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Homework answers / question archive / Part A: Compare and contrast term life insurance with whole/permanent life insurance
Part A: Compare and contrast term life insurance with whole/permanent life insurance.
Part B: Using the two approaches covered in the module, calculate the amount of life insurance that either you or a family member might need.
ANSWER
(I)
DIFFERENCE BETWEEN TERM LIFE AND WHOLE LIFE INSURANCE
| BASIS | TERM LIFE INSURANCE | WHOLE LIFE INSURANCE |
| MEANING | Term life insurance is perhaps the easiest to understand, because it’s straightforward insurance, without the bells and whistles. The only reason to buy a term policy is because of the promise of a death benefit for your beneficiary should you pass away while it’s in force. As the name suggests, this stripped-down form of insurance is only good for a certain period of time, whether it’s five years, 20 years, or 30 years. After that, the policy simply expires | Whole life is a form of permanent life insurance, which differs from term insurance in two key ways. For one, it never expires as long as you keep making your premium payments. It also provides some “cash value” in addition to the death benefit, which can be a source of funds for future needs. |
| BENEFITS | Because of these two attributes—simplicity and finite duration—term policies also tend to be the cheapest, often by a wide margin. If all you seek from a life insurance policy is the ability to protect your family when you die, term is likely the best fit. While no two families are exactly the same, new parents sometimes purchase insurance that lasts just long enough for their kids to finish college or join the workforce full time. | Most whole life policies are “level premium,” meaning that you pay the same monthly rate for the duration of the policy. Those premiums are split in two ways. One part of your payment goes to the insurance component, while the other part helps build your cash value, which grows over time. Many providers offer a guaranteed interest rate (often 1% to 2% annually), although some companies sell “participating” policies, which pay unguaranteed dividends that can increase your total return. |
| DRAWBACKS | A variety of factors will change those prices, of course. For example, a larger death benefit or longer length of coverage will certainly increase the premiums. Also, most policies require a medical exam, so any health complications could raise your rates above the norm as well. | The main disadvantage of whole life insurance is that it’s more expensive than a term policy—by quite a bit. Permanent policies cost on average between five and 15 times more than term coverage with the exact same death benefit. For a lot of consumers, the relatively high cost makes it hard to keep up with payments. A June 2016 report by the Wharton School at the University of Pennsylvania found that roughly 25% of permanent life policies lapse within the first three years. |
(II)
Evaluating Your Insurance Needs
A large part of choosing a life insurance policy is determining how much money your dependents will need. Choosing the face value—the amount your policy pays if you die—depends on a few different factors.
Your Debt
All your debts must be paid off in full, including car loans, mortgages, credit cards, loans, etc. If you have a $200,000 mortgage and a $4,000 car loan, you need at least $204,000 in your policy to cover your debts. But don't forget the interest. You should take out a little more to settle any extra interest or charges as well.
SINCE I DO NOT HAVE ANY DEBT I DONT NEED TO TAKE DEBT INTO CONSIDERATION
Income Replacement
One of the biggest factors for life insurance is to replace income. If you are the sole provider for your dependents and bring in $40,000 a year, you will need a policy payout that is large enough to replace your income plus a little extra to guard against inflation
Insuring Others
Obviously, there are other people in your life who are important to you, and you may wonder if you should insure them. As a rule, you should only insure people whose death would mean a financial loss to you.
Other Calculations
Most insurance companies say a reasonable amount for life insurance is six to 10 times the amount of annual salary. Another way to calculate the amount of life insurance needed is to multiply your annual salary by the number of years left until retirement.
KEEPING ABOVE DISCUSSION IN MIND MY INSURANCE COVER =
For example, if a am 40-year-old man currently makes $20,000 a year, the man will need $500,000 (25 years x $20,000) in life insurance.
