Term Life Insurance and Why Nightlight Prefers it Over Permanent

If you have a spouse, children, or other dependents who rely on your income to pay for things like a mortgage, car loans, or tuition, you need life insurance. And no, your free life insurance covered by your work is never enough! But what kind of life insurance? With so many options available, it can feel overwhelming to decide between term life and whole life insurance. If you’re interested in life insurance but overwhelmed by the options, you’ve come to the right place.

At Nightlight Insurance Agency, our primary goal is to help clients secure the insurance coverage they need to protect their families and loved ones. We believe that insurance should do what it’s meant to do—provide financial protection in case of loss. That’s why we’ve chosen not to offer whole life insurance, which combines insurance with an investment component. Instead, we focus on providing straightforward, affordable coverage through term life insurance, allowing our clients to separate their insurance needs from their investment strategies. By offering term life insurance exclusively, we stay committed to helping our clients protect their families in a cost-effective way, without the complexity and fees that come with whole life insurance policies.

What Is Term Life Insurance?

Term life insurance provides coverage for a specific period (hence the name “term”). Common term lengths are 10, 20, or 30 years, and if you pass away during that time, the policy pays a death benefit to your beneficiaries. If the term expires and you’re still alive, the policy simply ends—no death benefit, no payout.

Why is this such a popular choice? In a word: simplicity.

Term life insurance is:

  • Affordable: Term policies are often much more affordable than whole life policies. Why? Because they cover you for a limited time, making it less of a financial risk for insurers. According to NerdWallet, the average monthly cost for a non-smoking 40-year-old woman buying a 20-year, $500,000 term life policy is only $24 per month; the same 20 year-year-old pays an average of less than $15 per month. Curious about other average rates by gender and whether a smoker? Check out Average Life Insurance Rates for October 2024 by NerdWallet.
  • Temporary: Most financial obligations are temporary. Think about it: Your mortgage, car loans, and education expenses will eventually be paid off. Once your children are financially independent, the need for life insurance decreases. Term life insurance aligns with this reality—covering you for the period when your loved ones need it most.
  • Straightforward: There’s no investment component, cash value, or confusing fees. It’s pure insurance, plain and simple.
  • Flexible: You can choose a term length that matches your financial obligations. Whether you need coverage for 10, 20, or 30 years, term life allows you to choose the right period based on your current obligations. And once your term is over, you can simply let the policy lapse if it no longer serves your needs.
  • Wealth-Building: If you are looking to accumulate wealth, term life insurance allows you to invest the difference between the lower premiums of a term policy and the higher premiums of a whole life policy into other financial vehicles, like a retirement account or investment portfolio, where it can grow more efficiently. For instance, you could invest the difference in an index fund and let compound interest work its magic. Historically, the stock market has returned an average of 7-8% annually, making this a more effective wealth-building tool than whole life insurance, which typically offers lower returns on its cash value component.

How Much Term Life Insurance Do You Need?

Determining how much term life insurance to purchase depends on several factors related to your financial needs, goals, and obligations. While there is no one-size-fits-all answer, here are some common guidelines and methods to help you calculate the right amount of coverage:

1. Income Replacement Rule of Thumb

A common rule is to purchase life insurance coverage that is 10-12 (some experts have even recommended 20-25!) times your annual income. This ensures that if you pass away, your family can replace your income for a significant period.

Example: If you earn $75,000 annually, you might aim for a policy worth $750,000 to $900,000.

2. The DIME Formula

This method helps you calculate your coverage based on your financial obligations. It stands for Debt, Income, Mortgage, and Education. Here’s how it works:

  • D = Debt: Total any outstanding debts (e.g., credit cards, student loans).
  • I = Income: Multiply your annual income by the number of years you’d like to provide support for your family.
  • M = Mortgage: Include the remaining balance on your mortgage.
  • E = Education: Estimate the future costs of education for your children.

By calculating these components, you’ll have a clearer picture of the coverage you need. For example, if you have $50,000 in debt, $800,000 in income replacement ($80,000 annual income over ten years), $250,000 left on your mortgage, and $100,000 for education costs, you might want to purchase a $1.2 million policy.

3. Expenses-Based Approach

This method calculates how much your family would need to cover ongoing and future expenses. Consider:

  1. Final Expenses: Costs related to burial or funeral expenses, which are typically around $7,000 to $12,000.
  2. Living Expenses: Estimate how much your family would need for daily expenses (food, utilities, etc.).
  3. Future Expenses: Include major expenses like children’s education, weddings, etc.
4. Specific Needs or Goals
  • If you have unique financial goals, such as leaving an inheritance, funding a spouse’s retirement, or covering estate taxes, adjust the coverage accordingly.
  • You may also want to ensure that your term length covers the duration of key financial responsibilities, like paying off a mortgage or sending children to college.
  • If you have significant savings or investments, you may need less life insurance coverage.

What Impacts Your Term Life Insurance Rates?

Several factors can affect the cost of your term life insurance policy:

  • Age: The younger you are, the less you’ll pay. Lock in lower premiums while you’re young.
  • Health: Pre-existing conditions, blood pressure, and cholesterol levels impact premiums.
  • Smoking Status: Smokers pay significantly higher premiums.
  • Gender: Women tend to pay less because they have longer life expectancies.
  • Driving Record: Risky driving behavior, such as DUIs, can raise premiums.
  • Lifestyle: Risky hobbies (like skydiving) or dangerous occupations can raise premiums.

