Why is there such a difference between term and whole life insurance
premiums? Term life is so much cheaper.
Perhaps the best way to explain this is to look at what is probably the purest type of life coverage, the yearly renewable term policy.
As one gets older one is more likely to develop an ailment that could
eventually culminate in death.
Look at it this way, as you get older you get closer to the day when you will die. The older you are the more your policy costs. You buy a policy for $1,000,000 at age 25.
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At age 26 the same policy costs more, at age 27 your $1,000,000 policy costs even more and so on and so on for as long as you own it. To put it another way the older you become the more your yearly renewable term policy costs. If you could keep this policy up to age 100 the premiums would be quite prohibitive by the time you get there.
Now let us look at level term life. You can buy these policies for 5, 10, 15, 20, 25 or 30 years. Some carriers offer level term insurance to specific ages like age 65 or age 80 for example. How is it that these premiums never increase?
Here is how it works. The insurance company is very aware that premiums increase as one gets older. What they do is to total the premiums over the years and divide the costs over the number of years you plan to keep your policy. You end up paying a level amount as a result.
If you own a level 10 year term policy they calculate the costs for your coverage over the 10 year period and divide it by 10. You therefore will see from this that the longer the term period the higher the premium. The average cost will be higher as a result of the age that you will attain while you still are covered. You also have your plan for a longer period which results in higher cost.
If you appreciate why longer period term policies cost more you can easily see why whole life costs more than term life insurance. Whole life is kept up until age 100 or until death, whichever comes earlier. The company is at risk the entire time.
The carriers understand that the whole life premiums are high so they make adjustments as you go along. Let us say you get to year 5 and you are still alive a cash value is included as part of your whole life policy.
You can take this cash value if you decide to surrender your policy at that point. It is also available if you need to take a loan from your policy. Keep in mind that this loan does affect the cash accumulation of your policy as well as the death benefit of the policy. The death benefit will be reduced by the outstanding amount.
Your cash values increase each year and are guaranteed from the outset. If you own a participating policy you also earn dividends if the company performs well. This is added to your cash value though they are different and separate from your cash values. Dividends are a return of premium and are not guaranteed.
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I recently did some research on the development of the 30 year term insurance policy over the years. What I learned was quite interesting.
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