This whole insurance thing really does take a while to wrap your head around. The words "whole life insurance" and "term insurance" don't really mean or explain very much to the average person.

The typical Singaporean is also trained from a young age to run away from people who want to have such conversations with you, as if they were infected zombies. Still, at some point in your adulting, you come to the dreadful realisation that insurance is not avoidable for ever and that there is value to getting at least some sort of life insurance policy.

We're here to arm you with some basic knowledge before you face an insurance agent, so you know what you're getting into.

Contents

1. Whole life vs term insurance - what's the difference?
2. Endowment vs investment-linked whole life insurance policies
3. What's the difference in terms of premiums (cost)?
4. Who should buy whole life insurance?
5. How does "limited pay" work?
6. What is "surrender value"?

What's the difference between whole life and term insurance?

An insurance policy provides protection for financial losses suffered from a particular event. In the case of life insurance, the "event" is the loss of your life, or in the case of total permanent disability (TPD).

To put it simply, a life insurance policy is designed such that if you die, the insurer's payout should be enough for your dependents to live on when you are gone.

But before you buy any sort of life insurance, you need to decide whether you will opt for whole life insurance or term insurance. What's the difference between them, and which is right for you?

Both term and whole life insurance provide protection in the event of total permanent disability (TPD) and death. The two main differences between them are: (a) how long the policy will cover you and (b) how much money you get back if nothing happens to you.

Term insurance provides you with protection only for a fixed period of time, say 20 or 30 years, after which the plan expires. If nothing happens to you and you don't make a claim, you get nothing (apart from a letter thanking you for giving them money for the last 30 years).

This type of coverage is cheaper, and it makes sense if you plan to provide for your dependants for a limited time. For example, until your youngest child finishes tertiary education.

On the other hand, whole life insurance covers you till the end of your life, as long as you continue to pay the premiums.

It's much more expensive, but it has the potential to grow the money you paid. The potential growth varies depending on whether your whole life insurance is an endowment plan or an investment-linked policy (ILP). More on those in the next section.

In either case, the "advantage" of whole life insurance over term insurance is that, even if you terminate and surrender the policy, you can get back some of the monetary value.

Endowment vs investment-linked whole life insurance policies

In Singapore, whole life insurance usually includes a savings or investment component, named endowment and investment-linked policy (ILP) respectively.

Due to these features, some people see their whole life policies as an investment/savings plan instead of just being a plain old protection plan. These added features make whole life insurance more expensive than term insurance.

Endowment Policies

Endowment policies are often seen as a way to help you build up financial discipline since the savings component is built into the monthly insurance premiums.

For instance, let's say you pay a monthly insurance premium of $250 for your endowment policy. Of this amount, $100 might go into the insurance protection component, and $150 will go into the savings component.

After a fixed period of say 20 years, you will be able to get back some of the cash value accumulated, depending on the guaranteed and non-guaranteed benefit of your policy.

Investment Linked Policies (ILP)

For an ILP, the savings component will be replaced with an investment component where part of the premiums goes into buying units in investment funds.

Unlike endowment insurance policies, ILPs usually do not come with guaranteed values.

The value of the ILP depends on the performance of the fund you've bought into. So yeah, you could get zilch if things don't go well and this represents a potential opportunity cost as you could have made that money work somewhere else for you.

Some consumers like ILPs because they like the idea that they can invest and have financial protection through a single financial product. There is also have a range of funds to choose from that suits different investment objectives and risk appetites.

Whether you choose to buy term insurance, endowment plan or ILP, the main thing is to decide if your choice fulfils your financial objective and takes into consideration the long-term costs involved.

Let's compare the premiums for whole life vs term insurance

While life insurance used to be the "go-to" insurance for most people, with increased financial literacy, more people are open to getting term insurance instead.

One of the greatest advantages of choosing a term insurance instead of a life plan is the substantial savings you get from lower premiums.

So if you know you need insurance protection but are in a phase of life where you can't afford to set aside very much every month, this becomes the best choice for now.

