The Pros and Cons of Permanent Life Insurance

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Permanent life insurance policies, such as whole and universal life insurance, offer lifelong coverage and typically have a cash value component. A permanent policy’s cash value grows over time and can be used to pay premiums or take out a loan from the insurer. Since permanent life insurance policies have much higher rates than term policies, and most financial obligations go away over time, term life insurance is typically the better option for most people. However, if you need lifetime coverage and have the means to pay for permanent coverage, it can be a great way to ensure your loved ones are financially protected.

What is Permanent Life Insurance?

Permanent life insurance refers to a set of life insurance policies that provide coverage for your entire lifespan, so long as premiums are paid. So, whether you pass away immediately after purchasing coverage or 50 years later, your beneficiaries would receive a death benefit. The majority of permanent life insurance policies also have a cash value component, which is similar to an investment account. You can withdraw or borrow from your policy’s cash value once it’s large enough.

In addition, if you have a participating policy from a mutual life insurance company, permanent policies can also pay out dividends. Mutual life insurance companies are owned by their policyholders so, if the insurer brings in more money than is spent, the profits are distributed as dividends. These dividends can be taken as cash, used to pay premiums or used to pay for additional coverage.

Cash Value of Permanent Life Insurance

Each time you make a permanent life insurance premium payment, a portion of the money goes into a cash value account, and this account grows at a rate specified by the policy. Once the cash value has reached a certain size, you can borrow money from the insurer and use it as collateral. Policy loans don’t require any credit checks or qualifications since the insurer holds the money to cover the loan, and the loan doesn’t have to be paid back within a particular period of time. However, you are charged a small interest rate on policy loans. In addition if the loan, plus unpaid interest, exceeds the size of the cash value, your policy will lapse and you can lose your coverage. Finally, if you die before the loan is paid back, the loan amount will be deducted from the death benefit your beneficiaries receive.

For some permanent life insurance policies, you’re also able to pay premiums using the policy’s cash value. This option is usually only available 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 offer a measure of protection as, if you ever decide to give up your coverage to the insurer, you would get the cash value back. During the first several years of coverage, there are surrender charges, so you wouldn’t get the entire accumulated cash value. However, you’d still be able to recoup a portion of the money you’ve paid.

Note, though, that the cash value is separate from the death benefit of a permanent life insurance policy so, when you pass away, your beneficiaries will typically not receive any of the cash value.

Types of Permanent Life Insurance Policies

There are several types of permanent life insurance policies. The primary differences between these policies have to do with how premiums are paid and how the cash value grows over time.

Permanent Life PolicyPremiumsCash Value Growth
Whole Life InsuranceLevel for length of policy.Grows at a guaranteed rate.
Universal Life InsuranceMaximum 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 InsurancePremiums 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 InsuranceMaximum 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 InsuranceMaximum and minimum premiums are set, but you can pay any amount between these. You can also 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 InsuranceLevel for length of policy.Typically little to no cash value component.

Since there’s little cash value component to it, guaranteed universal life insurance is typically the best option if you’re interested in permanent coverage without an investment component. While guaranteed universal policies are still much more expensive than term policies, they’re usually the cheapest way to buy permanent life insurance.

Final Expense Insurance

There are some whole life insurance policies that are marketed as final expense insurance or burial insurance, which come at a low price. However, these tend to have death benefits limited to less than $50,000, so the cost per dollar of coverage is still quite high. Final expense insurance policies are expensive as they usually don’t require a medical exam or are “guaranteed acceptance,” meaning you can’t be turned down for coverage. Since the insurer is taking on a much higher risk, the cost of coverage can be incredibly high.

Exception to the Rule: Maturity Dates

In most cases, permanent life insurance will provide coverage for your entire lifespan. However, policies are often sold with a maturity date which is tied to your age. If the policy reaches its maturity date and you’re still alive, the insurer will typically pay you a sum of money and coverage will cease. The sum of money can be the policy’s death benefit, its cash value or a predetermined sum.

Whole life insurance policies are usually structured to mature when you turn 100 years old, at which point the cash value should equal the death benefit. Universal life insurance policies, on the other hand, will often specify in the policy at what age it matures. This has caused issues for some universal life policyholders, since at one time policies were sold with maturity dates of 85 years of age. If they lived past their policy’s maturity date, policyholders lost their coverage and received little cash value in return, since the funds had been used to pay premiums. This is less of a problem now as you can usually specify a maturity date as high as age 121 when you purchase coverage.

Term vs Permanent Life Insurance

The primary difference between permanent and term life insurance is that term policies only provide coverage for a fixed period of time, such as 20 years. In addition, term policies don’t have a cash value component. While this makes term life insurance significantly less expensive than permanent life insurance, it also means that you will not receive any benefit if you outlive the policy. You can add a return-of-premium rider to some term policies, meaning you will receive the sum of premiums paid if you live past the term; however, such a rider increases the cost of the policy.

