There are two basic types of life insurance: term and permanent life insurance.
Permanent life insurance provides lifelong protection for your family and financial dependents, as well as the ability to grow the cash value tax-deferred. The policy cannot be cancelled by the insurance company as long as your premiums are paid and remains in effect until the death of the insured person.
The Skinny On Permanent Life Insurance Products
Most permanent life policies require premium payments over the insured person’s entire lifetime and do not permit a change in the death benefits, coverage options, terms, or conditions. Despite the inflexibility and higher premiums, permanent life insurance may be a good option for families who have a long-term need for income replacement and estate planning.
They have several components.
All permanent policies have a savings or investment feature that increases in value over time. For this reason, permanent coverage is sometimes also referred to as cash value insurance. Whole life insurance guarantees a rate of return on the equity or cash value in the policy, while universal life may offer a minimum guaranteed return. Just know that the cash value will be very small in the early years of the policy.
The cash value in a life insurance policy can be fully-redeemed (which cancels the policy), or up to 90% of the value can be used as security for a low interest rate loan. The cash value can be used for a down payment on a home, to fund your children’s education, or to cover medical expenses during an illness. If the loan is not repaid, the loan balance will be deducted from any death benefit that is paid out.
Cash Value vs. Death Benefit (Face Amount)
With all types of life insurance, the death benefit, or face amount, is the amount your beneficiaries will be paid out in the event of your death or the contract’s maturity, which is usually around age 100.
In the case of permanent policies, the cash value is the amount of money available to you if you surrender or cancel your policy before your death or its maturity. Furthermore, the death benefit is a fixed number with most kinds of policies, while factors such as mortality rates, administrative expenses and investment returns can affect your cash value.
Why You May Need Permanent Life Insurance?
The logic behind permanent life insurance is that some individuals want coverage for a lifetime.
Even after your youngest child graduates college and becomes financially independent or your mortgage is paid off, what happens to your spouse’s current lifestyle, living expenses, medical bills, and outstanding personal loans? Maybe you have enough in your savings, retirement accounts and pension to cover all these costs, but what if you don’t? What happens if your spouse outlives you by 10, 20, or 30 years?
Permanent life insurance may be the type of coverage you are looking for.
Why I Prefer Term Life Insurance?
Some experts, financial planners and advisers argue that permanent coverage, such as whole or universal life insurance, offers an investment feature to help grow your cash value. Others explain that, if you have a very high income (think $250,000+) or $1 Million in assets, it might provide some benefits. Frankly, don’t believe the hype.
First, always beware of agents, brokers, and investment professionals who very strongly recommend permanent life insurance, especially whole or universal life. It is very well known that the sales commissions for these policies are high, making it more profitable for agents and brokers to sell.
Additionally, term life insurance is significantly cheaper than permanent protection. Depending on your current age, health and the type of term insurance you are comparing, permanent policies can cost 10 to 20 times more than term products.
If you are inclined to buy whole or universal life insurance because of its lifelong protection and investment component, imagine paying $5,000 or more in premiums for the rest of your life and getting a guaranteed 4% rate of return on your cash value.
Did you know that, on average, the stock market has returned a little over 9% per year for the last 100 years? And that statistic is including recessions and depressions.
So, instead of purchasing permanent life insurance, buy a 30-year term life policy, invest the difference in premiums in an index fund, and you’ll come out ahead of the game in the end. If you die within the term period, your spouse and dependents get a death benefit pay out; and if you don’t, you’ll have accumulated a nice nest egg in the process.
Nevertheless, for educational purposes, let’s discuss permanent life insurance.
Types of Permanent Life Insurance
There are three types of permanent life insurance: whole life, universal life and variable universal life. Although all three types of policies are permanent, each has different pros and cons that should be considered when an individual decides to buy coverage.
All permanent policies feature a fixed death benefit that cannot be altered if the policyholder’s financial needs change, but they differ in their investment potential, premium rates, and options.
Whole Life Insurance
Whole life insurance offers a fixed premium, death benefit and an equity/cash value feature with a guaranteed rate of return.
