Ask Linda: Which type of life insurance should we buy?
/Dear Linda,
My husband and I need life insurance. Should we purchase a Term Life or Whole Life policy to protect our young children? What is the difference?
The purpose of life insurance is to protect those who are dependent on your income in the event of your death. A dependent can be a spouse or a young child, but it can also be a sibling or a parent whom you help financially. While there are exceptions, we typically recommend Term Life over Whole Life for the following reasons.
Term Life is simple, customizable, and affordable.
You can choose a finite time, such as 10, 20, or 30 years. Most people obtain a policy that covers them until their planned retirement age. You can also layer multiple policies so the amount of coverage declines as your need declines.
Alternatively, Whole Life covers you until you stop paying premiums or reach a certain age, such as 100. When you die, your beneficiaries will receive your investment accounts and real estate equity. If you don’t have anyone dependent on you financially, that is likely sufficient.
Whole Life’s higher premiums may become unaffordable when you most need the insurance, forcing you to drop or greatly reduce coverage.
Both Whole and Term Life premiums are fixed, but Whole Life premiums can be up to 10X more expensive. Given this price difference, many people simply can't afford the amount of coverage they need if they purchase a Whole Life policy.
Here’s the other thing - even if you can afford the higher premium today, life changes. Think about how different your cash flow was 3 years ago. If money gets tight for whatever reason - a job change, a new baby, or a new car payment - you can temporarily stop contributing to your Roth IRA, 529, or 401k, but you can't stop paying insurance premiums without the risk of losing coverage.
The Whole Life investment component, or cash value, is overrated.
Both Whole and Term Life have an insurance component (death benefit), but only Whole Life has an investment component (cash value). The cash value is often sold as a benefit, but the returns are often barely keeping up with inflation. When you die, the cash value typically goes to the insurance company, not your beneficiaries. If you borrow from the cash value, the loan amount plus interest is deducted from your death benefit.
When Whole Life Makes Sense
There are situations where a Whole Life policy may make sense, such as if you have an estate tax issue or a special needs child, but the situations are limited. In our practice, Term Life is the best solution for most people because it allows you to obtain the sufficient amount of life insurance when you need it, at a much lower cost.
originally published 7/23/2018
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.