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. They also typically have a cash value component that grows over time and can be used to pay premiums or take out a loan from the insurer. Permanent life insurance policies have much higher rates than term policies.
Term life insurance is typically the better option for most people, because life insurance is often used after your death to cover financial obligations, which will decrease or go away over time.
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 life span, so long as premiums are paid. Whether you pass away immediately after purchasing coverage or 50 years later, your beneficiaries would receive a death benefit. Most 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.
If you have a participating policy from a mutual life insurance company, permanent policies can pay 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 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 pay a permanent life insurance premium, a portion of the money goes into a cash value account. This account grows at a rate specified by the policy. Once the cash value has reached a certain amount, 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, which doesn't have to be paid back within a particular period. However, you are charged a small interest rate on policy loans. In addition, if the loan plus unpaid interest exceeds the cash value, your policy will lapse, and you may 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 some financial protection. 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 will have paid.
Note, though, that the cash value is separate from the death benefit of a permanent life insurance policy. When you pass away, your beneficiaries typically will 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 them have to do with how premiums are paid and how the cash value grows over time.
Permanent life policy | Premiums | Cash value growth |
|---|---|---|
| Whole life insurance | Premiums are level for the length of the policy. | Growth is 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 using the policy's cash value. | Growth is based on the performance of the market, but there's a guaranteed minimum annual return. |
| Variable life insurance | Premiums can be level or variable, 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. | Growth is based on the performance of an index, such as the S&P 500, but 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 | Premiums are level for the length of the policy | There is typically little to no cash value component. |
Guaranteed universal life insurance is usually 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. While the rates for these are low, they tend to have death benefits limited to less than $50,000, so the cost per dollar of coverage is quite high.
Final expense insurance policies are expensive per dollar of coverage, because they usually don't require a medical exam. They are "guaranteed acceptance," meaning you can't be turned down.
Exception to the rule: Maturity dates
In most cases, permanent life insurance will provide coverage for your entire life span. However, policies are often sold with a maturity date 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 end. The amount 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, often specify in the policy at what age it matures.
This has caused issues for some universal life policyholders, since policies were sold with a maturity date of 85 years old at one time. If the policyholder lived past their policy's maturity date, they lost their coverage and received little cash value in return, as the funds had been used to pay premiums.
This is less of a problem now, because when you purchase coverage, you can usually specify a maturity date as high as age 121.
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, 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 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, but such a rider increases the cost of the policy.
Term life insurance is typically more suitable, since it's low cost and most people don't actually require lifetime coverage. As you get older, financial obligations tend to decrease significantly, because fewer people depend on your income and you’ve paid off more of your financial obligations. Common financial obligations that term life insurance can cover include:
- Mortgage
- Child's education
- Income replacement
- Wedding
- Student loans
If you're purchasing life insurance to help your family with any of these costs, a cheaper term life insurance policy may be a better fit, because the costs you would be covering with life insurance would be paid over time. You can purchase term life insurance coverage for a period of up to 35 years. Even if your child was just born, you can purchase coverage that would last until they turn 25, which would ensure the child would be able to pay for college if you were 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 cover the tax bill. In this case, you would probably want a guaranteed universal policy, because it provides a death benefit until age 121 (or whatever age you choose).
Permanent life insurance policies with a cash value component typically 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, but 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. In addition, 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 is no income tax, unless the amount you receive is greater than what 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, because you aren't 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 term coverage for a set period. In these cases, you have a few options for combining term and permanent life insurance.
- Permanent life insurance with a term rider: Term riders aren't available for all permanent life insurance policies, so confirm this before buying coverage. A term rider allows you to 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 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 future needs, you can buy a convertible term policy. This is a term life insurance policy with an option to convert it to permanent insurance later on, without the need to requalify. So, if you were diagnosed with a medical condition that would make a new policy incredibly expensive, your permanent policy would be priced based on 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 based on a certain age.
Cost of permanent life insurance
Because 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 you want to pay premiums. You can pay for coverage:
- For your entire life (annually or monthly)
- For a certain number of years (such as 20 years)
- Until you reach a certain age (such as 65)
- In a lump sum
Of course, should you choose to make fewer payments, you'll have a much higher rate for each premium payment. But, by paying more money early on, you can actually get the benefit of building a larger cash value, because the value is bigger at the start and has longer to grow with interest.
Universal life insurance policies are the only permanent policies with flexible premiums, meaning you can use the cash value to make payments. This can be helpful, should an 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: Costs can increase or the policy may not achieve its projected returns, and if the policy's cash value is used up, you will lose your coverage.
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