Because of the guaranteed interest rate, some view whole life as an insurance policy with a savings account. Some products, called participating policies, also pay out dividends directly to you or into the cash value. May of the top burial and funeral insurance policies are issued as this type of life insurance. Whole life insurance represents a secure “investment” and is favored by conservative investors since there is almost no risk of losing any of the investment.
Universal Life Insurance
Unlike the fixed premiums required by variable and whole life, universal life insurance has a flexible minimum and maximum premium, a flexible death benefit and an investment component for its cash value. Although universal coverage has a fixed premium for the insurance portion of the policy, consumers have the option to pay more into the cash value.
Universal life insurance offers the flexibility to invest more when your income is high, or to pay the minimum when your budget is tight. The more you pay into the policy, the more money is diverted to the investment account. Similarly, despite providing a fixed death benefit, policyholders are able to decrease or increase (with proof of continued insurability) the death benefit to fit their financial needs.
Furthermore, the equity (cash value) is invested in financial instruments like stocks and bonds, which have greater risks of gains or losses than the secure investments of whole life insurance, meaning the cash value is tied to the success of your investments.
However, most universal coverage guarantees a minimum rate of return, though this guaranteed rate may not outpace increases in administrative expenses, mortality costs and under-performing investments
Policyholders then have the option to obtain a low-interest loan from their cash value reserve. If the loan is not repaid before a claim results in a payout, your beneficiaries may not receive the full face value of the policy. The amount that will be paid out will be the face value of the policy minus your outstanding balance.
Variable Universal Life Insurance
Variable universal life insurance has many of the same features as universal, but the policyholder has more control over his or her equity investments.
As with universal life insurance, variable universal policies have flexible premiums and death benefits, allowing you to increase or decrease your coverage with changing financial needs. Although a portion of your premiums are diverted to the cash value, insurance companies do allow you to make lump-sum payments to increase the amount of investable cash.
In regards to the cash value, you can choose investments from a menu offered by the insurance company. Your investment options range from different asset classes to varying degrees of risk, and you can have one or multiple investment accounts under a single policy.
However, variable universal life insurance does not offer a guaranteed rate of return since you are responsible for the investment decisions in your portfolio. Finally, the cash value can even be used to cover premium payments when you’re on a tight budget due to decreased earnings. Overall, variable universal life policies are best for people with experience in financial markets and investment strategies.
The Pros and Cons of Permanent Life Insurance
PROS: Universal and variable universal life offer flexible premiums and if a policyholder is unable to pay a premium, both types of coverage allow you to use interest accrued on the policy’s cash value to pay the premiums. Moreover, these kinds of permanent protection allow you to change the death benefit if your long-term investment goals and financial needs change.
PROS: The returns from life insurance policies are tax-deferred until the proceeds are withdrawn. The returns of other types of investments are subject to income tax and capital gains tax, giving permanent life insurance obvious tax advantages as an investment. Since the money that is invested is taken from the premiums, permanent insurance may be a good choice for individuals who have difficulty following a savings plan.
CONS: Term life insurance offers the cheapest rates when you are young and healthy, and the cost of permanent life coverage may be prohibitively expensive for many consumers. As mentioned previously, whole contracts may be between 10 and 20 times more costly.
CONS: A whole life policy’s premiums and death benefit are not flexible and cannot be altered as financial circumstances change. The death benefit of universal and variable universal life insurance are tied to the success of investments, so the actual death benefit payout may be less than the policyholder planned to leave his or her family if the investments do not yield the anticipated return.
Permanent vs. Term Life Insurance
Term life insurance expires at the end of the term and has to be replaced or renewed at a higher premium rate. If an insured person develops a serious illness or reaches an advanced age during the term, he or she may be unable to qualify for new life insurance.
Permanent policies do not expire and cannot be cancelled by the company because of changes in your health or age. The cost of whole life is about the same as term insurance when averaged over a lifetime. The only difference is – do you really need life insurance coverage at the age of 60, 65, 70, 75 or 80 and do you want to continue paying premiums well into your retirement?
While permanent life insurance provides financial protection for families in the event of a premature death, it also allows you to invest in your own future. The right way to choose the best life insurance policy is to compare the coverage, options, benefits and rates of different types and find the one that fits both your needs and budget.