Term vs. Whole Life Insurance: How to Choose the Right Coverage for Your Family

If your kids count on your paycheck, life insurance is one of the simplest ways to protect them, and knowing the two main types can save you money and confusion.

A life insurance policy is a contract with an insurance company. You pay a regular bill, called a premium. If you die while the policy is active, the insurer pays money, called the death benefit, to the people you named. Those people are your beneficiaries.

There are two big families of life insurance: term and permanent (also called cash value). Whole life is the most familiar kind of permanent insurance. This guide explains how each works, walks through a real-numbers example of how much coverage a family might need, and gives you a checklist to use before you sign.

Term or whole life: the short answer

For most parents whose main goal is replacing income while kids are young, term life insurance gives the most protection for each premium dollar. Whole life costs several times more at the start but lasts for life and builds cash value. It can fit people who need permanent coverage and can comfortably keep paying for decades.

That trade-off comes straight from the NAIC Life Insurance Buyer's Guide, which states that term insurance "generally offers the largest insurance protection for your premium dollar" but generally does not build cash value, while early whole life premiums are several times higher than initial term premiums.

How term life insurance works

Term life insurance covers you for a set stretch of time, called the term. If you die during the term, your beneficiaries receive the death benefit. If the term ends and you are still alive, coverage stops and nothing is paid out. Terms such as 10 or 20 years are common, so many parents pick one that runs until their youngest child is grown or the mortgage is paid off.

• Lower starting cost. Term premiums are generally lower in the early years than permanent insurance for the same death benefit.
• No savings piece. Term insurance generally does not build cash value.
• Renewal usually costs more. According to the NAIC guide, most term policies can be renewed for one or more terms even if your health has changed, but premiums usually rise with each renewal. Ask whether you lose the right to renew at a certain age.
• Conversion options. Many term policies can be traded for a cash value policy during a conversion period, even if your health is poor. The new premiums will be higher.

Think of term insurance as renting protection for the years you need it most. For many parents, those are the years when kids are young, the mortgage is big and savings are still growing.

How whole life insurance works

Whole life insurance is designed to cover you for as long as you live, as long as you keep paying the premiums. It is one type of permanent, or cash value, insurance.

• Lifelong coverage. The policy does not expire after a set number of years.
• Level premiums. Premiums are generally level for life. Some policies let you finish paying sooner, such as by age 65, but each payment is higher.
• Cash value. The part of your premium not used for insurance costs builds cash value inside the policy. You can borrow against it, use it to buy reduced coverage, or draw on it later.
• Higher cost. Because it lasts for life and builds cash value, whole life costs much more than term for the same death benefit, especially in the early years.

Be careful with policy loans. The NAIC guide explains that if you don't pay back the loan and its interest, the amount you owe is subtracted from the death benefit, or from the cash value if you surrender the policy. Your family could receive less than you planned.

Quitting early can also be expensive. The Maryland Insurance Administration warns that dropping a permanent policy "may be very costly if you quit during the early years of the policy." Some permanent policies charge a surrender charge if you cash out, let the policy lapse or reduce its face amount, as Investor.gov explains for variable life.

Other kinds of permanent insurance

Whole life isn't the only permanent option. You may also hear about these:

• Universal life. Premiums are flexible and the face amount can be adjusted, though an increase may require proof of insurability. Premiums, minus expense charges, go into an account that earns interest. If that account value falls too low, coverage can end unless you pay more or reduce the death benefit.
• Variable life. The death benefit and cash value depend on the investment results of separate accounts you choose. Benefits can fall if investments do poorly. The NAIC guide says to get the company's prospectus before buying.

These policies have more moving parts than term or whole life, so they need closer attention over the years.

Term vs. whole life side by side

• How long it lasts. Term: a set number of years. Whole life: your whole life, if premiums are paid.
• Starting cost. Term: lower. Whole life: several times higher at first, per the NAIC guide.
• Builds cash value. Term: generally no. Whole life: yes.
• Premiums over time. Term: level during the term, then usually higher at renewal. Whole life: generally level.
• Flexibility. Term: easy to stop when you no longer need it. Whole life: dropping it in the early years can be costly.
• Complexity. Term: simple. Whole life: more features to understand, such as loans, dividends (on some policies) and surrender values.