What is Permanent (or Whole) Life Insurance?

Whole life insurance is a type of permanent life insurance that provides coverage for your entire life, as long as premiums are paid. Permanent insurance can come in many forms and names, such as whole life, cash value, indexed universal life, and variable universal life. Unlike term life insurance, which covers you for a specific period (e.g., 10, 20, or 30 years), whole life includes an investment component known as cash value. This cash value grows over time and can be borrowed against or withdrawn, making whole life a combination of insurance and an investment vehicle. However, it comes with much higher premiums compared to term life insurance, and many people find the returns on the cash value are lower than they could achieve through other investment options. Term life insurance, by contrast, is pure insurance with no investment feature, designed to cover you for a set period at a significantly lower cost, making it a more affordable option for most families.

When Does Whole Life Insurance Make Sense?

Whole life insurance provides lifelong coverage, meaning there’s a guaranteed death benefit, as well as a cash value component that grows over time. It’s more expensive but can make sense for certain individuals with specific needs:

1. You’ve Maxed Out Your Retirement Accounts

Before even considering whole life, make sure you’ve fully contributed to your 401(k) and IRA. These accounts provide significant tax benefits and growth potential that can often outweigh the benefits of whole life insurance, given the associated fees reducing your investment and return caps limiting the growth of your investment. Also, don’t forget that many employers match your 401(k) which is essentially “free money”.

If you’re not maximizing contributions to you tax-advantaged retirement accounts – term life insurance is your best option.

2. You Expect to Have a Large Estate

As of 2024, the estate exemption is $13.61M per individual (so a married couple can exempt up to $27.22M). This may be reduced in 2026 to $14M for a married couple and will continue to increase with inflation. An estate below this amount will already be passed down tax-free. If you are not expecting to have an estate that exceeds the estate exemption when you pass, there is no tax benefit to your heirs.

3. You Fully Understand the Product

If you’re considering whole life insurance, it’s crucial to fully understand what you’re buying. Combining insurance and an investment vehicle is often complex and fee-ridden.

You should be able to answer questions like:

  • Which payments are not invested?
  • What is the cost of insurance?
  • Are there expense fees?
  • Are there withdrawal fees?
  • What are the monthly fees?
  • Is there a surrender charge?
  • What are the floor and cap on your returns?
  • What is the incremental tax benefit for your specific situation?
  • What happens if you need to cash out?

If in doubt, consult with a Certified Financial Planner before committing.

What Do Others Say?

Nightlight specializes in insurance, so you may want to also hear from people who have dedicated their careers to personal finance. There is no shortage of experts weighing in on this topic.

Many personal finance professionals argue that products that combine life insurance with investments can be overly complex and not worth the cost. Even if you don’t follow them, check out pages dedicated to this topic from Dave Ramsey, Suze Orman, and Tiffany Aliche that advocate for term life insurance.

Interested in a deep dive read? Check out this blog from Personal Finance Club for a detailed breakdown of why they believe Indexed Universal Life (IUL) (i.e., Whole life, cash value, permanent, variable universal life, MPI) are products often not in your best interest.

More of a podcast listener? We love a more recent one, Money with Katie’s take on predatory life insurance, where Katie helps clarify why term life insurance may be the smarter choice for most people.

And there’s plenty more.

Bottom Line: Term Life Insurance for Most, Whole Life for a Few

For most families, term life insurance is the most affordable and practical way to provide financial protection during crucial years. Its cost-effectiveness and flexibility make it a better fit for temporary needs like covering a mortgage or ensuring your children’s education is funded. The savings from term life premiums can be invested elsewhere, helping you build wealth for retirement or other financial goals.

On the other hand, whole life insurance can be a valuable tool in very specific cases, especially for individuals with high net worth who are looking for tax-efficient wealth transfer or estate planning strategies. But before jumping into a whole life policy, it’s essential to make sure you’ve fully explored all other retirement investment options, such as your 401(k) or IRA.

Need Life Insurance or Have Questions? Let’s Talk.

If you’re not covered but need to be, don’t wait any longer! Term life insurance is affordable and can be a very quick process! At Nightlight Insurance Agency, we’re committed to helping you make informed decisions that align with your financial goals. Whether you’re just starting to think about life insurance or you’re ready to get a customized quote, we’ve got you covered.

Interested in learning more about term life insurance? Call or text Nightlight at (512) 488-3586, or request a quote on this page! Our experienced team will guide you through your options, ensuring you choose a policy that makes sense for your unique situation.

Remember, life insurance is a crucial part of your financial plan—but it doesn’t have to be complicated. Let us help you simplify the process and find the best coverage for your needs.


Disclaimer: I am a licensed insurance professional; however, the information provided on this blog is for informational purposes only and should not be construed as financial, investment, or tax advice. Every individual’s situation is unique, and decisions regarding tax and financial planning should be made in consultation with a licensed financial advisor or tax accountant. Please consult with your own professional advisors to ensure the strategies discussed are appropriate for your specific circumstances.

brett
Brett Dyer, Founder & President, Nightlight Insurance Agency

Call or Text Today (512) 488-3586

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