The two main types of life insurance options are term life and permanent life. A life insurance policy provides financial protection for your loved ones and mitigates the loss of your income when you die. But depending on the type of life insurance policy you choose, you can also use it as a cash value accumulation tool. Learn more about how a term or permanent life insurance policy could work for you.
An Overview of Options: Term vs. Permanent Life Insurance
|Type||Average Policy Length||Primary Purpose|
|Term Life Insurance||5, 10, 15, 20, 25, 30 years||To financially protect beneficiaries after death|
|Permanent Life Insurance||The lifetime of the insured||To financially protect beneficiaries after death and tax-deferred cash value accumulation|
Term life insurance policies typically only provide coverage for a select period of time. With term life, if the insured passes away during the term, the insurance company pays the beneficiary a tax-free settlement known as the death benefit.
For budget-conscious people that only require coverage for a specified term, a term life policy is a good fit. For example, mortgage life insurance is intended to protect the beneficiary by providing payments if the policyholder dies before the mortgage loan is paid in full. If the loan is a 20-year loan, then taking out a 20-year term life policy makes sense.
As opposed to term life, permanent life insurance policyholders accrue a cash value. This cash value provides a tax-deferred monetary account. The cash value component of permanent life insurance can be used for estate planning, to support dependents long term, or as an income source during retirement.
The downside of permanent life insurance is that it’s more expensive than term, and the cash value portion makes the policy more complex due to fees, taxes, and interest. For those who can afford higher premiums and anticipate having lifelong dependents, a permanent life insurance policy can be ideal.
Understanding Term Life Insurance
|Term Life Insurance Type||Average Policy Length||Death Benefit Amount||Convertible to Permanent Policy?|
|Renewable Term Life Insurance||Can be paid in 1-year increments||Based on preference||Yes, with convertible rider attached|
|Convertible Term Life Insurance||20 years||Based on preference||Yes|
|Group Life Insurance||1 year||Based on preference||Yes|
|Supplemental Life Insurance||20 years||Based on preference||Yes|
|Mortgage Life Insurance||Duration of loan||Remaining mortgage balance||No|
|Credit Life Insurance||Duration of loan||Remaining credit balance||No|
Term life insurance provides coverage for a set number of years for a set price before the policy expires or ends, or before the policy renews and premiums are increased. The policyholder pays premiums to the insurance provider, and if the insured dies during the policy’s term, the insurance company pays a set amount of money to the designated beneficiary. This is the policy’s death benefit.
However, if the term life insurance policyholder dies after the term has expired, and they did not renew or convert the term policy to a permanent policy, no death benefit will be paid out.
Pros and Cons of Term Life Insurance
Term life pros
- Premiums are more affordable than permanent insurance. For young consumers, this is an important consideration.
- Term life is good for protection against assets that are paid off over fixed periods of time. For example, you could provide cost-effective protection with a term life policy for a home mortgage.
- With term insurance, you can purchase at a low price, then convert it to a permanent policy later as your income increases. First-time homebuyers could better afford protection with a term life policy.
- Term life is simpler to understand than a permanent policy. The cash accumulation provided by permanent life adds in the complexities of fees, interest, and other stipulations.
Term life cons
- The set timeframe of term coverage isn’t suitable for everyone. If you’re looking to invest in the future of your dependents long term, a permanent policy is a better option.
- There is no cash value earned with term. Term life insurance is similar to renting a home versus buying one — when you buy a home, you accumulate equity over the life of owning the home, while there is no equity when renting.
- If the policyholder develops a serious health issue, they might not be able to purchase a new policy. If a 30-year-old purchases a 20-year term policy, but develops a serious health issue at age 40, they might not be able to purchase a new policy.
- A term policy can be converted to a permanent one, but you must stay with the original insurance company to do so. This means you may not land the best rate on a permanent policy.
Compare Term Life Insurance Types
- Renewable term life insurance: A renewable term life policy allows the owner to renew at the end of its term. Although the premium price will increase, you won’t have to undergo a new health evaluation, which can be important as you age.
- Convertible term life insurance: A convertible policy lets the owner convert their term policy into a permanent one. You can start with a term insurance policy, then as your income increases, you can convert to a permanent policy and begin accumulating a cash value.
- Group life insurance: Group life insurance — also referred to as annual renewable term — is an employee benefit provided by some employers. Group term has a 1-year duration and provides a fixed death benefit, a level premium, and no cash value.
- Supplemental life insurance: A supplemental policy is a type of term insurance which is intended to strengthen the coverage of an existing policy. If a basic policy doesn’t provide the coverage you need, you can add on supplemental insurance to fill in the coverage gaps. A supplemental policy that adds your spouse or child to your policy is a common supplemental add-on.
- Mortgage and credit life insurance: When a borrower takes out a mortgage loan, they can get a mortgage life insurance policy or a credit life insurance policy on the loan. The policy’s monthly payment is factored into the cost of the mortgage payment. Should the borrower die before the loan is paid in full, this policy pays the remaining balance.
Understanding Permanent Life Insurance
|Permanent Life Insurance Type||Cash Value Growth Method||Medical Exam Generally Needed?||Living Benefits?|
|Whole Life Insurance||Standard||Yes||Yes|
|Universal Life / Indexed Universal Insurance||Standard or Interest rate based on a stock market index||Yes||Yes|
|Variable Life Insurance||Variable interest rate invested in mutual funds||Yes||Yes|
|Final Expense Insurance||Standard||No||Not always|
|Simplified Issue Life Insurance||Conservative-yield||No||Not always|
|Guaranteed Issue Life Insurance||Conservative-yield||No||Not always|
|Joint Life Insurance||Conservative-yield||Yes||Yes|
Permanent life insurance policies provide coverage for the entire life of the policyholder as long as the premiums are paid. Most permanent policies have a built-in cash value accumulation tool, which allows value to grow tax deferred and to be used however the policyholder wishes. In addition, there are living benefits the policyholder can use for long-term care or other financial needs.