A worked example: how much coverage does a family need?

Coverage amounts are where many families guess. The Maryland Insurance Administration's life insurance guide notes that some insurance experts suggest buying five to eight times your current income, then encourages you to refine that by asking how your survivors would get by and how final expenses would be paid. Here is how one hypothetical family might run the numbers.

Meet a hypothetical parent who earns $60,000 a year, has two kids ages 3 and 6, owes $220,000 on a mortgage and has $20,000 in savings. The rule of thumb points to $300,000 to $480,000. A needs-based tally looks like this:

1. Pay off the mortgage: $220,000
2. Replace part of the income for the family's day-to-day costs. Say the household would need $25,000 a year for 15 years until the youngest finishes high school: $375,000
3. Help with future college costs: $50,000
4. Final expenses and other debts: $15,000
5. Subtract existing savings: −$20,000
6. Subtract any work life insurance you'd keep, for example one year of salary: −$60,000

That adds up to about $580,000, more than the rule of thumb suggested, mainly because of the mortgage. In practice, this parent might shop for a $500,000 to $600,000 policy with a 20-year term, which would cover the years until the younger child turns 23. Your numbers will differ, and that's the point: list your own debts, years of support and savings rather than relying on a single multiple.

For a deeper look at choosing amounts for a household with children, see our guide to life insurance for parents.

When each type tends to make sense

Neither type is best for everyone. These patterns can help you think about where you fit:

• Term often fits parents with young kids, a mortgage or other big debts who want the most protection for the lowest price during a specific window of years.
• Term also fits people on a tight budget. A policy you can keep paying is worth more than a bigger one you drop after two years.
• Whole life may fit people who need coverage that never ends, for example to support a lifelong dependent, such as an adult child with special needs, or to leave a set amount to heirs.
• Whole life may also appeal to people who have already maxed out other savings options, value guaranteed features and can comfortably afford the higher premiums for decades.

Some families buy term and put the money they would have spent on higher whole life premiums toward retirement savings or an emergency fund. Others value the forced savings and lifelong coverage of whole life. What matters is that the policy fits your budget and your goals.

Questions to ask before you buy

1. Who depends on my income? Think about kids, a spouse or partner, or aging parents.
2. How long do they need support? If your youngest is a toddler, you may want coverage that lasts until they finish school.
3. What would the money need to cover? List the mortgage or rent, childcare, everyday bills, debts and goals like college.
4. What can I afford every month for many years? Be realistic about the premium.
5. Can this term policy be renewed or converted, and until what age?
6. For a permanent policy: which values are guaranteed and which are only projected? What would I get back if I surrendered it in year 3 or year 10?

Smart shopping checklist

• Compare similar policies. The NAIC guide says no one company offers the lowest cost at all ages for all kinds and amounts of insurance, so get quotes from several insurers.
• Don't compare on premium alone. Ask for a year-by-year illustration and note which values aren't guaranteed.
• Check licenses and financial strength. Confirm with your state insurance department that the company and agent are licensed in your state, and check the insurer's financial strength ratings.
• Don't drop old coverage too soon. If you're replacing a policy, keep the old one until the new one is in hand, and study both carefully first.
• Name primary and contingent beneficiaries. A contingent beneficiary receives the money if the primary beneficiary dies first. Review choices after a birth, marriage or divorce. Our guide to beneficiary designations covers the details.
• Plan for minor children. Insurers may hold a payout to a minor until a court appoints a guardian of the child's estate or the child comes of age. Many parents ask an estate planning attorney about naming a trust or custodian instead. Pair this with naming a guardian for your kids.

One more helpful fact for your family: according to the IRS, life insurance proceeds a beneficiary receives because the insured person died generally aren't taxable income, though any interest paid on those proceeds is taxable.