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Know The Difference
Between Term & Whole Life Insurance
The
basic difference between term and whole life insurance
is this: A term policy is life coverage only.
On the death of the insured it pays the face amount of
the policy to the named beneficiary. You can buy term
for periods of one year to 30 years. Whole
life insurance, on the other hand, combines a term
policy with an investment component. The
investment could be in bonds and money-market
instruments or stocks. The policy builds cash value
that you can borrow against. The three most common
types of whole life insurance are traditional whole
life policies, universal and variable. With both whole
life and term, you can lock in the same monthly
payment over the life of the policy.
Forced Savings
Whole life insurance is expensive: You're paying not
only for insurance but also for the investment
portion. That extra cost might almost be worth it if
these policies were a good investment vehicle. But
usually they aren't. Insurance agents like to call
these policies retirement plans, emphasizing the
"forced savings" inherent in forking over
the premiums each month "for retirement."
Leaving aside the fact that there are many better ways
to save for retirement, these policies come with high
fees and commissions, which sometimes lop off as much
as three percentage points from the annual return. On
top of that, there are up-front (but hidden)
commissions that are typically 100% of your first
year's premium. Worse, it's often impossible to tell
what the return on the investment will be, and how
much of what you pay in goes toward the insurance and
how much toward the investment.
Premiums for term insurance are downright cheap for
people in good health up to about age 50. After that
age, premiums start to get progressively more
expensive. The same holds true for whole life
policies, though people who need coverage starting in
their 60s and beyond may have no alternative but to
buy whole life. Most companies simply won't sell term
policies to people over about age 65.
Term: Where the Value Is
To get a real sense of the value of term, let's
compare a term policy and a universal life policy. Say
a 40-year-old nonsmoking male has a choice between a
$250,000 Met Life universal policy with a $3,000
annual premium and a same amount of renewable term
coverage with a 20-year fixed premium of $350. At the
end of one year, the universal policy, assuming it
paid 5.7% per year, tax-deferred, would have a cash
value of exactly zero (cash value is the amount you
would get back if you canceled the policy). But say he
had instead invested $2,650 (the difference between
$3,000 and $350) in a no-load mutual fund that
averaged a total return of 10% annually. At the end of
the first year, he'd have $2,841, accounting for taxes
on the earnings at a 28% rate. At the end of 10 years,
he would have accumulated more than $46,000 in
after-tax savings in the mutual fund. Over the same
period, the cash value of the policy would have
climbed only to $31,819.
That's not to say that whole life insurance is always
a bad idea. Wealthy people can use whole life in their
estate planning by setting up an
insurance trust that will pay their estate taxes from
the proceeds of the policy. And for the growing number
of people in their late 40s or early 50s who are just
starting families, whole life is at least worth a
look.
Knowing the difference between term and whole
life insurance, you can make a better choice catering
to your needs.
By smartmoney.com
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