Guide to Permanent Life Insurance
Approximately 60% of Americans have some type of life insurance. Due to its low premium payments, term life insurance tends to be a popular type of policy. However, it is also a very limited type of insurance — a big reason why it is so inexpensive.
For some people, the limited benefits offered by term life are simply not enough. They’re looking for a different type of insurance, a lasting form of protection. That’s where permanent life insurance comes in. However, there are a few types of permanent life insurance with different investment and value options to choose from. Learning about permanent life insurance can feel confusing, but we will break it all down for you.
Read on to learn everything you need to know about the basics of permanent life insurance.
What Is Permanent Life Insurance?
Unlike term life insurance, which only covers you for a specific period of time, permanent life insurance never expires. The policy will pay out whether you live to be 57 or 107. For this reason, permanent life insurance policies tend to be several times more expensive than term life policies.
You can think of the difference between the two types along the lines of the difference between renting and buying a home. Term life is like renting. As long as you pay your premium each month, your beneficiary has the right to a death benefit if you die within the term length. However, once the term ends, the coverage ends and you have nothing to show for it, just as when you rent a home.
Permanent life insurance, by contrast, is like owning a home. You’re building equity in an asset that has value and that you will own. Most importantly, permanent life insurance doesn’t lapse. Unless you choose to surrender your policy, permanent life insurance covers you for your entire lifetime.
There are many options with permanent life insurance, which means it offers a great deal of flexibility. However, these options can also make the whole subject a bit confusing. To start breaking it down, let’s discuss the three main types of permanent life insurance.
Whole Life Insurance
Whole life offers a death benefit while accumulating a tax-deferred cash value. If the insurance company’s investment strategy is going well, you will also receive dividends on your money. You can choose to receive dividend payments, reinvest them into the cash value of your whole life policy, or use them to buy more coverage. If you don’t mind dipping into your cash value, you can also use them to pay some (or, eventually, even all) of your premiums.
When you first take out the policy, you can opt to pay premiums for a specific number of years or until you reach a certain age. The shorter the period of time you choose, the higher your premium payments will be. Premiums are fixed for the duration of the policy.
Even while you are alive, you enjoy some benefits from a whole life policy. You can borrow against the cash value, much like you can take out a home equity loan against the equity in your home. Your cash value must have reached a certain amount, and any such loan is subject to certain restrictions that depend on how much you have available. Your heirs are also responsible for paying the loan if you die before paying it back.
Additionally, you can cash out your policy in an emergency to receive the cash value, but doing so means you lose the death benefit.
Universal Life Insurance
Universal life insurance also offers both a death benefit and an investment portion. However, it offers greater flexibility when it comes to paying premiums. Each of your premium payments is split in two, with one portion going to secure your death benefit and the other to a tax-deferred investment account that earns interest.
Once you have built up a large enough balance in that investment account, you can use it to supplement your premiums. In this way, you can choose to pay higher premiums during times when you have extra cash and lower payments when money gets tight. At some point, you can even stop paying premiums altogether if that makes sense for your financial situation. However, you should always be aware of how much money is available in your cash account, or else your coverage could lapse.
You are also allowed to change your death benefit, though a medical exam may be required. The flexibility to add or reduce your amount of coverage without surrendering the policy altogether can bring peace of mind.
You can also withdraw funds or borrow against your cash value. However, you should be aware that if you take too much out of the account, you won’t have as much to fall back on if a time of need should arise.
Burial and Final Expense Insurance
Dying can be expensive. In fact, the average funeral in America costs between $7,000 and $12,000. If you want anything even remotely sophisticated, the price only goes up from there. For this reason, many people want to make sure their families aren’t scrambling to pay their final expenses after they are gone.
While you can do this with any of the life insurance plans we’ve talked about, burial and final expense insurance is an option in certain situations. For example, if you’re already too old or too sick to qualify for a different type of life insurance, you can usually take out a burial insurance policy. You may have to answer a few medical questions, but there is no medical exam.
Some policies even offer guaranteed issue insurance that doesn’t even require answering medical questions. However, while your heirs will receive the premiums plus interest that you had paid before dying, they will not receive a death benefit until after you have paid premiums for two or three years.
Burial insurance may appear attractive, but for most people other types of life insurance offer better value. This type of permanent life insurance generally covers the highest-risk group of people, which makes it more expensive.
