One often heard plea to potential buyers of life insurance—“Buy term and invest the difference”—has dogged the life insurance marketplace for the past few decades. Insurers who promote only term life insurance products often shout it out from the rooftops, while companies more focused on cash value life insurance policies wage an ongoing battle to convince customers to the contrary. To the buying public at large, this seems like an endless argument. The point is, what are the facts?

Term life insurance—so-called because the contract is good for a specified term, typically one calendar year—promises a death benefit, in addition to certain optional rider benefits. Additional rider benefits may come in the form of a disability waiver of premium, coverage for spouse or children, etc. With an annually renewable term life insurance policy, as the name suggests, the premium is subject to change every year.

On a similar note, there are level-term policies available that ensure level premiums for the term specified in the contract—5, 10, 15, 20, 25, or 30 years. Generally, the term life insurance policy’s unique proposition is: Lowest possible cost for a given period of time. With term life insurance, the outstanding feature is the death benefit.

Interestingly, when life insurance coverage is needed on a permanent basis, term life insurance may not be the most cost-effective option. The reason being, term life premiums increase as you grow older, and in the case of a level-term contract, may jump alarmingly once the specified term is over. Term life insurance makes good sense when the budget is limited, and especially when the need is for a known, pre-determined period of time.

An Ample Spread

The other life insurance option is a cash value policy—either universal life with flexible premium choices, or whole life, where the premium is level and generally higher (than both term and universal life). Another variation of the universal life policy—variable universal life—literally comes closest to “buying term and investing the difference,” all in one package. The premium difference in this case is invested in variable investments—securities that are subject to market volatility and fluctuation. Both universal life and whole life are designed to accumulate cash value, which can be used to buy additional insurance or to pay future premiums. It is indeed the cash value that provides permanence to these contracts.

The cost of insurance in a universal life policy keeps rising just as it does in term, but the cash value, which grows tax deferred at a compounded rate, may be used to meet insurance costs in case the policyholder is unable to pay future premiums. If the cash value is adequate, it may be able to keep the policy permanently in force. If it is inadequate, life insurance coverage may eventually run out. Since, in a whole life policy, the cost of insurance is permanently level, accumulated cash values have a better chance of being able to meet a fixed, predictable obligation year after year, rather than one that is constantly increasing.

The Bone of Contention

The premium amount is really the bone of contention when it comes to deciding which type of policy is the most appropriate. There is a substantial premium difference between the cost of term life insurance and cash value life insurance, commonly referred to as “permanent” policies. Term life insurance companies often suggest that people buy their less expensive term policies and invest the difference in premium into separate investment(s) that potentially promises a higher rate of return.

Companies offering cash value policies, on the other hand, have to convince their prospects that investing the difference into the policy itself has several outstanding advantages. For instance: 1) because cash value lends permanence to the contract (providing protection when it is most needed), making the higher premium payments is altogether worthwhile; 2) cash value growth fueled by dividend earnings, although modest, is steady and therefore not subject to unpredictable market fluctuations as many investments are and, in the long run, compares favorably with most conservative investments; and, 3) cash values grow tax deferred and can be used tax advantaged to help meet future needs such as a home purchase, college funding, and retirement income. (In a variable universal life policy, however, note that the investments would be directly subject to market fluctuations.)

Making an Honest Choice

While cash value policies have obvious long-term advantages, budgetary constraints could explain why people often shy away from them, and prefer to buy term instead. Generally however, only a small number of people intending to “invest the difference” actually end up doing so. They buy term and see no difference in their “intended” savings plan. In most cases, the premium difference never gets invested and therefore they miss out on systematic, tax-advantaged accumulations that could really add up in the long run. It is important to bear in mind that both types of policies have their unique advantages. However, affordability and need are the only issues that should honestly help you decide in favor of one type versus the other.