Should I Buy Term or Permanent Life Insurance?
If loved ones depend on you for financial support, it’s imperative you properly prepare for corresponding repercussions after you pass away. Though life insurance presents one of the easiest ways to accomplish this, it can be challenging to choose the right type for you—especially since the marketplace offers an infinite number of policy options and countless features therein.
In this post, we’ll review your life insurance options to help you decide which is perhaps best suited for your needs.
Types of life insurance
Life insurance falls into two primary categories: “term” and “permanent.” Term life insurance is the simplest, most affordable form of life insurance, lasting for a specific amount of time—often up to 30 years—and typically paying designated beneficiaries only if death occurs during this term (meaning they won’t receive any benefits if one outlives the policy). In this case, the death benefit is paid out as a lump sum, monthly benefit, or annuity.
Alternatively, permanent life insurance is an umbrella term for life insurance policies that don’t expire: meaning they’ll pay out regardless of when one passes away. These policies often also feature a savings component—funded by a portion of your premiums—that allows you to build or “accrue” cash value so you can access funds while you’re still alive. Permanent life insurance policies are generally much more expensive than their term counterparts due to the aforementioned features.
Permanent life insurance variations
Permanent life insurance features several options spanning whole life, universal life, variable life, and variable universal life insurance policies. Let’s dig into each one…
Whole life is the most common type of permanent life insurance, offering a guaranteed death benefit regardless of when you die and premiums that remain fixed. They also boast a cash value component—funded from a portion of premium payments—that often offers a fixed interest rate that accrues on a tax-deferred basis, meaning you won’t pay income taxes on the growth of your accumulation (only when you make a withdrawal).
Universal life policies (also called “adjustable life insurance”) offer more flexibility than whole life policies, allowing you to raise or lower your premium payments (within certain limits) and change your death benefit as circumstances evolve.
For example, you can sometimes put money accumulated in the savings portion of the account toward premiums (assuming enough is available to do so). You can also slash your premiums by reducing your death benefit or, alternatively, increase your benefit by boosting your premiums: thus avoiding the need to purchase a new policy.
Universal life insurance is often less expensive than whole life policies (more on that later), and the savings component within these account types generally earns a money market rate of interest that isn’t guaranteed.
Rather than pay policyholders the cash value component, some universal life policies—indexed universal life insurance—tie this to the performance of a stock market index such as the S&P 500 or NASDAQ 100.
Elsewhere, guaranteed universal life insurance (GUL) policies behave similarly to term policies in that the term ends whenever the policy matures; but they do allow you to select coverage up to any specified age rather than a set term of 15, 20, or 30 years. While GUL policies generally offer a cash value component, they aren’t designed to build cash value and therefore won’t generate enough of a return to represent a worthwhile savings option. These types of policies are thus typically the least expensive form of permanent life insurance.
Finally, variable life insurance policies resemble whole life policies but differ in that policyholders can decide how to invest the cash value component of the policy. A variety of options—including stocks, bonds, and money market mutual funds—can help increase (or reduce) the value of the savings component within your policy. With variable universal life insurance, meanwhile, you’ll enjoy the features of both a variable and universal life policy (as the name implies).
Life insurance costs
Primary factors determining the cost of premiums are the coverage amount, term length, and life expectancy (the younger you are, the less expensive the policy). Other determinants include gender (men pay more than women due to their shorter average life expectancy), smoking status, health, occupation, and lifestyle.
Let’s run through some specific scenarios based on age and gender. According to ValuePenguin.com, a $500,000 term life insurance policy with a 20-year term would cost a non-smoking forty-year-old man $50 versus $41 for women. The average premium is $118 and $92, respectively, for 50-year-olds, while the average monthly cost for 60-year-old non-smokers rings in at $318.
Permanent life insurance is generally much more expensive, however. For the same $500,000 coverage noted above, guaranteed universal life monthly rates (to age 121; while you can choose your age, GUL policies commonly mature between age 95 and 121) can cost 40-year-old females $298 and males $338 based on rates published by Policygenuius.com. For 50-year-old females, average premiums increase to $468 ($525 for males) and then to $770 ($866 for males) for 60-year-olds.
