Permanent insurance or term which is better?
Well let’s look at both first and discuss the pros and cons
Permanent life insurance
Life insurance coverage for which the policyholder pays an annual premium, generally for the life of the insured. This type of policy features a savings component, known as the cash surrender value.
Premiums generally are level and payable for life: Generally premiums are level, the younger you are when you purchase a whole life policy, the less expensive the annual premiums will be.
Dividends: Whole life insurance policies can earn dividends. Be wary of ‘universal life’ policies which may or may not be truly permanent policies. “Whole Life” typically is only available from mutual life insurance companies whereas ‘Universal life” is a term policy with a cash value element designed to mimic a whole life policy. Dividends result when our actual life insurance costs turn out to be less than we assumed in setting the premiums. When this happens, the company may return a portion of your life insurance premium to you as a dividend. Dividends are not guaranteed, since an insurance company doesn’t know our actual costs in advance.
Guaranteed Cash Values: Unlike term life insurance, which does not accumulate any cash values, some of the money you pay into your whole life policy accumulates as guaranteed cash values. If you choose to surrender the policy, these guaranteed cash values would be available to you. Or, as long as the policy is in force, you may borrow against them as a policy loan at the current policy loan interest rate.
The amount of your guaranteed cash value depends on the kind of whole life policy you have, its size and how long you have had it. The growth in cash values is tax deferred under current federal income tax law. Borrowed amounts reduce the death benefit and cash surrender value. As with all life insurance, the death benefit is generally free from ordinary income tax.
Some of the weaknesses involved in permanent insurance include:
Cash Value Rate of Return: Typically the rate of return on the cash value element on whole life or universal life policies are lower than actually investing the money separately. The reasons for this vary but mainly is derived from the insurance company removing the actual cost of insurance and its profits or cut’.
Higher Initial Premium: Permanent policies have a higher premium than term insurance particularly in the initial years. The insurance company needs a higher premium in order to build a reserve for the later years increasing cost of insurance and to build cash values. A better performing mutual company with have a higher premium but often will also have a higher dividend resulting in a better policy performance.
Risk of Lapse on Universal Policies: A very real hazard on universal life policies is late term lapse. This is where the internal cost of insurance outstrips the cash value element you have accumulated inside the policy and it ‘implodes’. This happens when an insurance companies cost of insurance increases and the overall interest paid on the policy lowers due to insurance company investment performance. Make sure to review universal policies on a regular basis to prevent this.
Term Life Insurance
Term life insurance is probably the most basic form of life insurance. It typically provides affordable protection, often with a guaranteed premium, for some period of time. If the insured should die while the policy is in force, the face amount is paid to the named beneficiary. At the end of the premium guarantee period, the insured can renew the coverage at a higher premium. The premium for term life insurance is initially lower than a comparable permanent insurance policy; however, it can increase at each renewal. This initial lower premium usually makes term insurance an ideal choice for individuals with a temporary need for life insurance protection
Term insurance has its weaknesses as well. It certainly isn’t right for all people or under all circumstances. Among its weaknesses, be aware of the following:
You do have to die to collect. Term life insurance provides a death benefit only, for a specific period of time. When the term coverage expires, so does your protection. Also, if you stop paying premiums, the coverage ends. Period.
Purchasing term insurance is often compared to renting a house. When you rent, you get the full and immediate use of the house and all that goes with it, but only for as long as you continue paying rent. As soon as your lease expires, you must leave. Even if you rented the house for 30 years, you have no “equity” or value that belongs to you.
There is the risk of becoming uninsurable when the term coverage expires. While many term policies are convertible to permanent coverage, others may not be. Few companies offer non-convertible term but they DO exist. Most of all, even if the coverage is convertible, there are time limits. If the policy is allowed to expire, you may be required to reapply. If you are found to be uninsurable at that time, you will be without coverage. Also, before making a purchase, make sure you discuss with your agent the types of coverage available that you can convert to. Many cheaper term policies offer a conversion privilege to a permanent policy that is such poor quality you would never want to convert in the first place.
