Nowadays, we know how important it is to have life insurance if we want to provide protection for our loved ones and ensure that there are enough funds to cover any debts after passing away. However, there are many different options on the market from numerous insurance companies so we are on a mission to make the process of deciding between term life vs permanent life more accessible and easy to understand.
In this article we will look at the differences between term life versus permanent life insurance. As well as explaining each option fully, we will also take you through the pros and cons of term life vs permanent life so you will be left in a better position to make this very important decision.
And check out our 13 life insurance riders article for more information on how to structure your policy for maximum benefits.
What is Term Life Insurance?
First up, we have term life insurance and this describes a policy with fixed premiums but will only last for a certain amount of time. With policies of five years available, this can go all the way up to thirty years from some insurers but the main fact is that it does have an end date. When the policy has finished, the same premiums will not be guaranteed for a new insurance policy and the application process will have to be completed once again.
During the term, a death benefit will be in place and this will be awarded to the beneficiary should the insured pass away. Once the term has finished, however, this death benefit will disappear and the insured will not be able to access it in any way. Overall, this option is the cheapest form of life insurance because it only lasts for a certain amount of time and the coverage is simple.
For the most part, term life policies are used to cover certain expenses that may not be necessary in the long-term. For example, one may have a mortgage that will be paid off in fifteen years. In this scenario, the term can be fifteen years and the death benefit can be in place to pay off the mortgage just in case the insured were to die beforehand. If the term is outlived, access to any future rewards or benefits would be lost.
Types of Term Life Insurance
There are a few different types of term life insurance. A standard level term life policy offers term lengths from 1 year all the way up to 30 years. Let’s take a look at a few different variations of term life.
Annual Renewable Term
Annual renewable term or ART is a term life policy that lasts for one year at a time. Every year the policy must be renewed. Since you are older, the premiums go up slightly each year. The older you are, the more the premiums will increase. Overtime, ART does not make sense because it becomes cost prohibitive. It is usually used by those looking at securing an SBA loan or small business loan.
Level Term Life
Level term life provides a fixed premium and a fixed death benefit for the duration of the term policy. Today, this is how most term life policies are designed.
Alternatively, some companies increase premiums every five years based on certain age brackets, such as age 50, age 55, age 60, and so on. Our advice would be read the fine print to make sure your premium and death benefit is FIXED.
Exam vs. No Exam
The policy is available in fully underwritten and no medical exam term life. With a fully underwritten policy you will take an exam, which requires a blood draw and urine sample. For those short on time or with an aversion to needles, not having to take a physical exam might be the best choice.
Return of Premium
A term life policy with ROP rider allows the premiums to be returned to the policy owner upon completion of the life insurance policy’s term. For anyone out there that struggles to save, this policy works great as a forced savings account.
However, tying your money up for 30 years in a life insurance policy is not the best choice. You would be better off choosing permanent life insurance with cash value so that you can borrower against your policy and use the funds to make investments, pay down debt, or finance big ticket items, such as vehicles.
Decreasing Term Life
Decreasing term life is a policy where the death benefit goes down over time. This type of coverage was popular years ago as a form of mortgage life insurance. The policyholder could take out a decreasing term for the same amount of time as the mortgage term. The idea being that as the mortgage went down, so did the need for life insurance.
Nowadays, the best route to take to cover a mortgage is level term life, which you will find is typically the same price as decreasing term life. If the purpose of the coverage is to protect a mortgage, where you are required by a lender to use the life insurance as collateral, you can always collaterally assign the death benefit to a loved one so that the bank does not get the full face amount of the policy. This prevents the bank from getting more than its share of the death benefit as you pay the mortgage down.
What is Permanent Life Insurance?
On the flip side, we have permanent life insurance and this is a policy that has no end date because it is designed to last until the death of the insured. When the insured does pass away, the death benefit will go to the beneficiary just as we saw previously. However, there is another side to this type of life insurance and it is the ‘cash value’ which grows over time. As this savings section grows, the policyholder can even borrow money against the funds or withdraw it to use when desired.
Nowadays, there is a good tax incentive for owners of permanent life insurance policies because the cash value that builds is normally free from all tax (or at least tax deferred) as we will discuss when listing the benefits later. As long as the policy is active, this means that the money will be tax-free when it is borrowed from the policy because policy loans aren’t considered in the conversation with other types of income and earnings.