Benefits of Permanent Life Insurance
Compared to term life insurance, permanent life policies offer some clear benefits. The main one, of course, is the cash value they accumulate. While a term life policy gives you nothing once it expires, permanent life insurance is actually worth something. It can also be a good option for wealthy individuals who have already exhausted other tax-deferred retirement options such as an IRA or 401(k).
In addition, permanent life policies offer significant tax benefits. While your heirs will not have to pay taxes on the death benefit even with a term life insurance policy, the tax benefits of permanent life go well beyond that.
For example, your investment account money grows tax-deferred, making it like other savings accounts that you can use to fund your retirement. In addition, any money that you receive back, such as dividends or from cashing out your account, is tax-free. You will have to pay taxes, though, if the amount you remove exceeds the amount of the premiums you’ve paid.
Particularly with universal policies, there is substantial flexibility in paying your premiums. Having the ability to adjust your payments as your financial situation changes can be a real asset.
Drawbacks of Permanent Life Insurance
The main disadvantage of permanent life insurance is the cost. While term life might only cost about two large pizzas a month, permanent life will be more like twenty. Some of that money is going into your cash account and being invested, but it is still a lot of money to pay out each month.
Generally, the earlier in life you begin making payments, the lower those payments will be, which is something to keep in mind if you plan on buying this type of insurance in the future. Buying it earlier will make more financial sense.
Who Needs Permanent Life Insurance?
While virtually everyone needs some form of life insurance, not everyone can justify the extra expense of permanent insurance. People who would most benefit from permanent life policies include:
- Those with a high net worth who want to cover estate or inheritance taxes
- Those who have already maxed out their 401(k)s and IRAs and are looking for additional tax-deferred investment options
- Young investors who are willing to take a higher risk and want to reap the rewards of greater cash value
- Those who already have a term life insurance policy but want more security
- Those who want to ensure a death benefit for their heirs when they die, regardless of how long they live after taking out the policy
How Much Life Insurance Do You Need?
A major determination of your monthly premium will be the amount of coverage you choose. A death benefit of $5 million will require a much higher monthly payment than a $500,000 benefit. Because of this, you don’t want to sign up for an exorbitant amount of coverage. Your beneficiaries will appreciate it, but you don’t want to squeeze your cash flow too much during your lifetime. However, you don’t want to sign up for too little insurance either.
A good rule of thumb is to aim for roughly 10–15 times your annual salary. This will give your beneficiaries enough money to pay off a house, cover college expenses, or simply pay bills until small children are grown and become self-sufficient.
As you might imagine, your individual circumstances can change the amount of insurance you need, so we recommend speaking with a financial advisor. For example, parents with special-needs children who will need care for the rest of their lives may need more coverage.
All in all, permanent life insurance is a good option for people in certain financial situations. Generally, wealthy individuals looking for more investment options or those wanting to ensure their heirs receive a death benefit regardless of when they die will benefit from choosing a permanent policy.
If you can afford the premiums (or begin paying when you are young), a permanent policy’s cash value provides a reliable financial backup for emergencies. However, this factor alone does not make permanent life insurance worth the cost for most people.
Frequently Asked Questions About Permanent Life Insurance
Is permanent life insurance a good investment?
It can be, for the right person. High-net worth individuals looking to reduce estate taxes will benefit from investing in permanent life insurance.
However, most people would do better taking out a less expensive term life insurance policy and investing the difference.
Can you cash out permanent life insurance?
Yes, you can withdraw funds from the cash value of your insurance policy, borrow against its value, or surrender the policy altogether.
However, be sure you fully understand the implications before making any decisions. Going about it the wrong way could incur unexpected tax penalties or reduce your death benefit. In addition, surrendering your policy altogether translates to a complete loss of the death benefit. Depending on your situation, you may also have to pay income taxes on the amount you receive.
Which is better—term or whole life?
It is hard that say that one type of insurance is always better than the other; the answer depends on each person’s situation. For most people, a less expensive term life policy will make more sense. What they save on expensive permanent life insurance premiums can be invested for their retirement.
However, for individuals who have already maxed out their available tax-deferred retirement account options, a permanent policy might make more sense. Whole life is also better for those who want to ensure a death benefit for their heirs, regardless of how long they live.