Life Insurance

What Is Permanent Life Insurance and How Does It Work?

Permanent life insurance provides both living benefits for the insured and death benefits for the beneficiaries. It may be a good choice for those seeking health insurance coverage.

AdobeStock 384413049

If you’re in the market for life insurance, understanding permanent life insurance and its advantages and disadvantages is a crucial part of the process to learn what type of policy best suits your needs. When it comes to permanent life insurance, these types of policies offer lifelong coverage while providing a possible investment opportunity.

What Is Permanent Life Insurance?

Life insurance policies that provide coverage throughout your lifetime, provided you pay the premiums, are considered permanent insurance policies. Regardless of when you die after purchasing the policy, whoever you appoint as a beneficiary will receive the death benefit as long as your policy was still active at the time of your passing.

Permanent life insurance policies often accrue cash value, which can be used to pay upcoming policy premiums or as an investment that you can borrow or withdraw from while still living. Some insurance carriers even pay annual dividends, which can be used to purchase additional coverage.

How Does Permanent Life Insurance Work? 

While term life insurance provides a death benefit for a certain length of time, permanent life insurance is designed to last the entire duration of your life. Whether you buy it now and live for 80 more years or pass away the day after your coverage begins, your death benefit will be paid out. Most companies have a maturity age of 121 years, meaning if you live to be 121 years old, the death benefit will be paid out while you are still alive.

Permanent life insurance accrues cash value, and many policyholders use the cash value that builds up to keep costs down, especially as insurance costs tend to increase over time. As such, cash value is one of the most significant benefits of permanent life insurance because you can use it as a living benefit. You could choose to apply some of it to your own insurance payments to keep your policy active, or utilize it as a loan for emergencies that you pay back with interest, or as a withdrawal if available as supplemental retirement income. It can be used as an investment tool to help round out your portfolio. 

In addition, the cash value that you accrue is not taxed as income, though any withdrawals could be taxed. The death benefit received by your beneficiary is also typically not taxed, ensuring they receive the entire amount you intended.

Types Of Permanent Life Insurance

Whole Life Insurance

Whole life insurance is the most commonly purchased permanent life insurance policy that offers a death benefit of your choosing, along with a dividend or cash value accumulation that you can utilize. These benefits are determined at the time of purchase and cannot be changed.

The cash value can be borrowed against, typically with low interest. Keep in mind, though, that if you don’t repay it, the death benefit will be reduced. The premium you pay will stay the same since the cash value accrues and is used toward any background increase in premiums. Once you reach a certain age, you no longer pay premiums, though the age will vary by insurer and plan.

Universal Life Insurance

Universal life insurance is the second most common type of permanent life policy and has flexibility for adjustments if you want to increase or decrease the insurance limit. This is helpful for those who may be working to pay off debt and can have a lower death benefit, but who want to lock in the savings of purchasing a permanent life insurance policy while they are young and more likely to receive lower rates.

This policy will also grow in cash value, but this value is based on the current market and is not fixed like whole life. Additionally, you can choose to pay lower premiums and allow the accumulated cash value to pay for the policy, but that could result in a lower death benefit.

Variable Life Insurance

Some permanent life Insurance policies can be purchased on a fixed or variable basis. Just like the name says, the components of variable life insurance can vary. With this type of policy, the death benefit and cash value are determined in units. Those units will then fluctuate depending on current market conditions. Then, the cash value and premiums can be used to invest in tools like mutual funds, stocks, bonds, real estate pools, and money market accounts if you are comfortable with investment risk for potential gains. This may be a good option for those willing to invest a little to get a return, but can also afford the risk of loss if the market warrants it. 

Variable Universal Life Insurance

Combining the benefits and terms of universal life and variable life insurance policies gives you a variable universal life insurance policy. With this type of policy, you can invest in certain risks with the possibility of gains like a variable policy, and also increase or decrease both the death benefit and premiums you pay like a universal policy. It is critical to keep in mind that if you choose to use the investment options and take a loss, that may ultimately reduce the policy’s cash value and maybe even the death benefit. 

Indexed Universal Life Insurance

An even better chance to increase your policy’s cash value is one of the benefits of indexed universal life insurance because the interest rate is not fixed. This means in a market where interest rates remain reasonable, you could gain substantial returns on your investment.

However, this also means you could lose your investments. However, most indexed universal life insurance policies do have a guaranteed specified minimum interest rate, so even if you do take a chance on investing in it, there is still a bare minimum amount of expected return.

