Many people are confused by the terminology used to describe different types of life insurance. Before you purchase a policy, you should understand the difference between whole and term life insurance.

The primary difference between the two types of insurance is that term insurance is a life insurance policy only. This means that when the insured person dies, the insurance company pays the amount of the policy, say $500,000, to the beneficiary named on the policy. Term life insurance can be purchased for a specific number of years which is where the word “term” comes from. The term for most policies can range from one to thirty years.

Whole life insurance is much like a term life insurance policy with the addition of an investment component. So when you purchase whole life insurance, you are purchasing the term insurance as well as putting money into an investment. The extra money is invested into bonds, stocks or a money market fund. Over time, the policy will build up value and the insured person can borrow against this.

If you guessed that whole life insurance is more expensive than term insurance, you are right. Not only are you paying for the term policy and the extra money for the investment, but you are also usually paying higher fees for agent commissions, investment costs and other hidden fees. These fees can sometimes knock as much as three percent off the annual return on your investment. To make matters worse, insurance companies and agents typically won’t tell you what the total fees are or what rate of return you will get on your policy.

The fees for term life insurance are usually inexpensive for someone in reasonably good health who is under the age of fifty. Once you get beyond fifty, the prices increase steadily which is also true for whole life policies. However once you get beyond sixty, it is typically impossible to purchase term life insurance and you must go with whole life or do without.

Many insurance agents will tout whole life policies as a form of “forced savings” meaning it is a good way to put money away for retirement. While there may be some truth to this, the return you get investing yourself in your 401k at work or individual retirement account will typically give you a much better rate of return. If you invest your money in a low cost, passively managed mutual fund, you will typically get a much better return on your money.