The same source reports the lowest monthly rate on a $500,000 whole life policy (fully paid up to age 100) for 40-year-old women is approximately $588 ($706 for men). Premiums average $920 and $1,081 for 50-year-olds and then increase to $1,545 and $1,802 for 60-year-olds.
Universal life policies, which are often less expensive than whole life, are much pricier than term life insurance.
Other life insurance considerations
You can add an accelerated death benefit rider to your insurance policy to help protect loved ones in the event of your death. While most common for permanent life insurance policies overall, some insurers also offer this option for term policies (sometimes at no extra cost).
More specifically, an accelerated death benefit rider is a policy provision that enables you to receive benefits (sometimes called “living benefits”) while you’re alive but deemed terminally, critically, or chronically ill. This can ultimately help offset financial stressors on both yourself and your family, but know that any benefit paid for these riders will go on to reduce your death benefit payout.
Long-term care riders that allow you to pay for related expenses, triggered for individuals who need help with two or more “activities of daily living” (ADLs), are also available as often the most expensive riders tacked onto a policy.
Life insurance is sometimes also an efficient wealth-transfer mechanism, as death benefits paid are typically income tax-free (and possibly estate tax-free as well, if structured correctly). This is especially true when estates include illiquid assets; if heirs aren’t expected to involve themselves in a family business, for example, a life insurance death benefit can play a significant role as an equalizing transfer of wealth.
How to choose between term and permanent life insurance
First and foremost, term policies are a great option if you need coverage and are seeking the most affordable premiums. You should also consider a term policy if you need coverage for a specific period of time: such as when paying off a mortgage, putting kids through college, shouldering costs for a wedding, or replacing income.
Permanent life insurance policies, meanwhile, are best suited for those seeking coverage for a longer duration or for as long as they live (if you can afford corresponding premiums). Because they offer various features, permanent policies are also sometimes desirable for those who would appreciate their flexibility. Beyond this, permanent life insurance is often a viable option for those looking to further diversify a large investment portfolio via a life insurance policy.
Options for undecided individuals
If you’re still unsure of which type you’ll need, know that a convertible term life insurance policy may make sense as a permanent policy conversion option; you also wouldn’t need to requalify in this case as a permanent policy is predicated on your original health rating.
You can also enjoy added flexibility with some permanent life policies that allow you to add a term rider during years when you have greater financial obligations.
Finally, anyone still unsure should remember they can always employ both types of policies.
In sum: term vs. whole life insurance
Choosing between term and permanent life insurance policies ultimately boils down to your objectives. As most larger financial obligations will likely subside over time and premiums are much lower, however, the former type typically suffices for most people.
Still have questions about which life insurance solution is best for you? Schedule a FREE discovery call with one of our financial advisors.
FAQs
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The best approach here is to total your current and future obligations (mortgage, loan debt, college tuition, etc.) and subtract your liquid assets (the amount of money in your savings and retirement accounts); the result is how much insurance you’ll likely need. Want an even simpler approach? A common rule of thumb is to use a multiplier (10 to 15 times) of your annual salary. If you make $100,000 a year, for example, you’ll need a minimum of $1 million in coverage.
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In general, you aren’t required to report life insurance proceeds to the IRS (meaning they’re tax-free). Any interest received is taxable, however, and should be reported accordingly.
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While exact timing varies, it generally takes 14 to 60 days after your insurance carrier receives a death claim to receive a payout.
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While it’s generally smart to buy life insurance when you’re in your 30s (as policies are less expensive for young, healthy individuals), personal circumstances also come into play here. For example, if you own a home, are married, and/or have kids, life insurance quickly becomes a necessity.
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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.
Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.
Variable universal life insurance/variable life insurance policies are subject to substantial fees and charges. Policy values fluctuate and are subject to market risk and possible loss of principal. Guarantees are based on the claims-paying ability of the issuer.
Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy’s account value and death benefit. Withdrawals are taxed only to the extent that they exceed the policy owner’s cost basis in the policy, and loans are typically free from current federal taxation. A policy loan can result in tax consequences if the policy lapses or is surrendered while a loan is outstanding.