Since premiums increase at each renewal, the long-term cost of term can be expensive. Many people buy term coverage when they’re in their 20s because it seems more affordable when compared to a cash value life insurance policy with the same death benefit amount. By the time they’re in their 40s, the coverage seems a bit pricey, as the rate goes up. In their 50s, the cost has generally outstripped the cost of permanent coverage. Finally, in their 60s, if not sooner, they drop the policy not because they no longer need the protection, but because they usually can’t afford it. Meanwhile, the person who may have paid more for that permanent policy in his or her 20s may still be paying the same premium. That’s why the term policy’s conversion privilege is so important. This valuable feature is usually available in the first few years of the policy, and allows you to convert to permanent insurance without submitting evidence of insurability. Converting to a permanent policy lets you “lock in” a fixed and level premium, and your coverage can never be canceled provided premiums are paid.
Cash-Value Permanent Life Insurance
Cash value life insurance can be a long-term solution for some people. The reasons:
Cash value life insurance provides life-long insurance protection, provided premiums are paid. With few exceptions, once you have been approved for the coverage, your policy cannot be canceled by the carrier. Regardless of your health, the insurance will remain in force.
There are higher initial premiums than term, but cash value life insurance can actually be less expensive than term in the long run. Most permanent policies are eligible for dividends, which are not guaranteed, if and when they are declared by the insurance company. Many companies offer the option to apply current and accumulated dividend values towards payment of all or part of the premiums. If dividend values are sufficient, out-of-pocket premium payments may end or be reduced after several years, yet coverage can continue for life. So while premiums must be paid under both the permanent and term insurance plans, long-term out-of-pocket cost of permanent life insurance may be lower compared to the total cost for a term policy.
It can eliminate the problem of future insurability. Cash value life insurance does not expire after a certain period of time. Also, some policies contain guaranteed purchase options, which allow you to buy additional coverage at specified times, regardless of your health. If you suspect your health may deteriorate with time, a permanent policy may be a better option than a term one.
It builds cash value. This amount part of which is guaranteed under many policies can be used in the future for any purpose you wish. If you like, you can borrow cash value for a down payment on a home, to help pay for your children’s education or to provide income for your retirement. Borrowing cash value from your policy requires the payment of loan interest and will affect your total policy values. Plus, if you decide to stop paying premiums and surrender your policy, the guaranteed policy values are yours.
The term versus permanent life insurance debate has gone on for years, as if it were possible to say that one type of coverage is all good, the other all bad. Sorry, it’s just not that simple.
Term insurance is designed to help people purchase the protection they need when they can’t afford to purchase all permanent insurance or when they only need coverage for a specific period of time. Term life insurance has a guaranteed death benefit but no cash value and the premiums will increase at pre-determined intervals such as 1 year, 5 years, 10 years and 20 years. Policies may be available for as long as 30 years depending on the age of the insured. In most cases, a 30 year term pricing begins to approach the cost of permanent insurance.
It is also very often the product of choice when protection needs may be high for a period of time, then drop back, such as when your family is growing. Term insurance can also be an effective way to supplement permanent insurance during high-need years, such as when family and other financial responsibilities are outpacing income.
In these situations, term coverage allows you to obtain crucial death benefit protection without breaking your budget. Also, if the coverage is convertible (the coverage can be “converted” to a comparable cash value policy, without the need to provide evidence of insurability), you can get the coverage you need today with the ability to obtain permanent coverage in the future. In this respect, term insurance meets a valuable need.
When purchasing coverage renewing or converting a term policy look at more than just the premium. Be careful to think about the pros and cons about each before making your purchase and seek the advice of licensed professionals before making a final purchase. There is no “right” or “wrong” policy for everyone or in all circumstances. Make sure you are properly informed.