Here's a simulation of how much term life vs whole life insurance premiums will cost based on the following criteria: 35-year-old man, non-smoker. Let's call him Mr Siva.

As you can see, the difference in the amount of premiums paid between term and whole life insurance is huge.

This is why some financial advisors even advocate "buy term and invest the rest". In other words, buy a term policy for the necessary protection, and then use the money you didn't use to invest. This is a strategy that has the potential to grow your money if you make the right investment decisions.

On the other hand, some consumers like to get a whole life policy because it offers some cash value should you decide to surrender the policy. That means the total premiums paid for your whole life policy will be reduced substantially and this brings it more on-par to term plans in terms of cost.

One important consideration when choosing to take up a term plan is that the coverage term may expire at a time when you'll continue to need protection (or need it most).

For the above case, the term plan will expire when Mr Siva is 65 years old. Depending on his situation, Mr Siva may want to continue getting life insurance coverage for another 20 years.

However, depending on his health at 65, some companies may consider him "uninsurable". Even if he does qualify for a new insurance plan, premiums are going to be very expensive at that age, and he may not be able to afford them during his retirement years.

Who should buy whole life insurance?

While it may seem that the "buy term and invest the rest" mantra makes total economic sense, there are instances where buying whole life insurance can be a better choice.

Whether you need life insurance really depends on your stage in life. If you are a young 20-something with no dependents and limited obligations, you'll likely not need a whole life insurance policy.

But say you are 40-year old, and the sole breadwinner in a family with two young children and elderly parents. In such a case, whole life insurance can help to provide financial protection for your loved ones while simultaneously helping you build up some retirement funds for your golden years.

Life insurance coverage is a way of caring for your family because you don't want them to suffer when any misfortunate befalls you.

In a survey by NTUC Income published in April 2019, 48 per cent of 329 married adults surveyed expressed that they were motivated to buy life insurance because they want their loved ones to maintain the same standard of living when disaster strikes.

The other situation where whole life insurance can make sense is for your young child. You might think, "Why would my two-year-old need whole life insurance?"

For one, it guarantees insurability and no exclusions since most young children have a clean bill of health. Many parents also take up a whole life policy with an endowment plan in order to start saving for their child's future education. Also, your child is likely to enjoy lower premiums when getting insured from a younger age.

If you're getting a whole life policy for a child, choosing a limited pay option can be a good idea. Your child can get lifelong coverage with premium payments for as short as 12 years. It can thus be a meaningful gift for a young child instead of saving money in a bank deposit account that cannot beat inflation.

How does "limited pay" work?

Getting life insurance with a limited pay period means you only need to pay premiums for a limited number of years in exchange for a lifetime's coverage.

Say, for instance, Andy (male, non-smoker, age 35) decides to make premium payments of $250 per month for only 15 years for his whole of life plan up till age 50.

For the next 15 years, Andy pays about $45,000 for a sum assured of $100,000. The insurance coverage will continue for the rest of his life even after he ends his premium payment at age 50.

Depending on his insurer and plan, he will likely also be entitled to some accumulated cash value if he surrenders his policy when he reaches 65 years old.

What is this "surrender value" thing?

When you buy life insurance, you have a surrender right - the opportunity to terminate your life insurance contract in exchange for its cash value. You can only do this if you've not made any claims before.

When you choose to surrender your policy, you will give up the remaining coverage while your insurer presents you with a cash surrender value, which is how much money you will receive in return.

Do note that the surrender value of your policy will be lower than the death benefit payout.

This means that you will receive less money by surrendering your policy as compared to having the death benefit when you pass on. Thus, it is often not advisable to surrender your policy. 

Not only will you lose out in terms of monetary value, but taking up a new insurance policy at a later age will probably incur a higher premium payment.

Ultimately, there's no right or wrong in choosing whether to get a term plan or whole life insurance - it all depends on what you need and how much you can afford.

Whole life insurance costs more, but it can be a convenient option for those who want both financial protection as well as a savings/investment component. 

On the other hand, a term life insurance plan offers a great cost-effective option for those who want (only) pure protection.

This article was first published in MoneySmart.