The term versus permanent life insurance debate has lingered for years. It is a long-standing question, but it need not be “either-or.” Neither type of coverage is universally superior to the other. Both options have appropriate uses, depending on the needs and situation of whoever is purchasing the policy.
First, let’s discuss the basics of each type of life insurance.
Term Life Insurance
Term insurance is designed to help people who need coverage for a certain time period. Generally speaking, most term life insurance has an underwriting process which will require a personal medical examination. For those who can’t afford permanent coverage, term coverage can be an efficient, shorter-term option. Term policies tend to last 10-30 years. The most common coverage period is for 20 years.
When it comes to term life insurance, here are key factors to remember:
- Term insurance provides a guaranteed death benefit, but no cash value
- Premiums stay level throughout the coverage period
- After the period ends, premiums will go up, as you are older – your age and other variables used to calculate your premiums have changed
- If you stop paying premiums, the insurance coverage ends
If permanent insurance may be of future interest, you may want to consider term insurance with a “conversion privilege.” This allows you to turn your term coverage into permanent coverage, but you don’t have to demonstrate proof of insurability. Your new permanent insurance may also retain the rate class which your term policy had at its beginning. Note, however, that a conversion privilege may be subject to certain terms and conditions. Be sure to review the details of any specific term life insurance product you may be considering.
Permanent Life Insurance
Generally speaking, permanent life insurance gives lifelong coverage, as long as premiums are paid. There are many types of permanent insurance, including whole life, universal life, indexed universal life, and variable life.
In the short run, term life insurance tends to be less expensive than permanent life insurance. But once the duration of a term policy has passed, premiums will go up, as the insurance carrier takes on more risk as people age. So, term insurance can prove to be costly over the long haul.
Unlike term, permanent insurance comes with a “cash value,” or a savings component. The cash value is also called a “cash surrender value” or a “surrender value.” If you decided to stop paying your premiums and end your policy, the value of the policy contract at that point would be yours. Premiums you pay go towards maintaining lifelong coverage and building up the cash value.
People can do many things with the cash value in their permanent life policy:
- Take partial withdrawals from the cash value
- Borrow money, or take out policy loans
- Completely withdraw the entire cash value sum, and surrender the permanent life policy
- Upon reaching a certain level of cash value growth, paying premiums using the cash value itself
With partial withdrawals and policy loans, the money will have to be repaid. Policy loans also come with interest to be repaid. If the loans or withdrawals aren’t repaid, they are taken from the policy’s death benefit. However, an upside to this financial flexibility is the favorable treatment of life insurance within the IRS tax code. Policy loans and withdrawals from a permanent policy can potentially be tax-free, which can be used for funding retirement income or other longer-term financial objectives.
How Does the Cash Value Grow?
How the cash value grows differs from type to type of permanent life insurance. So, it would depend on the kind you bought. With that said:
- Whole life provides a guaranteed interest rate on the cash value
- With universal life, the cash value is determined based on current interest rate assumptions – it performs well when interest rates are high, and vice versa
- In the case of indexed universal life, growth of the cash value is linked to an index, like the S&P 500 price index
- In a variable universal life policy, premiums are put into subaccounts, and cash value growth depends on how the underlying investments perform
Term or Permanent Life Insurance: Which is Right for You?
Many people rely upon term insurance for more temporary coverage of certain needs, such as:
- Income protection when household’s primary income-earner is younger
- Having emergency money available should primary income-earner pass away
- Financial protection to cover large or rapidly-increasing needs – for example, a fast-growing family, a loved one having special care needs, or other situations where needs may be outgrowing household income
- A supplement for permanent coverage during years of high protection needs
On the other hand, permanent insurance may be a better-fitting option for more long-term goals. When structured properly in relation to other assets, permanent life insurance can also be used for retirement or lifelong financial objectives. The cash value component enables a number of functions, including:
- Providing another tax-advantaged “bucket” to build up retirement money, in addition to 401(k), IRAs, or other retirement savings plans
- Generating potentially tax-free income for retirement
- Paying for college tuition or other costly educational expenses for loved ones
- Paying off mortgage debt or other holdover debt at time you need it
- Having money to put towards a rainy-day purchase
Term or Permanent Insurance: Some Closing Thoughts
You may also want to consider life insurance coverage, in general, for estate planning purposes. Many Americans forget about the potential effects of taxes on their estate. Because their estate plan is not setup to be tax-efficient, upon death, federal and state taxes are levied on the estate and erode its value. Life insurance provides instant liquidity and can give your beneficiaries an efficient wealth transfer.
While permanent life insurance has many benefits, it isn’t right for everyone. And vice versa for term life insurance. The bottom line? Any life insurance should make sense for your needs, goals, and situation. Insurance rates are important, but since this affects your future, it’s prudent to consider more than just premiums when looking at life insurance.
Working with a knowledgeable financial professional can help you identify what coverage is best for you. To request a free, no-obligation consultation, contact us today.