Term vs. Cash Value Life Insurance: What’s the Difference?

Updated

Have you ever heard the saying, “It’s tempting to treat everything as a nail if the only tool you have is a hammer”? Some people believe that, to life insurance companies that sell permanent life insurance policies, cash value life insurance is their hammer. Agents that are hired and trained by many, not all, of these life insurance companies are taught to sell cash value life insurance first and to sell term life insurance as their fallback product.

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Some life insurance agents sell cash value life insurance because it pays higher commissions than term life insurance does, but many life insurance agents sell it because they believe it’s the smartest long-term purchase a life insurance buyer can make.

But many agents and financial planners counsel their clients only to buy term life insurance and never to buy cash value life insurance. These agents are also firm in their beliefs, and they’ve helped countless families because of this.

So who’s right? What’s the difference between term life insurance and cash value life insurance? Let’s answer that question as we talk about these policies’ features, costs, and more.

Overview: Term vs. Cash Value Life Insurance 

Term life insurance and cash value life insurance are similar in the respect that both pay a beneficiary a sum of money when the insured party dies, but the similarities pretty much end there. Let’s take a closer look at each product to understand the glaring differences.

Term life insurance has been called “temporary insurance” because you only keep it for a set period, or term, of time. There are several different types of term life insurance:

  • Annual renewable term life
  • Level term life
  • Decreasing term life
  • Convertible term life

Let’s take a quick look at each.

Annual renewable term life insurance (ART)

This type of term life insurance is priced one year at a time and renews automatically as long as you keep paying the monthly premium. The death benefit remains level, and you don’t have to have a medical exam to qualify each year.

ART is the least expensive type of life insurance you’ll find, particularly for younger people. For example, a $100,000 ART policy for a 25-year-old female could cost about $11.00 per month with some insurers. When she turns 26, the premium increases to $11.80 per month; at age 27, it goes up to $12.25 per month, etc. The percentage of each increase rises as each year passes, and the price of ART will eventually become prohibitive for most people.

Level term life insurance

Level term life insurance is one way to lock the premiums in for a set dollar amount for a set period of time. Using our 25-year-old female as an example, a $100,000 level term life insurance policy with a 30-year term could cost her $37 per month, which seems much higher (about three times as high) than the ART policy. But that $37-per-month premium won’t change for the next 30 years. In the long run, she’ll spend less money on the level term than she will with ART.

Decreasing term life insurance 

Decreasing term life insurance has a face value that is reduced every year, making it ideal for someone insuring a loan with a decreasing balance, like a home or automobile loan. For example, in year one, the face amount of a decreasing term life policy could be $100,000, then be lower at $98,000 the following year, $95,000 the next year, and so on. Decreasing term life insurance also has premiums that never increase or decrease, even though the face amount changes each year.

Convertible term life insurance 

Convertible term life insurance is ideal for people who want the option to convert their term policy into a cash value life insurance policy down the road. Many times, young adults with few financial obligations will start with an inexpensive term life insurance policy and convert it to a more expensive cash value policy as their income and debt increase.

All term life insurance policies do not build any cash value; they are purely life insurance policies only, designed to pay a death benefit to a named beneficiary for a set period of time.

Cash Value Life Insurance

The element of cash value life insurance that sets it apart from term life insurance is the policy's savings feature (cash value). With a cash value policy, a portion of every premium pays for the life insurance protection, and the rest goes into the cash value side of the policy. Over time, the cash value will grow and be available to the policyholder.

There are four primary types of cash value life insurance:

  • Whole life
  • Universal life 
  • Variable universal life
  • Indexed universal life

Let’s briefly look at each of these.

Whole life insurance

Whole life insurance is aptly named because it’s designed for someone to keep their “whole life,” as opposed to term insurance, which is only in force for a limited period of time. Whole life insurance accumulates cash value with each premium payment, which is credited with a fixed annual interest rate. If the insurance company is a mutual insurance company and has a profitable year, they will often add a dividend payment to the cash value of their policyholders.

Universal life insurance 

Universal life insurance is known for its flexibility. The monthly premium becomes flexible over time because the accumulated cash value can be used to pay the premiums. If the cash value drops to a certain level, then the insured would need to resume making premium payments until the cash value had once again risen to a level to sustain premium payments.

Universal life insurance’s cash value is credited an interest rate that is based on the current market or a minimum interest rate specified in the policy.

Variable universal life insurance 

Variable universal life insurance is very similar to universal life as far as its flexibility. Where it differs is how the cash value grows. With a variable universal life policy, the cash value gains (or losses) depend upon the performance of mutual funds the policy owner has selected. If the market is up and their funds rise along with it, the cash value will increase. If the market drops, the cash value of the policy can decrease. 

With a universal life or variable life insurance policy, the cash value must remain at a minimum level, or the insurance company will raise the monthly premium. This is done to ensure that the policy won’t lapse because the cash value was insufficient.

Indexed universal life insurance 

Indexed universal life insurance is very similar to variable universal life insurance in that the cash value will fluctuate according to market performance. The difference between the two is that indexed universal life’s increase or decrease depends upon total market performance, like the S&P 500. In contrast, variable universal life’s cash value depends on the performance of select mutual funds, not the entire market.

Term vs. Cash Value Life Insurance: Payouts and Payment Schedule

The life insurance death benefit payouts for term life and cash value life insurance policies are the same. The beneficiary can select either a lump sum payout of the death benefit or a fixed monthly payout for a specified number of months.

The payment schedule for both types of policies varies across the board depending upon which type of term policy you have or which kind of cash value life insurance policy you have. As mentioned above, term life premiums can fluctuate year-to-year or term-to-term. Conversely, premiums won’t vary for a cash value life insurance policy unless the cash value of a universal life policy drops below a set point. Whole life insurance premiums never change.

Term vs. Cash Value Life Insurance: Costs

More term life insurance is purchased than cash value life insurance because of how much lower term life’s premiums are. 

For example, a 30-year-old male might pay $65 per month for a $250,000 30-year level term policy and pay $225 per month for a whole life insurance policy. This is because the cost of insurance for cash value life insurance policies is higher than term life. The premiums are also higher because some of the premium is going into the cash value side of the policy.

Term vs. Cash Value Life Insurance: Who Are They For?

Cost-conscious life insurance buyers will choose term life insurance 90% of the time when given a choice. These buyers are usually younger and would prefer to save money in a 401(k) plan at work than through the cash value portion of a life insurance policy.

Savers often prefer cash value life insurance. They like the fact that the cash value can be taken out of the policy if they need it, via a partial surrender or policy loan, and that some types of cash value life insurance have a minimum guaranteed rate of return. They also see a need to keep life insurance for the rest of their life, to pay for expenses later in life, like when they’re responsible for funeral costs.

It’s Important to Choose

Depending upon what stage your life is at, both term life insurance and cash value life insurance are beneficial to have if you die with outstanding financial obligations, whether it be a mortgage, consumer debt, or student loans. Beneficiaries receiving a death benefit check from a life insurance company rarely ask what type of policy the deceased person owned. 

Buying life insurance has been called an “unselfish act” because you’re paying for something that you’ll never benefit from, but your family will. The optimum way to find the best life insurance is to work with a professional life insurance agent. But make sure they price both types of policies, term and cash value, and explain the differences before you sign on the dotted line.

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