Types of Permanent Life Insurance
While term life insurance is fairly simple in nature, permanent is a little bit different in that there are numerous options depending on your needs and wants. At first, it is normal to feel a little intimidated when looking through but they are actually relatively simple to understand.
Whole Life Insurance
As we have seen previously, this is a policy that sees consistent premiums throughout the life of the policy as well as the two sides – death benefit and the cash value. Just like normal, the death benefit will be paid to the beneficiary upon the passing of the insured. As long as the premium payments are made when required, the cash value will continue to build at a minimum guaranteed rate which will be tax-free when the policyholder decides to withdraw (up to your basis) or take a policy loan.
Furthermore, there may also be an opportunity to earn dividends on the policy if the insurance company offers participating whole life insurance. Dividends can boost your cash value even more, especially if you use the dividends to purchase more paid up insurance through a paid up additions rider.
Finally, a whole life policy will also have a ‘surrender value’ which is what the policy is worth at any given time if the policyholder decided to cancel the policy and surrender all rights to future benefits. If the policy was cancelled, this value would go to the owner but the chance to earn the death benefit would be gone.
With universal life insurance, there is a little more flexibility because premiums can periodically be adjusted. The most basic of universal life is called guaranteed universal life. The guaranteed portion is the death benefit, which will last until age 95 up to age 121.
Interest on Universal Life is typically credited monthly compared to annually with whole life. The pro for universal life vs whole life is in a rising interest rate environment, universal life will keep up with the rising rates, and owners may see faster cash value accumulation as whole life policies take longer to adjust and catch up.
Indexed Universal Life
As a type of universal life insurance, this indexed variant sees the interest build in a different way. Rather than building a small amount each time as with regular universal life, it will increase with an equity index without being directly invested into the stock market. With some policies, you will be able to choose multiple indexes while also remaining in control of what percentage goes towards a fixed account and what percentage is indexed so you can be guaranteed at least some returns.
How does it work? After choosing an index, the value of said index will be compared from the beginning of the measured period to the end. If there has been an increase, this interest will add onto your cash value. The policy has a minimum (floor) and maximum (cap) return built into the policy. Currently, the minimum is 1% and the maximum is 13%. That means you will not participate in a negative market but your gains in an up market will be capped.
As you can tell, there is a potential to see higher rewards than in a standard universal life policy but there is also another option we haven’t yet discussed that can maximize returns—and losses.
Variable Universal Life
Finally, this is another flexible option for the policyholder because the premium amount can be changed; of course, this will have an impact on the coverage amount itself. As for the cash value side of things, the investment will normally go into sub-accounts which work in a very similar way to mutual funds. With an exposure to stocks and bonds, there is a chance of seeing a much higher return than with the previous two options. This being said, the risk is also higher and may deter those who are looking for a simple life insurance policy. Ultimately, it is all about assessing your needs as to which one you choose from this list.
Term Life Insurance: Pros and Cons
When looking to decide whether to go for term life v permanent life insurance, it is important to know that there are both pros and cons to both term and permanent life insurance and these should be discussed.
Benefits of Term Life
- First and foremost, the price is often one of the most important factors for life insurance and term life has the advantage of being cheaper. Because it only covers a specific period of time and because there is no cash value involved, the premiums are cheaper which means that you will have more of your disposable income for other things. If things are tight financially right now, it can be good to go for this option because then at least you know that your family will be protected.
- Second, we should also point out that it is rather flexible if you only need life insurance for a certain reason. If we use a mortgage as an example, a term life insurance policy can cover the amount of years left on the mortgage before finishing as the mortgage is paid off. Furthermore, there may also be options to see the coverage reduced as years pass which will see the premiums fall and make the whole process less risky and more beneficial to your circumstances.
- Sticking with the theme of being flexible, you could also use the policy for your children. While young, you need to ensure that there will be a replacement income should you pass away to cover nursery, school, babysitting fees, college, extra-curriculum classes, or whatever it may be. However, these expenses won’t be needed once they reach adulthood so this is when you could have the insurance come to an end.
