It’s virtually an article of faith that whole life insurance is more expensive than term life insurance. But have you ever wondered exactly why that is? The most conventional answer is that whole life insurance policies include an investment provision. But while that is certainly a contributing factor, it’s hardly the only reason.
In fact life insurance agents who sell whole life insurance policies are generally very reluctant to explain all the reasons why whole life insurance is more expensive than term. And they’ll pull out impressive charts showing why the higher prices you’re paying for whole life insurance will be in your best interest.
But you may be surprised to find out some of the real reasons why whole life is more expensive. And that may cause you to conclude that term really is the better choice to meet your life insurance needs.
The Common Given Reason: The Investment Provision
As noted above – and as you are probably aware – life insurance agents will emphasize this point exclusively in explaining the difference between whole life insurance and term. And it is a legitimate reason for the higher price, at least partially.
When you take a whole life insurance policy, part of the premium goes into your cash value, which also begins to earn investment income. The insurance company will allocate part of your premium into this investment portion in each and every year.
Fair enough.
And while that accounts for a large amount of the price difference between whole life and term, it’s important to understand that the policy is now crossing over into the realm of investments, as much as it is a life insurance policy. This is also where the argument in favor of the investment provision gets weak, for the simple fact that insurance related investments generally under-perform mutual funds.
In this way, the benefit of the investment provisions contained in a whole life insurance policy is vastly overrated – by life insurance agents. You will pay more for a policy that has an investment provision that provides what are generally only lackluster returns.
A Claim is More Likely to Be Paid on a Whole Life Policy
Since a whole life insurance policy represents permanent coverage, there is a far greater likelihood that an insurance company will be required to pay out a claim on a whole life insurance policy than they will on a term policy.
For example, if a 30 year old takes out a 20 year term life insurance policy, it is extremely unlikely that he or she will die within that timeframe, at least statistically speaking. More likely, the insurance company will collect 20 years worth of premiums, and never have to pay out a claim of all.
On a whole life policy however, the coverage lasts for the rest of your life. If that same 30-year-old takes out a whole life policy, it is virtually certain that he will die at some point in the future, and that the insurance company will have to pay a claim.
This reality is reflected in the higher cost of whole life insurance.
Whole Life Insurance Policies Have More Fees
Have you ever wondered why so many life insurance agents prefer to sell you a whole life insurance policy rather than a term policy? The answer that you will almost never hear – and that will drive the entire sales pitch – is that life insurance agents are compensated more generously on whole life policies than on term policies.
The difference can be substantial, and represent a major incentive for the agent to sell you a whole life policy, even if a term policy will work better in your situation. Whole life policies pay more, because the higher premiums provide the room for that to happen.
The insurance company is trying to incentivize its agents in the selling of whole life policies, through higher commissions – paid for out of your higher premiums.
Term Life Insurance Really Is the Most Cost Effective Life Insurance
Now that you know the full story on why whole life insurance is more expensive than term, it’s easier to see how term life insurance is the most cost-effective type of policy you can own.
Yes whole life is permanent life insurance, and it has an investment provision. But you will pay dearly for those advantages, if in fact they even are advantages.
But term life insurance is pure life insurance – that is, it is life insurance coverage minus the bells and whistles that make whole life insurance so expensive. Most people who are looking to buy life insurance have very specific needs, such as covering a young family, or providing sufficient funds to payoff a home mortgage in the event of their death. But once your kids are grown and gone, and the mortgage is paid, the need for the coverage will be gone too.
In that way, a 20 or 25 year term policy may be all the coverage that you need, and can afford. And if you can follow the timeless advice of buy term and invest the difference, you may even reach a time in your life when you have sufficient assets that you will no longer need life insurance at all.
Moral of the story: Don’t buy whole life if term will get the job done for less money.
