance policy: You’ll never be left with a sudden lack of coverage, as you might be when a term policy expires at a time when you’re in poor health.


Figure 1. Despite their higher cost, permanent policies are considerably more popular than term policies, according to a study by LIMRA, an insurance and financial services trade association. Source: LIMRA
How Much Do You Need?

Beyond the type of policy, you also have to figure out how much protection to buy. That can be a tricky task.

Some financial gurus suggest the face value of your policy be 10 times your annual salary, as a starting point. But keep in mind that there are a number of factors that could affect how much insurance your family needs. How much do you owe on your home? Do your kids go to private school? Does your spouse earn a substantial salary or have significant earnings potential if something happens to you? All of these could affect how much of a cushion you’d want to leave for your loved ones.

It may help to take an inventory of the main family expenses going forward. The resulting number should help tell you whether you need a $250,000 death benefit or a $750,000 one.

The family breadwinner isn’t necessarily the only one who needs coverage. If you’re a stay-at-home parent, your spouse may need help paying for things like childcare or housekeeping in the event of your untimely passing. Whoever is insured, you may also want to factor in the cost of a funeral or cremation services, which usually cost several thousand dollars at minimum.
‘Captive’ Agent or Independent Broker?

When it’s time to take out insurance, your first instinct might be to contact a salesperson for one of the major carriers. There are certain advantages to working with these “captive” agents, to be sure. For example, you might be able to keep multiple policies under one roof, and get a deal, if you get life insurance through the same company as your homeowners or auto insurance coverage.

But you might also think about talking to an independent agent, also known as a “broker,” who works with several different life insurance companies. By shopping your policy out to multiple providers at once, a broker can often help you find better pricing.

Going with a broker is particularly helpful if you have medical conditions such as high cholesterol or diabetes. Before offering you a policy, most carriers will have you go through medical underwriting. At the very least, that involves filling out a detailed health history form; in many cases, you’ll also have to undergo a health screening or full physical exam. While some insurers may charge you higher rates or deny your application if they consider you high-risk, an independent agent might be able to find a carrier willing to extend their standard rates.

And don’t think you have to pay more to use a broker, either. Like captive agents, they are compensated through sales commissions and policy renewal fees paid by the insurance company. (Bear that in mind, though, if a broker seems to be pushing a particular policy hard: Perhaps that company pays more generous commissions.)

Yet another route is to buy life insurance through your employer. However, you may be able to find better terms elsewhere. Plus, you can’t take your group life coverage with you, should you end up leaving your job.


7 Mistakes to Avoid When Buying Health Insurance

Health insurance is one of the most important purchase decisions a person can make. It protects you and your loved ones against life’s unexpected turns. With the right health insurance, it’s possible to save money and save lives.

The topic of proper health insurance has been pushed to the forefront as the United States begins to adopt the universal health care principles pioneered by other countries such as Canada. Whether the insurance is through the Affordable Care Act, through an employer or through a self-employment service, you need to make decisions as to the amount of coverage and the cost of that coverage.

With a decision as important as health insurance, there are several potential mistakes to be aware of so you can avoid them.
1. Don’t focus solely on the premium and deductible

When people look to purchase health insurance, it’s very common to look at the premium and deductible only. This approach makes sense on the surface; it’s important to know what the monthly premium costs are so you can budget and account for them, and it’s also important to know the deductible to get a sense of overall coverage.

However, there are other costs and situations to consider, too. For example, some health insurance policies may have a deductible of $2,000, but they only cover 80% of surgical procedures. If you have an accident that results in a $13,000 surgery, the out-of-pocket payment will exceed the $2,000 deductible.

Look at all the associated coverages and costs, and not just overall deductible.
2. Make sure to read the fine print

As with any multi-page contract, one of the biggest mistakes people make is not thoroughly reading the fine print.

For example, some health insurance may have great in-network coverage, but very poor out-of-network coverage. If a situation arises where you must see or use an out-of-network provider, the great coverage might result in a large out-of-pocket payment.

Additionally, some health insurance covers specific procedures while others do not. If a specific health insurance looks great on the surface but doesn’t cover unique or uncommon surgeries, it’s possible that it will result in paying large out-of-pocket fees.
3. Always shop around to multiple providers

When people decide to buy a house or a car, they shop around for months, finding the best price and the best asset for them. When people decide to purchase health insurance, however, they often take the first provider that suits their general needs.

Often, health care providers have different cost structures and coverages from each other. It’s possible to save time and money by choosing the proper health insurance carefully. Many of these providers compete with each other on price and coverage, improving your ability to find great coverage at affordable prices.
4. Don’t forget about COBRA

COBRA insurance is a U.S. federal government service that provides a continuation of coverage for up to 18 months to employees who have recently separated from their companies.

If you’ve been fired or resigned from your job, COBRA allows you to keep the coverage you’re used to while you look for other employment or health coverage. However, the company often pays most, if not all, of the health insurance’s premium. If you elect to take out COBRA insurance, you have to pay the entire premium amount, which might result in a large out-of-pocket fee.

Look at both state and federal health insurance exchanges created under the Affordable Care Act if you have recently left your job.
5. Coverage is great, but don’t get too much insurance

While it’s important to have peace of mind and ensure everyone who needs health insurance has it, it’s also important not to over-insure. High-end health insurance may cover you against any situation imaginable, but the monthly premiums will be very high.

If you are healthy and rarely go to see a doctor, it may be a better option to purchase a health care plan that has a lower premium. In fact, if one person pays a premium of $300 and never sees the doctor once, and another person pays a premium of $100 but sees the doctor one time for a fee of $500, the second person still pays less overall.
6. No one is too healthy for health coverage

While it may be important to your wallet not to pay for the best coverage if you have a strong track record of good health, it is still important to be covered.

Many people take the opposite stance of over-coverage; they believe that since they rarely see a doctor, they don’t need coverage at all. This is a big mistake. The thing about insurance is that it insures against unexpected life events. If everyone expected to be perfectly healthy all the time, no one would get any coverage; if everyone expected to be constantly sick, everyone would have the best coverage available.

Illness and injury are completely random and cannot be predicted with accuracy. It’s possible to know if you’re likely to be sick or not, but you can’t be absolutely sure. Purchase health coverage, even if it is the most basic plan. It protects you against life’s unexpected events.
7. Don’t miss the health insurance marketplace’s open enrollment periods

Take advantage of open enrollment periods to sign up for health insurance. Often, people wait until the last second to purchase health insurance or wait until they desperately need it.

However, most health care providers offer open enrollment periods when you can reassess your need for health insurance and adjust or purchase coverage as necessary. If you are an employee, your employer’s provider should offer an open enrollment period once a year. If you are self-employed or have recently left your job, the Affordable Care Act also offers an open enrollment period.

Regardless of your own situation, if you miss an open enrollment period, you may have to remain uninsured until the next enrollment period opens, or you may be required to pay an increased amount for taking out insurance during a closed enrollment period.


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