Permanent Life Insurance vs. Term Life Insurance
Which to Buy?
The insurance industry is second only to the legal industry in making things more complicated than they need to be. There are really just two kinds of life insurance: permanent and term. Variations of each type exist, but let’s define “Perm” and “Term” as a starting place.
I’ll use the example of purchasing a house versus renting a house to illustrate the difference between permanent and term life insurance.
Permanent Life Insurance Information
Permanent Life Insurance (also called cash-value life insurance and two examples are: Whole Life and all variations of Universal Life)
Each of these is a variation on the theme of permanent life insurance, designed for specific or niche purposes.
Summary: Permanent life insurance is meant to be held for your lifetime. The insurance company pays your beneficiary upon your death. It’s also designed to build equity or cash value.
The following is not legally correct and is only used so one can get a general understanding between Perm and Term. When you purchase a house, part of every mortgage payment goes toward reducing the principal of your loan. As the amount of your loan decreases, the amount of your equity in the house increases.
Likewise with permanent life insurance. Part of your annual insurance premium is put into savings for you. That is, you have equity in the policy. Just as you can take out a home-equity loan based on the equity in your home, so you can borrow against the amount of equity in a permanent life insurance policy. Also, like a house mortgage, permanent life policies mature and are paid up after a certain amount of time. After the policy is paid off can you “cash out” the equity and cancel the insurance?
So permanent life policies have two benefits: the accumulation of equity (savings) over the premium-life of the policy which can be accessed by the policy holder, plus the insurance payout to your beneficiary when you die.
Because of the permanent equity features and designed duration, permanent life policies are more expensive than term life policies.
Term Life Insurance Information
Term Life Insurance
Summary: Term life insurance is purchased for a specific period of time. The insurance company pays your beneficiary only if you die within the time the policy is in force.
Term life insurance is like renting that same house. You pay rent (the insurance premium) each month for the privilege of having insurance for a designated amount of time. You choose the dollar value of the policy and the length of time you want it to be in force: 10, 15, 20 or 30 years. When you end a rental lease on a house or apartment, you have no equity. Likewise, you build up no equity (savings) in term life insurance policies. So you are renting your life insurance and when the “lease” is up, you “move out” or renew the contract at a higher rate.
Because there is no savings or equity-building feature associated with term life insurance, term life insurance is less expensive.
A recent variation of term insurance called “return of premium” term is also available. At the end of the specified term of the insurance you get all your premiums back if you have outlived the term of the insurance. But it is very expensive. And if you die before the end of the term, the insurance company pays the death benefit but does not return any of the premium. This kind of policy is another play on the risk-reward calculations the insurance industry is famous for.
Which to Buy: Term or Permanent Life Insurance?
To cover a specific person for a specific reason for a specific period of time when cost is a factor, term life insurance is best. For example, a young family would use term insurance on the breadwinner(s) for 20 years to insure against the death of a breadwinner during the expensive child-rearing years. So if you need a pile of life insurance, term is the way to go.
For estate planning purposes (for example, a significant payout to the heirs of an estate upon death), fewer budgetary constraints, a fixed period of premium payments yet a lifetime of coverage, and the added advantage of savings which can be accessed, permanent life insurance is best.
Many people today (2017) are buying the hottest product on the market. It’s called Indexed Universal Life. Be very wary of the policy as there are many pitfalls to it. Most don’t understand (that includes agents too) how the contract works. If you are approached to buying one, be sure to visit my article on Universal Life. I believe the insurance industry is repeating the errors they made in the 1980’s after the initial introduction of Universal Life. That cost them millions in class action lawsuits.
For comparison purposes:
|Permanent Life||Term Life|
|Term||Designed for Lifetime||Set period of years|
|Cost||More expensive||Less expensive|
|Primary Benefit||Savings, end of life payout||Protection against
loss of income.