Permanent Life Insurance Explained
Life insurance is designed to financially protect your loved ones in the event you pass away. If you’re shopping for life insurance and decide you need coverage throughout your entire life, permanent life insurance guarantees lifelong protection and comes with a cash value component.
While permanent life insurance is more expensive and complicated than term life insurance, there are some cases where it can make sense to purchase this type of policy. If you’re considering a permanent life insurance policy, here’s what you need to know before you make your final decision.
What Is Permanent Life Insurance?
Permanent life insurance policies generally provide lifelong coverage and the opportunity to build cash value, which accumulates on a tax-deferred basis. You can tap into the policy’s cash value while you’re alive. The coverage length, cash value and policy charges are why permanent life insurance is more expensive than term life.
Permanent life insurance policies include types of insurance like whole life insurance and universal life insurance.
If you decide to cancel or surrender the policy at any time, you can receive the cash value of the account but may have to pay a surrender charge, if there is one.
Do I Need Permanent Life Insurance?
Whether you need a permanent life insurance policy or a term life policy depends on why you need life insurance.
Permanent life insurance is good for people who want to build cash value. It’s also better than term life insurance for people who want to make sure there is a death benefit payout for their loved ones when they die.
A few typical goals that lead people to permanent life insurance include:
Need for lifelong life insurance protection because of people financially dependent on you.
Want to fund a trust for heirs.
Desire to leave a financial legacy to heirs.
Desire to capitalize on the cash value or investment component of a permanent policy.
Want to make sure your loved ones get money to pay final expenses and funeral costs.
If you want the most affordable life insurance coverage, term life insurance is your better bet. Term life may also be better if your main objective is to pay off your mortgage or replace your income during peak earning years.
Cash Value Within Permanent Life Insurance Policies
When you make premium payments on a permanent life insurance policy, a portion of the money goes toward a cash value account. Once you build up the cash value in the account, you can borrow against it or withdraw it. But if you’ve depleted your cash value and there’s not enough money within the policy to cover policy charges, you may have to pony up more premiums in order to prevent the policy from lapsing.
If you took out a loan from the cash value that you haven’t paid back, the loan amount and interest will be deducted from the death benefit if you pass away.
If you decide you no longer want a permanent policy, you may be able to walk away with some cash value. If you terminate the policy, the insurer will give you the cash value minus any surrender charge.
Types of Permanent Life Insurance
There are multiple types of permanent life insurance that vary in terms of how cash value builds and how much flexibility policyholders have.
Whole life insurance
A whole life insurance policy has fixed and guaranteed premiums, rate of return on cash value and death benefit. The cash value component increases over time based on your interest rate. You can withdraw funds or take out a loan against the cash value.
There are several reasons consumers purchase whole life insurance over other types of permanent policies. First is its predictability, due to the guarantees within the policy.
Another advantage of a whole life policy is that you usually have the opportunity to earn dividends every year. Dividends allow policyholders to share a part of the profitability of a mutual insurance company. While dividends are not guaranteed, you can take the money as cash, use it to pay your premiums, or plow it into your cash value.
Additionally, the growth of the cash value component of the policy is tax-deferred. You’ll pay a tax on gains if you surrender the policy and take the cash value. You won’t pay tax on the portion you take that was from your premium payments.
As with any life insurance policy, the death benefit to your beneficiaries is paid tax-free.
Whole life insurance also has some downsides:
Compared to term life insurance and even other types of permanent policies, whole life insurance tends to be the most expensive.
The interest rate you earn on your cash value is likely less than what you could gain if you invested your money another way.
Whole life insurance policies don’t offer the same type of flexibility you can get with a universal life insurance policy. With a whole life insurance policy, you can’t alter your premium payments or death benefit.
Universal life insurance
Universal life insurance (UL) policies often offer more flexibility than whole life insurance policies. You may be able to adjust your premium payments and death benefit within certain parameters.
The cash value gains within a universal life insurance policy will vary depending on the type of UL policy you buy:
Guaranteed universal life insurance: A guaranteed universal life insurance policy has a set minimum rate of return on cash value.
Indexed universal life insurance: An indexed universal life insurance policy ties your cash value to the performance of an index, such as the S&P 500.