- Standard permanent life policies: Standard permanent insurance policies are a contract between the policyholder and the insurance company. In exchange for premium payments, the insurance company pays a tax-free lump sum of money — the death benefit — to the policyholder’s beneficiaries.
- Cash value: Every time the insured makes their premium payments, a portion of the amount goes into an account where it grows at a rate specified by the policy. Once the cash value has grown to a certain amount, money can be borrowed or withdrawn from the policy.
- Living benefits: Living benefits, as opposed to death benefits, can be enjoyed during the policyholder’s life. Long-term care payment, non-forfeiture options during policy surrender, tax-deferred growth of cash value, and the ability to borrow against your policy’s cash value are all examples of living benefits.
Pros and Cons of Permanent Life Insurance
Permanent life insurance has many advantages over term life insurance, but that doesn’t mean that it’s a perfect fit for every person. Here’s a look at the pros and cons of permanent life insurance.
Permanent life pros
- There are options that provide the ability to build wealth, which can be accessed tax-deferred. Although term insurance is more affordable, there is no cash value accumulation.
- The accumulated cash value associated with permanent insurance can be accessed during the insured’s lifetime. This is considered a living benefit, and one that a term policy cannot match.
- The cash value of your policy grows as you pay into it, so it can be used as an income source during retirement. This is similar to purchasing a home. Homes increase in value over time, earning the owner equity; cash accumulation from a permanent policy functions in a similar fashion.
Permanent life cons
- Permanent insurance is not as affordable as term insurance. This can price out some people, such as those just entering the workforce.
- Permanent insurance is a lifelong purchase. Premiums must be paid or the policy will lapse resulting in a loss of coverage. If you’re unsure whether you can afford the cost of a permanent policy for the long haul, a limited-term policy might be a better choice.
- The intricacies involved in the process of cash value can make permanent insurance confusing. With term insurance, policyholders don’t have to worry about interest fees, taxes, and other nuances.
Compare Permanent Life Insurance Types
Like term insurance, permanent life insurance is available in many different shapes and forms. Whole, universal, variable, final expense, simplified issue, guaranteed issue, and joint life insurance each have their own integrated structures.
- Whole life insurance: Whole life is a type of permanent policy that builds cash value over time, and the cash value accumulates from a percentage of the premium amount as it’s paid. The premium levels are fixed, as is the death benefit, so they won’t fluctuate over the life of the policy.
- Universal life insurance: Universal life is similar to whole life with some important distinctions. With universal life policies, the premiums the insured pays and the death benefit are flexible rather than fixed. Another distinction is that the cash value earned on a universal policy can fluctuate based on current market rates if the policy holder has chosen the indexed option for their refunds. This means that the interest rate earned can change or decrease.
- Variable life insurance: Variable life insurance is comprised of separate accounts made up of multiple financial instruments and investment funds. These tools include equity funds, money market funds, bond funds, and various stocks. Variable policies are considered securities contracts due to inherent investment risks and are regulated by federal securities laws. With a variable policy, the death benefit can be linked to the performance of the separate account funds.
- Final expense life insurance: With final expense insurance, the policy’s death benefit is usually lower to only cover final expenses like burial costs. It’s commonly referred to as burial insurance or funeral insurance and is designed for older adults who are making end-of-life plans.
- Simplified issue life insurance: For those concerned that their health may limit their ability to get permanent life insurance, a simplified issue policy is an option. With this type of policy, there are minimal health questions and no medical exam requirement. This is ideal for those looking for coverage quickly.
- Guaranteed issue life insurance: With a guaranteed issue life insurance policy, there is a guaranteed death benefit. This type of permanent policy is available without a medical exam, so it’s geared toward those who don’t qualify for other types of insurance policies due to poor health. Coverage amounts are typically lower due to the lack of screening necessary.
- Joint life insurance: Joint life insurance is a type of policy designed for two people, such as spouses or domestic partners. Depending on the specifics of the policy, benefits can be paid out when one or both policyholders die. These types of policies can be offered as term insurance, but the majority are offered as permanent insurance policies.
What Type of Life Insurance Is Best For You?
The type of life insurance that would best suit your needs depends on your budget, coverage amount, dependents, and whether or not you’d prefer cash value options. Here are some questions to consider when determining if a term life policy or a permanent policy would be best for you.
How much money will your budget allow?
If you’re single with no children and are just entering the workforce, you may not need life insurance now. However, you will need it at some point, and even with no dependents, the younger you start paying into a policy, the lower your rates tend to be.
Term insurance is ideal for young people because the payments are more affordable. Even without children now, you may want to start a family sooner than you think, so with a term policy, you’ll have the coverage you can afford now for when you may need it in the future.
How much coverage do you need?
How much you earn and how many people financially depend on you will drive the amount of coverage your life insurance policy should have. One way to determine the amount of insurance needed is to multiply your annual salary by 10. For example, if you earn $30,000 a year, a good policy amount would be $300,000.
10 x $30,000 = $300,000
So, if you’re earning $30,000, a policy that pays out $300,000 would replace your income for 10 years. Depending on what you can afford in premiums, you could choose a term or permanent policy.
How many dependents do you have?
The amount of protection you need is dependent on how many people rely on your income to survive. If you have one child and your spouse also works full time, the level of protection you need have will likely not be as high as a single-parent provider with three children.
Do you need cash value options?
You won’t accrue any cash value with a term insurance policy. If you’re looking to the future, a permanent insurance policy can create supplemental retirement income, become a college fund for your kids, or act as emergency funds.