Guaranteed Universal Life Insurance

Similar to universal life insurance, guaranteed universal life provides an alternative to those who do not need the investment option, but do want to ensure they will have a death benefit.

Guaranteed universal life includes a no-lapse guarantee, which means as long as your premiums are paid and current, the death benefit will be paid. While this policy does accrue cash value, it is minimal. A guaranteed universal life insurance policy may be a good fit for seniors or those looking for a more affordable option to whole life insurance and do not need investment options.

Advantages of Permanent Life Insurance 

There are several advantages to permanent life insurance that you can consider when deciding which type of policy will best suit your needs.

Cash Value

As mentioned above, the cash value is a benefit of permanent life insurance that you can utilize while still living. Insurance carriers do not require credit checks or any of the typical loan qualifications to lend you money if you borrow against your cash value, other than using the policy as collateral. As long as you pay it back, your death benefit stays intact.

Sometimes, you can use the cash value to help pay policy premiums. Be careful doing this, though, as your policy can lapse if you use all of the value, leaving the balance at $0.

Favorable Tax Treatment

While both term and permanent life insurance provide an income tax-free death benefit to your beneficiaries, permanent life has a few extra tax perks. Like a retirement investment option, the cash value grows tax-deferred. In addition, if a carrier pays dividends and you decide to surrender your policy, that amount will be tax-free as long as you do not receive an amount that is more than what you paid into the policy. There are also no taxes if you take out a loan as long as your policy does not lapse.

Lifelong Coverage

Unlike term insurance, permanent insurance offers lifelong coverage. That is to say, the policy remains in effect as long as premiums are paid, or until the policyholder turns 100 or 121 years old. The exact age depends on the specific policy. This means you won’t have to renew your policy and undergo any medical exams or underwriting questions associated with assessing policy rates.

In the rare cases where you are still alive at the maturity of your policy, the insurance company usually pays you a lump sum, which is sometimes the cash value, a specified amount that was predetermined, or the death benefit.

Steady Premiums With Whole Life

Whole life insurance comes with a predetermined premium depending on the underwriting factors and death benefit you choose. While it may be one of the more expensive options for life insurance, the premiums will never change. On the other hand, if you choose to purchase a term life insurance policy, the premiums will always be higher at the policy’s maturity because it will be rated on your age, and you will be older at each expiration.

Disadvantages of Permanent Life Insurance 

While the advantages of permanent life insurance are abundant, it is also essential to understand the disadvantages before making your decision. 

Affordability

Because of the lifelong nature of permanent life insurance, the cash value and dividend benefits, and possible investment opportunities, it is the most expensive life insurance option available. If you are on a strict budget or only need additional life insurance coverage for a short amount of time — such as if you took out a business loan and need extra protection for the duration of that loan — a term life insurance policy may be a better choice.

Slow Cash Accrual

Cash value is a benefit, but one disadvantage is that it can take an extremely long time to accrue. It can take up to 5 years for you to see any cash value on your policy, and even then, it may not be enough to withdraw or take out a loan. Also, keep in mind that the cash value is not paid out with the death benefit when you do pass away.

Complexity

Permanent life insurance can be complex. The cash value component can be confusing and time-consuming for someone who may be looking to use it as an investment tool. Using cash value to pay premiums sounds excellent, but it does require monitoring to ensure the balance does not run out and cause your policy to lapse. In addition, if you take a loan out against the cash value and cannot pay it back, your death benefit could be decreased.

Who Should Consider Permanent Life Insurance?

Permanent life insurance is not for everyone, but it can be beneficial to many policyholders. If you have maxed out all of your investment and retirement options and are looking for something a little extra, a permanent life insurance policy could be an option.

Those looking for a long-term life insurance solution and those with lifelong dependents could also find a permanent life insurance advantageous, as it guarantees a death benefit for beneficiaries as long as the policy remains active, and there is no need for costly policy renewals.

Finally, if you think you may want to accumulate cash value and use it in the future, consider a permanent life insurance policy.

You also do not have to enroll in a permanent life insurance policy outright to eventually have it. Since it is the more expensive option, many policyholders will start with a term life insurance policy and then convert it to a permanent life insurance policy once they are able to afford the change. However, check with your insurer and individual policy to see if this is a possibility because not all term life policies can be converted to permanent policies.