- For one more example, you could even cover a business loan and take out the insurance for business purposes. If the business would fold after your passing because of the loan, you would need the death benefit in place. When the business loan is all paid up, the insurance is no longer necessary which makes term life insurance perfect for this type of situation.
Drawbacks of Term Life
- Despite the many benefits, we should also point out the negatives and this starts with those who are younger. For now, term life insurance might seem like a great idea because the premiums are cheap but what about in the future? When the policy runs out and you outlive it, you will be stuck because a new policy will have to be found but the premiums will be higher because you will be older and could even have health issues. At least with permanent life insurance, you know that premiums will remain steady regardless of your age.
- Aside from this, the policy ending is a negative in itself because you could be left with nothing at the end of the policy. However many years from now, you will have no insurance, no death benefit, and no built-up cash value so you essentially have to start again.
- This being said, there are two ways to counter this problem – return of premium rider and the conversion option rider. With the first option, you will pay a higher premium but all premiums will be returned to you if the policy is outlived. With the latter, again the premium may increase but you will have an option to convert your policy from term life to a permanent form of insurance at any time during the term.
Permanent Life Insurance: Pros and Cons
So we have seen the pros and cons of term life insurance but what about permanent life insurance? Will this option be better suited to your needs?
Benefits of Permanent Life Insurance
- Above all else, you know that you have coverage until you die with permanent life insurance and this can be great for providing peace of mind. Rather than worrying about when your policy expires and when you have to renew or find a completely new policy, you know that you have the coverage in tow as long as you keep paying the necessary premium payments. With this, you are also safe in the knowledge that you have stability when it comes to your premium payments. Throughout the policy, they could remain at exactly the same level which enables you to focus on your finances and plan well into the future.
- Next, it is also extremely useful for those looking to plan their estate. When the death benefit is received, it will be free from tax which means that it can all go towards what it was intended for such as funeral costs, medical bills, and beneficiaries. On some occasions, there may be tax involved if the estate falls above the federal estate tax exemption level but life insurance has been designed so that the recipients of the benefit should be free from tax.
- If your family has a particularly large estate, the settlement costs involved will be significant which can be problematic when there are businesses involved because your family will want to keep them as going concerns. In many cases each year, the family left behind needs the liquidity from the life insurance to keep assets in place for the future generations. Therefore, most planners of estates will suggest keeping the policy in an irrevocable trust so that the proceeds are not seen as part of the estate and, therefore, taxes can remain at a respectable level.
- Moving onto businesses, you may be vital to the success of your business and without you, the business may have to cease trading. If this is the case, permanent life insurance offers an option called ‘key man’ or ‘key person’ which ensures that the remaining business partners receive an amount of money to either keep the business going or compensate for the loss should the insured pass away. Without this insurance in place, the people left behind may have to pay out of their own money to keep the business going or to stop all activities.
- In addition to the previous example, buy sell agreements can also be placed into life insurance policies and this is where the business will actually own the policies for all co-owners. If one owner was to pass away, the death benefit would be split between the remaining parties with the main aim of buying the deceased’s shares so that the business can continue. Normally, the business will actually pay the premiums so it is a fair agreement between all co-owners.
- Finally, permanent cash value life insurance also allows you to look towards your retirement. With a policy in place, loans can be taken against the cash value to supplement the retirement you have taken. Furthermore, this will be tax-free which leaves you in a greater position moving forward. Without this life insurance, loans come at a cost and financing can be hard but life insurance provides an opportunity to enjoy retirement more comfortably.
Drawbacks of Permanent Life
- On the other hand, there is one negative and why some people are better off choosing to go with term life insurance. Mainly, the cost of permanent insurance may be too much for the younger generations. Seeing as though it is a more expensive option than term life, at least initially, it takes a larger percentage of income and this can be tough for the young people who are just trying to get started in life. Therefore, term life insurance is a more common option within this age range. If they wanted a permanent policy in the future, the conversion option rider could be a great choice.
Term vs Permanent Life Insurance Summary
There we have it, your guide to term life vs permanent life insurance. With all of this information we have provided today, you should be able to assess your current position to then decide what type of coverage you need. If you need any extra help, it is just a phone call away. Regardless of which way you make the decision, just make sure that it gets made – going without life insurance is nothing short of criminal these days.