Term vs. Whole Life Insurance: What Is the Difference?

Term vs. cash value, in plain terms

The National Association of Insurance Commissioners (NAIC) frames the core choice this way: "Term insurance is intended to provide lower cost coverage for a specific period of time ('a term'). If you want coverage for a longer period of time, such as for your lifetime, cash value insurance may be more cost effective. Most term policies don't build up cash values that you can use in the future." Whole life is the most common type of cash value, or permanent, insurance.

What cash value means

A whole life policy sets aside part of every premium into a cash value account that grows over time and is separate from the death benefit. Per the NAIC guide, in some policies the cash value starts low and builds later; in others it grows more gradually from the start. Most term policies have no cash value at all.

You can typically borrow against the cash value or withdraw from it while you are alive, though doing so reduces the death benefit if it is not repaid. If you cancel, or "surrender," the policy entirely, the insurer pays out the policy's current cash value instead of the death benefit. Some policies reduce that payout with a surrender charge in the early years, so ask your agent what applies to your specific policy.

Term policies have no such account. You are paying purely for the death benefit during the term, which is why term premiums start out lower.

What happens when a term policy ends

Most term coverage can be renewed at the end of the term, even if your health has changed. The catch, per the NAIC guide: "If you renew a term policy, the new premiums are higher." It is worth asking what that renewal premium will be, and whether you lose the right to renew at a certain age, before you buy. A "nonrenewable" term policy cannot be continued at all; you would have to apply for new coverage from scratch, which means new underwriting.

Many term policies also include a conversion option, letting you convert some or all of the coverage to a permanent policy without a new medical exam, though the terms of that option vary by policy and are worth confirming with your agent.

Whole life vs. universal life

Both are cash value insurance, but they differ in how you pay. Per the NAIC: "You typically pay premiums for whole life insurance according to a set schedule. In a universal life insurance policy, you can choose a flexible premium payment pattern as long as you pay enough to keep your policy in force."

A third variation, indexed universal life, ties part of the policy's growth to a market index rather than a fixed rate the insurer sets. It works differently from a standard fixed universal life policy, and its costs, caps, and guarantees vary a great deal by carrier and contract, so it is worth treating as its own conversation with an agent rather than assuming it behaves like ordinary whole life.

Who each one tends to fit

• Term life: often fits a need tied to a specific period, such as income replacement while raising kids or paying off a mortgage.
• Whole life: often fits a need that does not expire, such as covering final expenses whenever death occurs, plus a cash value account.
• Universal life: fits people who want permanent coverage with more flexibility in how much and when they pay premiums.

Your agent can lay out how the length and structure of each option lines up with what you need.