The Math Behind Term vs. Whole Life Insurance

When deciding on life insurance, you have a lot of options to choose from. I am often asked about my opinion between whole life and term insurance. Whole life policies are designed to last your whole life, while term insurance only lasts for a certain amount of time.  

In general, I am an advocate for term insurance but there are some benefits to whole life - 

(1) Peace of mind – you have locked in a death benefit for your family. As long as you pay the premiums, your family will get the death benefit when you die, whether tomorrow or in 100 years.  

(2) Cash value flexibility – most policies accumulate a cash value that you can draw from.  

(3) Guaranteed rate of return – The rate of return on your cash value is often guaranteed.  

(4) Forced saving mechanism – The large monthly premiums force you to save and not spend the money. 

However, there are several drawbacks to whole life insurance as well.  

(1) It is very expensive – It can often be 10-20X the cost of term insurance.  

(2) The cash value really isn’t yours. If you make a withdrawal from the cash value, it reduces the death benefit your beneficiaries receive. And when you die, your beneficiaries get the death benefit only. The cash value goes back to the insurance company!  

(3) Low rate of return – The average rate of return on the cash value of guaranteed whole life policies is roughly 1.5%.1  

To test the two policies, I went to Policy Genius and got a quote for a $1,000,000 life insurance policy for a 30-year-old male in good health with no medical conditions. The term insurance was a 30-year policy that would end when he turns 60. 

Term Policy - $53/month 

Whole Life - $827/month (keep in mind this was only from one carrier, I’m sure there are others that would differ in cost)

Let’s assume that we have two 30-year-old, Jim and Bob.  

Jim goes with the 30-year term instead of the whole life policy. He pays $53/month and invests the difference of the two premiums, $774/month, in the S&P 500 index until he dies at age 80, earning returns of 7% per year (hypothetical - not guaranteed). Since he died more than 30 years after his 30-year term policy started, there is no death benefit for his beneficiaries. They will have to get by with whatever he saved in investments.  

Bob goes with the whole life policy and pays $827/month until he dies at age 80, leaving his beneficiaries with the $1,000,000 death benefit.*  

Jim takes the early lead as he invests the extra and slowly builds a nice nest egg. However, at age 60, you will see a steep drop off as his term insurance ends. He continues to save and by the end of his life has accumulated more than $4,000,000 in investments – roughly 4 times more than Bob’s whole life death benefit of $1,000,000! 

This is why I am an advocate for keeping your insurance and investing separate. When you are younger, it may be hard to imagine not needing insurance, but many diligent savers “self-insure” over time, just as Jim did.  

With that said, there are some whole life policies that allow you to invest that can be advantageous, and with certain estate planning issues, whole life insurance can be helpful. But for the vast majority of people, term insurance is all you need if you can force yourself to save and you are comfortable with the risks inherent with investing.  

Thank you for reading, 

Alex 

This blog post is not advice. Please read disclaimers.

*Some whole life policies allow dividends to increase your death benefit over time, but some do not. For this illustration, I assumed they do not. If they do, the death benefit would be more than $1,000,000 but likely by no more than a few hundred thousand.

1 - “Is Whole Life Insurance Right for You? - Consumer Reports.” Is Whole Life Insurance Right For You?, Consumer Reports, 6 Apr. 2015