The Pros and Cons of Permanent Life Insurance
Permanent life insurance policies, such as whole and universal life insurance, provide coverage for the rest of one's life and typically include a cash value component. The cash value of a permanent policy grows over time and can be used to pay premiums or obtain a loan from the insurer.
Because permanent life insurance policies have much higher rates than term policies, and most financial obligations fade away over time, term life insurance is usually the better choice for most people. However, if you require lifetime coverage and have the financial means to pay for permanent coverage, it can be an excellent way to ensure your loved ones' financial security.
What is Permanent Life Insurance?
Permanent life insurance refers to a group of life insurance policies that cover you for the rest of your life as long as you pay your premiums. So, whether you die soon after purchasing coverage or 50 years later, your beneficiaries will receive a death benefit. Most permanent life insurance policies include a cash value component that functions similarly to an investment account. Once your policy's cash value has grown sufficiently, you can withdraw or borrow from it.
Permanent policies can also pay dividends if you have a participating policy with a mutual life insurance company. Because mutual life insurance companies are owned by their policyholders, profits are distributed as dividends if the insurer earns more than it spends. These dividends can be received in cash, used to pay premiums, or used to purchase additional coverage.
Cash Value of Permanent Life Insurance
When you pay a permanent life insurance premium, a portion of the money is deposited into a cash value account, which grows at the rate specified by the policy. You can borrow money from the insurer and use it as collateral once the cash value reaches a certain amount.
Policy loans do not require any credit checks or qualifications because the insurer holds the funds to cover the loan, and the loan does not have to be repaid within a specific time frame. On policy loans, however, you are charged a small interest rate. Furthermore, if the loan plus unpaid interest exceeds the cash value, your policy will lapse and you may lose coverage. Finally, if you die before repaying the loan, the loan amount will be deducted from the death benefit received by your beneficiaries.
Some permanent life insurance policies allow you to pay premiums using the cash value of the policy. This option is typically available only with universal life insurance policies and is somewhat risky because your policy will lapse if its cash value reaches zero.
The cash value of permanent life insurance does provide some protection because if you decide to surrender your coverage to the insurer, you will receive the cash value back. There are surrender charges during the first several years of coverage, so you would not receive the entire accumulated cash value. You would, however, be able to recoup a portion of the money you paid.
However, because the cash value of a permanent life insurance policy is separate from the death benefit, your beneficiaries will typically not receive any of the cash value if you die.
Types of Permanent Life Insurance Policies
Permanent life insurance policies come in a variety of forms. The main differences between these policies are in how premiums are paid and how the cash value grows over time.
Permanent Life Policy | Premiums | Cash Value Growth |
Whole Life Insurance | Level for length of policy. | Grows at a guaranteed rate. |
Universal Life Insurance | Maximum and minimum premiums are set, but you can pay any amount between these. You can also pay premiums by using the policy’s cash value. | Grows based upon performance of the market, though there’s a guaranteed minimum annual return. |
Variable Life Insurance | Premiums can be level or vary, depending on the policy. | You choose how to invest the cash value from a set of options which are similar to mutual funds. |
Indexed Universal Life Insurance | Maximum and minimum premiums are set, but you can pay any amount between these. You can also pay premiums using the policy’s cash value. | Grows based upon the performance of an index, such as the S&P 500, though there are caps on annual returns. There’s also a guaranteed minimum annual return. |
Variable Universal Life Insurance | Maximum and minimum premiums are set, but you can pay any amount between these. You can pay premiums using the policy’s cash value. | You choose how to invest the cash value from a set of options which are similar to mutual funds. |
Guaranteed Universal Life Insurance | Level for length of policy. | Typically little to no cash value component. |
Guaranteed universal life insurance is typically the best option if you want permanent coverage without an investment component because it has a low cash value component. While guaranteed universal policies are still significantly more expensive than term policies, they are typically the least expensive way to obtain permanent life insurance.
Final Expense Insurance
Some whole life insurance policies are marketed as final expense insurance or burial insurance and are inexpensive. However, because the death benefits are typically limited to less than $50,000, the cost per dollar of coverage is quite high. Final expense insurance policies are costly because they usually do not require a medical exam and are "guaranteed acceptance," which means you cannot be denied. Because the insurer is taking on a much higher risk, the cost of coverage can be prohibitively expensive.
Exception to the Rule: Maturity Dates
In most cases, permanent life insurance will cover you for the rest of your life. Policies, on the other hand, are frequently sold with a maturity date that is linked to your age. If the policy reaches its maturity date and you are still alive, the insurer will usually pay you a lump sum and your coverage will end. The sum of money can be the death benefit of the policy, its cash value, or a predetermined sum.
Whole life insurance policies are typically designed to mature when the policyholder reaches the age of 100, at which point the cash value should equal the death benefit. Universal life insurance policies, on the other hand, frequently specify the age at which the policy matures. This has caused problems for some universal life policyholders, because policies were once sold with maturity dates of 85 years old.
Policyholders who lived past the maturity date of their policy lost coverage and received little cash value in return because the funds had been used to pay premiums. This is less of an issue now that you can usually specify a maturity date as far in the future as age 121 when purchasing coverage.
