“Life insurance that doesn’t expire!” is how one life insurance company touts its permanent life insurance products. “Buy term and invest the difference!” is the mantra of many life insurance agents as they try and steer people away from permanent coverage and towards term coverage. Who’s right?
In this article, you’ll get enough information about permanent life insurance and some comparisons to term insurance that will let you make your own decision about what’s right for you.
What is permanent life insurance?
Permanent life insurance is a term that you won’t find printed on any life insurance policy. It’s actually an umbrella term covering policies that will offer coverage permanently, as long as premiums are paid and up-to-date. Permanent life insurance provides a death benefit, and it has a savings element as well.
There are two primary types of permanent life insurance:
- Whole life insurance
- Universal life insurance
Whole life offers coverage for the insured’s entire lifetime and has a savings element with a guaranteed minimum rate of return. Universal life also provides a death benefit, but its savings element is tied to market performance. We’ll look at both in greater detail later.
What is it about permanent insurance that has so many people choose it over term insurance? Answer — it’s the savings element of the policies. While the savings grow, the money (cash value) accumulates slowly in the policy's early years. Because of this, borrowing from the policy isn’t allowed during the first few years you own it, which is specified and explained in the policy.
Once the waiting period is over, and loans are allowed, you can borrow money from the accumulated cash value, which is charged interest. If the unpaid balance of the loan and the unpaid interest add up to more than the amount of a policy’s cash value, the policy and coverage will terminate (the insurance company provides fair warning to prevent this from happening).
Another feature of permanent life insurance is that it receives favorable tax treatment. The cash value building as part of the policy accumulates tax-deferred, meaning the earnings won’t be taxed as long as the policy remains active (in-force).
There are limits, but money can be taken out of the cash value as a loan without being taxed since they’re not considered taxable income unless the loan exceeds the total of all premiums paid for the policy.
Types of permanent life insurance
If you decide that permanent life insurance is best for your situation, your next decision concerns the type of permanent life policy you want. Let’s look at four types of permanent life insurance.
Whole life insurance
Whole life insurance provides a death benefit and the opportunity to save money and earn interest on that savings. It’s named “whole life” because coverage is guaranteed for your whole life.
The premium amount is tied to the policy's face amount (the higher the face amount, the greater the premium). Your premium is fixed, meaning it won’t ever change on you. Premiums can be paid in a variety of ways, such as paying them all the way up to age 100 or for a fixed number of years, such as 10, 15, or 20 years. Premium payment can also be made in a lump sum.
Borrowing from the policy’s cash value is allowed on a tax-free basis. If you die while there is an outstanding loan, the loan amount will be deducted from the death benefit.
Learn More: Whole Life Insurance
Universal life insurance
For many people, their preferred type of permanent life insurance is universal life insurance because of its flexibility. With universal life, you can adjust your premiums and the death benefit as your circumstances dictate.
While a whole life’s death benefit isn’t affected by the cash value portion of the policy, universal life has an option where the death benefit is equal to the face amount of the policy plus the accumulated cash value (the premium is higher if you choose this option).
There is also the potential for more significant savings accumulation with universal life compared to whole life. Indexed universal life is a type of universal life that is very popular because the accumulation amount is tied to a stock index, like the Dow Jones Industrial Average or the S&P 500.
Learn More: Universal Life Insurance
Variable life insurance
As a policyholder, variable life insurance allows putting your cash accumulation amount into an investment account that the insurance company manages. The earnings from the investments can be used towards the premium (which is fixed like whole life) or added to the policy’s death benefit.
There is an element of risk with variable life insurance. If the investments perform poorly, you won’t have that money to put towards premium payments, and the death benefit may decrease. You’re protected against this to some degree because most policies have a guaranteed minimum death benefit, which will provide you with some peace of mind knowing your heirs will receive something.
Learn More: Variable Life Insurance
Variable universal life insurance
What do you get when you combine universal life and variable life? Answer — variable universal life insurance. Variable universal life takes a bit more time to understand since it’s a bit more complex than the other types of permanent life insurance.
With variable universal life, you, not the insurance company, will choose the investments for your accumulating cash value. This can be riskier than what the insurance company would choose, depending on the degree of risk there is with the investments you select. Most policies offer quite a few different investments to choose from that will satisfy both the conservative and aggressive investor.
The premium payments with variable universal life can be adjusted at any time, providing that they adhere to the policy’s stated minimum and maximum limits. There is always the risk with variable universal life that you could end up owing money to the insurer or losing your coverage if your investments don’t perform as you hoped they would.
Learn More: Variable Universal Life Insurance
Pros & cons of permanent life insurance
As you evaluate permanent life insurance, some things stick out as pros and cons. Let’s take a closer look.
Pros of permanent life insurance
Cash value accumulation: Everyone needs to save money for expected and unexpected life events. A permanent life insurance policy's cash value can be accessed to help fund retirement, college tuition, medical expenses, and more. It can also increase your policy's death benefit, so as your obligations grow, so will your protection for your loved ones.
Flexible premium payments: Some types of permanent life insurance allow you to stop making payments and continue receiving the benefit of having a death benefit in place for your heirs. With some policies, you can pay a higher premium amount in the early years for a shorter length of time, such as five years, and never have to make another premium payment.
Beneficial tax treatment: Permanent life insurance offers you numerous tax advantages. These include the cash value accumulating tax-deferred and tax-free policy loans and withdrawals. Also, the death benefit is tax-free, so your heirs will receive the full amount you intended them to receive
Cons of permanent life insurance
Cost: Permanent life insurance is significantly more expensive than term life insurance. You’ll find that many younger people who are starting a family and building a career prefer term insurance because of its lower cost. Permanent life insurance is often bought by people who are more established financially and are older than term life buyers.
Possible policy lapse: A permanent life insurance policy can lapse if you miss a premium payment or you can’t afford to pay the premiums any longer. If your policy cancels, any future life insurance you buy will be more expensive because you’ll be older, and premiums increase as you age.
Not convertible: If you own a permanent life insurance policy, you may later decide that you would like to convert the policy to a term life policy. This isn’t possible with whole life insurance, which means you may need to let the policy lapse, losing all of the money you had paid in premiums.
Is permanent life insurance a bad idea?
Although there are some advantages to buying permanent life insurance, its detractors will tell you that you should avoid it like the plague and buy term life insurance instead. They cite several reasons:
- They believe permanent insurance is prohibitively and unnecessarily expensive, that the risk is too great that at some future date you won’t be able to afford the premiums, and you’ll lose every dollar you paid out for the policy. As a result of the policy lapsing for non-payment, your heirs will lose all of the benefits they would have received.
- They also believe that it takes too long for the cash value to accumulate because of the low-interest rates that insurance companies pay on permanent policies. It can take fifteen to twenty years for a policy’s cash value to exceed the premiums paid into it because of all of the policy's expense charges, fees, and high commissions.
- Lastly, they claim that you can do much better financially by accumulating savings in a 401(k) plan or an IRA than you can with the cash value growth with permanent life. 401(k)s and IRAs both allow you to borrow if you need to, like when buying a new home.
Opponents of permanent life insurance agree that it has one benefit for some people: forced savings for people that need life insurance but aren’t good savers of money. But, at the same time, they’ll also tell you to buy term life insurance and have money automatically debited from your bank account each month and put into investments.
The best type of life insurance policy for some people is permanent insurance because it pays a death benefit to their heirs while providing living benefits from cash value accumulation. It’s certainly worth investigating and comparing it to term life when you’re ready to buy life insurance.
Jack Wolstenholm is the head of content at Breeze.
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