Ask Tim a Question? Business, Finances, Money, or Taxes
Question: “Tim, can you explain the difference between term and whole life insurance, and which one is better?” Kristin from Flowood, Mississippi Answer: Kristin, thank you for your question!
Before I begin to explain the difference between those two types of life insurance, let me first talk about the purpose of life insurance.
In my opinion, life insurance has four purposes: 1) To cover the cost of your burial, cremation, and/or funeral services: As of today, the national average for these services range between $5,000 and $10,000.
2) To pay off your debt: You should only focus on your secured debt (home, vehicles, etc.) that you want to leave to your loved ones upon your death. Never focus on your unsecured debt (credit cards, medical bills, personal loans, student loans, etc.). The only exception to this rule is, if the unsecured debt is in you vouand a joint tannlicant’s name, treat it as a secured debt. I say that because, due to the unsecured debt being a joint responsibility, the institution or lender will still pursue collection procedures from the living party upon your death. Other than that reason, unsecured debts typically die with you.
3) To provide financial support for those who rely on your income: If you have a spouse, dependent children, etc. that requires your source of income to cover daily and living expenses, their needs do not change upon your death. In most cases, their financial needs increase following your death.
4) To leave an inheritance to your loved ones: Regardless of how much income you make, how much money you have saved, or the size of your investment portfolio, life insurance is a great tool to use in order to pass down wealth to your loved ones and the next generation for many years to come. Out of all four purposes, this is my absolute favorite one!
Now that I have discussed the four purposes of life insurance, let me discuss the components and differences between term and whole life insurance.
Term life insurance coverage will be in place for a set period of time (5, 10, 15, 20, 25, 30, 35, etc. years) versus whole life insurance coverage is permanent, and will be in place your entire life.
Term and whole life insurance both have fixed, monthly premium amounts, but keep in mind, whole life insurance is significantly higher than term.
Your monthly premium for term life insurance is being allocated for life insurance purposes only. On the other hand, your monthly premium for whole life insurance is being allocated to build cash value and for life insurance purposes, which is the reason the cost of this particular life insurance is much more expensive.
Typically, cash value is paid to the insured by the life insurance company at an interest rate of three to five percent.
The cash value component of whole life insurance is typically a major selling topic to consumers by life insur- ance agents, but there are some key factors of the cash value component that is not explained Or understood by consumers.
These key factors include: 1) In the first one to three years of the life insurance policy, it does not build any cash value.
2) Once cash value is accumulated in the life insurance policy, the insured can not just take out the money that has accumulated. Instead, they must borrow from it, and pay it back. The interest rate at paying the cash value back is typically higher than the interest rate that was being paid to the insured to accumulate the cash value.
3) If the insured dies while there is still a balance on any borrowed cash value, the beneficiaries are responsible for paying the balance from the death benefit they are entitled to receive.
4) If the insured dies and there is cash value accumulated within the policy, with or without a loan balance, the beneficiaries do not get the balance of the cash value and the death benefit. They get the one with the greatest value, not both In mv oninion anv tvne of cash value life insurance (universal life, variable universal life, whole life, etc.) is a horrible product.
As a licensed life insurance agent that can offer and sell all life insurance policies, I only recommend to my clients term life insurance.
The mistake a lot of people make is thinking that they need life insurance for their entire life, and you absolutely do not!
Based on the four purposes I mentioned earlier, your life insurance needs are higher when you are younger with debt and dependent children. As you get older, your debt decreases and your once dependent children are now grown and independent.
Instead of focusing on the cash value component that only pays a three to five percent interest rate to the insured, I recommend you buy term life insurance, while at the same time, invest in the stock market.
On average, investing in the stock market will earn you a rate of return of more than double, and sometimes triple the rate that a cash value life insurance would pay you.
Following my advice of buying term and investing in the stock market simultaneously will put you in a position that by the time your term life insurance policy ends, you will be considered “self-insured.”
Meaning, you have accumulated enough assets and wealth that you will not need life insurance once your term life insurance policy ends.
Upon your death, your beneficiaries can simply pay for your burial, cremation, and/or funeral services from the inheritance you have strategically built and left them.
Again, thank you Kristin for your question! Tim C. Lee is the CEO & Founder of TCL Financial & Tax Services, and the host of “The TCL Show” that airs every Monday from 6:00 p.m. to 7:00 p.m. CST on WMPR 90. I FM in Jackson, MS. This is the show that is about “You, Life, and Money: ») Got an article idea or a question you would like answered, e-mail Tim at timclee(@TCLFinancialTaxServices com
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