Term vs Permanent Life Insurance
The primary distinction between term and permanent life insurance is that term policies only provide coverage for a set period of time, such as 20 years. Furthermore, term policies do not have a cash value component.
While this makes term life insurance significantly less expensive than permanent life insurance, it also means that if you outlive the policy, you will not receive any benefits. Some term policies allow you to add a return-of-premium rider, which means you will receive the sum of premiums paid if you live past the term; however, this rider raises the cost of the policy.
Term life insurance is usually the better option because it is less expensive and most people do not need lifetime coverage. Financial obligations tend to decrease significantly as you get older because fewer people rely on your income and more of your financial obligations have been paid off. The following are examples of common financial obligations that term life insurance can cover:
- A home loan
- The education of a child
- Earnings replacement
- A wedding ceremony
- Loans for students
If you're looking for life insurance to help your family with any of these expenses, a cheaper term life insurance policy would be a better fit because the costs would be spread out over time. Term life insurance can be purchased for a period of up to 35 years. Even if your child is a newborn, you can purchase coverage that will last until she is 25, ensuring she will be able to pay for college if you die.
If you have significant financial obligations that are not time sensitive, permanent life insurance policies are a better fit. For example, if you have enough assets to require your family to pay estate taxes when you die, you could purchase permanent coverage to help cover the tax bill. In this case, a guaranteed universal policy would be preferable because it provides a death benefit until the age of 121. (or whatever age you choose).
Permanent life insurance policies with a cash value component are typically appropriate if you require lifelong coverage and have a sizable investment portfolio that you want to diversify.
Underwriting
Term and permanent life insurance policies are very similar in terms of underwriting. You have the option of purchasing a fully underwritten policy, which requires a medical exam but is the least expensive. You can also purchase a no-medical policy, though these typically have a lower death benefit and are more expensive.
The fact that guaranteed acceptance life insurance policies are only available with permanent coverage is a limitation. However, few people require these policies, which are very expensive and have a death benefit of less than $25,000. Given that insurers will accept the vast majority of medical issues, we would not recommend a guaranteed acceptance policy unless you have a severe condition or are unable to perform daily activities on your own.
Tax Benefits of Permanent Life Insurance
The death benefit for both term and permanent life insurance is tax-free to your beneficiaries. However, permanent life insurance has a few tax advantages that term insurance does not have:
- Permanent life insurance policies' cash values grow tax-deferred, similar to gains in a retirement account.
- There are no income taxes if you receive dividends or surrender your coverage unless the amount you receive exceeds the amount you paid in premiums.
- There are no taxes if you take out a policy loan as long as the policy is still in force (that is, the outstanding loan and interest do not exceed the cash value). While other types of loans are not taxed, this is important in the context of policy loans because you are not required to pay the money back to the insurer.
What Happens If You Require Both Term and Permanent Life Insurance?
Depending on your financial situation, you may require a certain amount of permanent coverage as well as coverage for a specific period of time. You have a few options for combining term and permanent life insurance in these situations:
- Permanent life insurance with a term rider: Term riders aren't available for all permanent life insurance policies, so make sure you check before you buy. A term rider is similar to a term policy in that it allows you to add coverage during years when you have higher financial obligations, such as until your mortgage is paid off.
- Permanent life insurance and term life insurance: If you are unable to add a term rider to your permanent policy, you can purchase a term life insurance policy in addition to your permanent policy. This enables you to increase your total coverage when you require a higher combined death benefit while spending significantly less than if you purchased a larger permanent policy.
- Convertible term life insurance: If you believe you will only require term life insurance but are unsure about your future needs, you can purchase a convertible term policy. This is a term life insurance policy with the option to convert to permanent insurance later without re-qualifying. In other words, if you were diagnosed with a medical condition that would make a new policy prohibitively expensive, your permanent policy would be priced based on your original health rating. However, you should inquire about when you will be able to convert the policy, as you may only be able to do so after a certain number of years or when you reach a certain age.
Cost of Permanent Life Insurance
Permanent life insurance rates are significantly higher than term life insurance rates because the insurer is guaranteed to pay a death benefit to your beneficiaries as long as all premiums are paid. A guaranteed universal life insurance policy may cost four times as much as a term policy with comparable coverage, while a whole life policy may easily cost ten times as much.
Most permanent life insurance policies allow you to choose how long you want to pay premiums for. You can pay for coverage in the following ways:
- Throughout your entire life (annually or monthly)
- A specific number of years (such as 20 years)
- Until you reach a certain age(such as 65)
- In the case of a lump-sum payment
Of course, if you choose to make fewer payments, the rates for each premium payment will be much higher. However, by paying more money early on, you can gain the benefit of accumulating a larger cash value, because the value is greater at the start and has a longer time to grow with interest.
The only permanent policies with flexible premiums are universal life insurance policies, which allow you to use the cash value to make payments. This can be useful if an unexpected emergency expense arises.
Alternatively, you can wait until the policy's cash value is fairly large before touching it, and then simply stop paying premiums later in life. However, this benefit is only available if you have contributed enough to the policy to give it a significant cash value. Furthermore, you must keep a close eye on the cash value because costs can rise and the policy may fail to deliver the expected returns. You will lose coverage if the cash value of the policy is depleted.