Term life insurance is typically the more suitable choice, since it’s low-cost and most people don’t actually require lifetime coverage. As you get older, financial obligations tend to be reduced significantly, since fewer people depend on your income and more of your financial obligations have been paid off. Common financial obligations term life insurance can cover include:

  • A mortgage
  • A child’s education
  • Income replacement
  • A wedding
  • Student loans

If you’re purchasing life insurance to help your family with any of these costs, a cheaper term life insurance policy would be a better fit, since the costs would be paid over time. And you can purchase term life insurance coverage for a term of up to 35 years. Even if your child was just born, then, you can purchase coverage that would last until she turns 25, which would ensure she would be able to pay for college were you to pass away.

Permanent life insurance policies are a better fit if you have significant financial obligations that are not time-sensitive. For example, if you have enough assets that your family would have to pay estate taxes when you die, you could purchase permanent coverage to help them cover the tax bill. In this case, you would probably want to consider a guaranteed universal policy, since it provides a death benefit until 121 years of age (or whatever age you choose). Permanent life insurance policies with a cash value component typically only make sense if you need lifelong coverage and have a large investment portfolio that you want to diversify.

Underwriting

As far as underwriting goes, term and permanent life insurance policies are quite similar. You can choose a fully underwritten policy, which requires a medical exam but costs the least. Alternatively, you can purchase a no medical policy, although these tend to have a limited death benefit and cost more.

A restriction is that guaranteed acceptance life insurance policies are available only with permanent coverage. However, few people actually need these policies, which are very expensive and restrict their death benefit to less than $25,000. Considering insurers will accept the vast majority of medical issues, we wouldn’t recommend a guaranteed acceptance policy unless you have a severe condition or can’t handle daily activities by yourself.

Tax Benefits of Permanent Life Insurance

The death benefit for both term and permanent life insurance is paid to your beneficiaries free of income tax. However, permanent life insurance has a few tax benefits that aren’t available with term coverage:

  • The cash value for permanent life insurance policies grows tax-deferred, similar to gains in a retirement account.
  • If you receive dividends or surrender your coverage, there are no income taxes unless the amount of money you receive is greater than the amount you’ve paid in premiums.
  • There are no taxes if you take out a policy loan, so long as the policy remains in effect (meaning the outstanding loan and interest don’t exceed the cash value). While you’re not taxed on other types of loans, this is important in the context of policy loans as you aren’t actually required to pay the money back to the insurer.

What if You Need Both Term and Permanent Life Insurance?

Depending on your financial situation, you may need a certain amount of permanent coverage, as well as a certain amount of coverage for a set period of time. In these cases, you have a few options to combine term and permanent life insurance:

  • Permanent life insurance with a term rider: Term riders aren’t available for all permanent life insurance policies, so you would need to confirm this before buying coverage. A term rider acts like a term policy in that you can add coverage during years when you have greater financial obligations, such as until your mortgage is paid off.
  • Permanent life insurance and term life insurance: If you’re unable to add a term rider, you can purchase a term life insurance policy in addition to your permanent policy. This allows you to increase your total coverage when you need a larger combined death benefit, but to spend much less than if you bought a larger permanent policy.
  • Convertible term life insurance: If you think you will only need term life insurance but are unsure about your needs in the future, you can buy a convertible term policy. This is simply a term life insurance policy that gives you the option to convert to permanent insurance later on, without the need to re-qualify for coverage. So if you are diagnosed with a condition that would make buying a new policy incredibly expensive, say, your permanent policy would be priced based upon your original health rating. But you need to ask about when you’re able to convert the policy, as you might only be allowed to do so within a certain number of years or when you turn a certain age.

Cost of Permanent Life Insurance

Since the insurer is guaranteed to pay a death benefit to your beneficiaries so long as all premiums are paid, permanent life insurance rates are significantly higher than those for term life insurance. A guaranteed universal life insurance policy might be four times the cost of a term policy with similar coverage, while a whole life policy could easily be 10 times the cost.

Most permanent life insurance policies give you the option of choosing how long you want to pay premiums. You can pay for coverage:

  • Your entire lifetime (annually or monthly)
  • A certain number of years (such as 20 years)
  • Until you reach a certain age (such as 65)
  • In a lump-sum payment

Of course, should you choose to make fewer payments, you’ll have much higher rates for each premium payment. But by paying more money early on, you can actually get the benefit of building a larger cash value, since the value is bigger at the start and has longer to grow with interest.

Universal life insurance policies are the only permanent policies that have “flexible premiums”, meaning you can use the policy’s cash value to make payments. This can be helpful should an unexpected emergency expense come up. Alternatively,you can opt not to touch the policy’s cash value until it’s fairly large, and then simply skip paying premiums later in life. However, this benefit is available only if you’ve paid enough into the policy that it has a sizable cash value. In addition, you must carefully monitor the cash value, since costs can increase or the policy may not achieve its projected returns. If the policy’s cash value is used up, you will lose your coverage.

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