Variable universal life insurance: A variable universal life insurance ties your cash value to investment subaccounts that you can choose and manage. It has more risk but also has more potential upside if your investments perform well.
Your choice of universal life insurance will be based on how much investment risk you want and how much you desire to manage subaccounts.
Universal life insurance tends to be less expensive than whole life insurance policies, but still more expensive than term life insurance.
Additionally, universal life may not have fixed costs within the policy. The premium you pay is split among the cash value account, the cost to insure you and policy charges and fees. But many policy costs increase as you age. If you’ve dipped into your cash value, you might be stuck paying more premiums to cover the charges and keep your policy in force.
Variable life insurance
Variable life insurance offers a death benefit with a cash value component that you can allocate across a variety of investments including stocks, bonds, and money market funds. The investments you select will determine the level of gains or losses within your cash value.
Variable life insurance is designed for those who are willing to assume more investment risk. While you may be able to achieve a greater return than you would see with a whole life policy, you’re also taking on more risk.
If your cash value does well, you could use the gains to pay some of your premiums for the policy.
Additionally, a variable life insurance policy’s fees and expenses can significantly reduce the portion of your premium payments that go toward the cash value. Variable life insurance policies have mortality and expense fees, administration fees, investment management fees and more.
If you’re considering variable life insurance, make sure to understand what parts of policy are guaranteed (such as cash value) and which are not.
Burial and final expense insurance
Burial insurance, also known as funeral insurance or final expense insurance, is a small whole life insurance policy with a death benefit that’s usually between $5,000 and $25,000. These policies are generally sold without a medical exam and you can’t be turned down. Consumers with health issues and/or with tight budgets tend to buy this type of permanent life insurance to cover their burial or funeral costs.
Burial or final expense insurance is designed only to help your beneficiaries cover funeral costs and other miscellaneous expenses after you die. It has a high cost based on the amount of coverage you get.
Burial insurance is not intended to help your family pay for other financial priorities such as college tuition, mortgage payments or daily living expenses.
Survivorship life insurance
Survivorship life insurance is sometimes called “joint life insurance” or the more eyebrow-raising “second-to-die life insurance.” It’s usually a whole life insurance policy. It differs from other permanent life insurance policies because the policy insures two people—usually a married couple. Once both spouses have passed away, the policy pays out the death benefit to the beneficiaries.
Survivorship life insurance is often used to fund a trust so that beneficiaries can pay estate taxes and other estate settlement expenses.
Survivorship life insurance is generally less expensive than buying two separate policies on the same people. This is especially true if one of the people to be insured has medical problems.
Additionally, a survivorship policy is easier to qualify for than a policy for one individual. Since both policyholders must pass away before the policy pays the death benefit, insurers are less concerned if one applicant is less insurable due to health issues.
But this type of policy doesn’t work well if both spouses rely on one another financially. Also, if you and your spouse decide to divorce, you may want to undo the policy. If this is a concern, some insurers may allow you the “right to split” the policy into two individual insurance policies.
Term Life vs. Permanent Life Insurance
There are two main differences between term life and the types of permanent life insurance described above:
Term life insurance has a set period of level premiums, such as 10, 15, 20 or 30 years.
After the level term period is over you can renew the policy every year but at a higher price. It may become unaffordable.
Term life insurance does not build cash value.
Nonetheless, term life insurance is a very good choice for many families. Life insurance needs are often finite, allowing you to match the length of the term to your need for life insurance protection. For instance, someone age 35 might decide to provide $80,000 a year for 30 years with term life insurance.
Term life insurance is the most affordable type of life insurance, so you can get the most bang for your life insurance buck.
Later on, if you discover you need permanent coverage, many term life policies have a term life conversion option to convert the policy to a permanent one. The life insurer will tell you the policy choices at the time you convert. Your rate will be based on the age at which you convert and on your original health class. You won’t need a new life insurance medical exam.
As you weigh out your options, remember there is no one-size-fits-all solution. A financial advisor can help you figure out where life insurance fits into your overall financial plan, and a life insurance agent can help you zero in on the insurers that will give you the best price.
References:
A. Kilroy. (May 12, 2022) Permanent Life Insurance Explained. Frobes Advisor. https://www.forbes.com/advisor/life-insurance/permanent/