June 25, 2007

Term or Whole Life Insurance?

Recently I saw from a forum whereby a reader was asking whether if he should be buying a term insurance or a whole life insurance, and he also ask what is the difference between the two.

To answer his question, I think we should start off by seeing what the similarity is.

Both type of insurance give the insured a form of protection. Should the insured die, the insurance company will pay the beneficiary a sum of money, which is the insured amount. The differences between the two are as follow:

· There is a saving element in whole life policy, and this makes the premium for whole life insurance more expensive. In whole life insurance, part of the premium went to pay for the “insurance protection” element, and part of the premium went into savings. While in term insurance, none goes to saving.
· The term policy will lapse if you do not pay the premium. As for the whole life insurance, because of the saving element, it can be used to off-set the premium and therefore your insurance policy will not lapse immediately.
· Term insurance is valid for a certain term, ranging anyway from 1 to 30 years or more, depending on the insurance company. Whole life, as it name suggest, is valid for life.
· While the premium for whole life insurance tends to be the same as time passes, term insurance premium increases over time, though it normally remains the same for a five year term. This is because the premium for term insurance has to increase to compensate for the risk to the insurance company.

Should one buy term or life? Well, you may have heard of the saying, “buy term and invest the difference”. Before I give my own take on this, I would like to highlight some points concerning term insurance.

Firstly, for term insurance, there is a maximum time period, it can be a 2 year term, or it can be until certain age like 60 years old. Why is this point crucial? In my view, this is crucial because if the term happens to be shorter tan what you wanted and the policy do not allow you to extend it, you may find yourself unprotected just when you need it most! For example, assuming you buy a 20 year term policy when you are at the age of 25. Therefore when you reach 45 years old, your term policy expire and thus you have no more coverage. What if you die immediately after the expiration of the policy? At age 45, you are probably at a time whereby your financial commitment is at your highest.

Secondly, human being as we are, we may not have the discipline to really “invest the rest”. Say you compare a term policy and a whole life policy. The premium for term policy is $50, and the premium for whole life is $350. So you buy the term policy and pay $50 per month, and you invest the balance of the $300. Now, say after a few years, you saw a very beautiful car and you thought of buying it. You realized that you do not have enough to buy it, so you start to think of ways to get the money. And one of the way is to liquidate your investment and to buy the car! If you buy whole life, because of the penalty in surrendering your policy, you may give the idea of buying a miss.

Thirdly, a term is a form of "temporary" insurance whereby one can buy it to provide insurance coverage at a cheap premum. There are a few reasons for doing this, one main reason is that someone who just started ot in the workforce may not have much cash to spend, and therefore look to buy term insurance as a temporary cover. As time passes by, when the person's salary increases, he can than covert it into a whole life policy.

Therefore, my own opinion is that unless you can have the discipline to stay focus on your investment, it may be better to have a mix of both term and whole life policy.

1 comment:

Kelila said...

Interesting to know.