There are two basic differences.
The first is the length of time the insurance policy covers. When you buy term life insurance, it's life insurance just for a specified "term" or period of time, say twenty years. Once that time period is up you no longer have coverage (so if you're still living no one gets any payout). Think of it like renting a policy. Cash-value or permanent (such as whole, universal, and variable life) insurance is more like buying the policy outright since it is meant to cover your entire lifespan, whatever that might be.
The second difference is tax-deferred savings. Term insurance is just life insurance. Cash-value insurance also serves as a tax-advantaged investment tool. In addition to the life insurance payout at your death, it also includes a mechanism to save money in a tax-deferred savings account (as in it grows tax free, but you pay taxes on the earnings when you withdraw them). Each payment you make goes partly to cover insurance costs, partly to cover management costs, and partly to your savings account that will accumulate over time.
So what does this mean to you?
- Since term insurance covers less time, it is understandably less expensive. (Odds that you are going to die within say, twenty years, are a lot less than the odds that you will die within your lifetime. Makes sense, right?) Additionally, term insurance doesn't include a built-in savings account. So it makes sense that term insurance is cheaper. And for most people it's a great option since it does the job that you want your life insurance to do-- covering funeral expenses and providing sufficient resources to care for your surviving spouse and children. The goal would be to mainly cover the period of time your children are living at home. After that, hopefully your children would be financially independent and you'd have enough savings to cover funeral expenses, etc. on your own. Additionally, other tax-advantaged accounts exist so you're not losing out by not investing in a cash-value life insurance policy.
- So who buys cash-value life insurance if term insurance is better deal? People who have already maxed out their savings in tax-advantaged accounts like 401(k)s, Roth IRAs, and Traditional IRAs (there are limits to how much you can contribute to these) might use life insurance as an investment. Life insurance proceeds are tax-free, so it can be used as a tool to minimize estate tax (which, unless you are fortunate enough to be very wealthy you will probably not have to deal with). But before you jump on the whole life insurance bandwagon, make sure that it's a good fit. This Forbes article suggests that, typically, unless you're making over $250,000/year or have over $1 million in assets, you're probably better off with term insurance. As always, there is no one size fits all solution. But make sure you are making an informed decision based on your own situation and financial profile whatever you decide. I love this quote from the Motley Fool (in fact, I highly recommend reading the two Motley Fool article listed in the sources below): "please do not enter into a cash value insurance plan without doing a lot of homework."
- "Term Vs. Perm Life Insurance (in 90 Seconds)" by Tim Maurer
- "Should I Buy Term Life or Cash Value Insurance" on The Motley Fool
- "Are Withdrawals from a Cash Value Life Insurance Policy Ever Tax Free?" on axa-equitable.com
- "Estate Tax: Will Your Estate Have to Pay" by Denis Clifford
- "What are the Differences Between Term Life and Cash Value Policies" on The Motley Fool