Everyone who’s ever thought of buying life insurance or have looked around for one will be faced with the long standing debate of permanent versus term life insurance policies. Buying the incorrect type of life insurance can actually prove to be really detrimental to a person’s financial future. So, if you are planning on acquiring a life insurance, you might as well consider whether to get term, permanent, or a combination of both. In order to make a sound decision, you should know at least the basics of the different kinds of life insurance.
Term life insurance provides only death benefits. If you die within the term of the policy, then you get the death benefits. If you live beyond the policy’s term, then you will not get anything but you can certainly renew your policy for another period of time. This type of policy works well if you want to be insured long enough for your kid to finish college. This means that they will have something to use for their college education should you meet an untimely demise.
Permanent life insurance, on the other hand, provides coverage for the duration of the insured’s life. This policy also has death benefits plus a savings component also known as the cash value. So, even if you stay alive for a long time, you can recover some funds from your insurance, which would be more than the money you paid for the premium. This money can be recovered either by borrowing against the policy or cashing in.
It goes without saying that permanent life is more costly than term life mainly due to its savings component. But the longer you maintain the policy, the higher the cash value will be because the funds accumulate and earn dividends, interest, or both. This is where the debate on whether to buy a permanent or term life insurance lies. If you purchase a life insurance today, you can expect that your first premium will be significantly higher for permanent than for term life.
You should know though that the premiums for permanent life remain the same all throughout, but the term life premiums increase over time. The high premium you pay during the early years of your permanent life will be invested and can grow. This investment is tax-deferred if you cash in on the policy while you are still alive. If you die, the proceeds will go to your beneficiaries tax-free.
You will always get the advice to buy term life and just invest the rest of your money. This may work for some people, but you still have to consider the length of time you want to be covered. How long you want to keep your policy will depend on factors like your health, age, policy coverage, interest rates, dividends and more. The answer is not really that simple because life insurance is not a simple product. Experts will suggest a rule of thumb you can use when deciding on which type of policy to purchase. They say that if you want to have life insurance for ten years or less, then you are better off with a term life policy. If however, you want to be covered for up to around 20 years, then you should consider permanent life.
Another relevant consideration is how much insurance you need. The simple computation can be based on how you plan for the proceeds to be used. Let us say you have children going to college and you estimate that they will need $60,000 each for tuition. If this is the only purpose for ensuring against your death, then you can simply multiply the value to the number of children going to college and consider the year that your youngest will graduate for the duration of the term life policy.
On the other hand, if you have an estate that you expect to pay a significant amount on when you pass away, then a permanent life insurance might be more appropriate for you. You may also need to re-consider your succession plan for your estate, but that is an entirely different issue. If you feel you cannot conduct you own needs analysis, you can always consult an insurance agent or a lawyer well versed on financial planning.
You may find that term insurance is easier to understand. You can choose among the fixed length of time you want the policy in force. You also get to choose the premium and how much it will increase annually, if you are getting a policy on annual renewal term. You can also decide to keep the premiums the same for the duration of the term of your policy. You may find that insurers will reserve the right to raise premiums for different reasons like the rising costs of the company or your health.
Typically, term life policies can be converted to permanent life even without proof of good health. Permanent life has three types. There is the traditional whole life where the premium is guaranteed as well as the death benefits and the cash values. Most whole life policies are participating, which means the dividends earned may be applied to either the cash component or the death benefits, or it can be used to pay off premiums or be withdrawn for other use.
Another type of permanent life insurance is universal life which offers premium flexibility. The premiums for this policy can change from year to year and some carriers will even let you skip a year if needed. This type of policy has maximum guaranteed premiums and minimum guaranteed values for the death benefits and the cash component.
The last type of permanent life is the variable life policy, which offers the lowest guarantees but has the best potential for increases in cash value. You will not get guaranteed cash value and you will have to decide on the direction of your investment. Insurers would typically have a variety of mutual funds that you can apply your investments to.