Permanent Life Insurance, it seems that people either love it or hate it. It’s been around for over two centuries, yet it’s perhaps the most misunderstood life insurance product of all.
Jump ahead to these sections:
- Definition of Permanent Life Insurance
- What Are the Different Types of Permanent Life Insurance?
- What’s the Difference Between Permanent Life Insurance and Term Life Insurance?
- Who Typically Buys Permanent Life Insurance?
- How Much Does Permanent Life Insurance Cost?
- What Are the Pros and Cons of Permanent Life Insurance?
- Are There Any Good Alternatives to Permanent Life Insurance?
This article aims to explore the nooks and crannies of permanent life insurance: what it is exactly, the different types, how it stacks up against other types of life insurance, its pros and cons, and more.
After reading this article, you’ll be able to decide for yourself if permanent life insurance is the right product for you and your family, assuming you need life insurance.
Definition of Permanent Life Insurance
Defining permanent life insurance is best accomplished by looking at the definition of the word "permanent." Merriam-Webster defines permanent as "lasting or continuing for a very long time or forever; not temporary or changing." Many people buy life insurance to provide a lump sum of money to their heirs, no matter how long they live. Life insurance with a sense of permanency can be reassuring and is the primary reason some people buy it.
On the other hand, many people only have a temporary need for life insurance. Their financial situation doesn't merit them paying for life insurance protection for their entire life, but they do see the need to have it for a while. Term life insurance, which we'll look at in a moment, meets this need, and it's the biggest competitor of permanent life insurance.
Before we compare the two, let's first look at the different types of permanent life insurance.
What Are the Different Types of Permanent Life Insurance?
Over the years, life insurance companies have developed multiple types of permanent life insurance policies which meet the different needs of a diverse group of people. In many cases, these different types of permanent life products resemble each other, but you’ll see some subtle differences if you look closely at them.
Whole life insurance
The grandfather of all permanent life insurance policies is whole life insurance. It was aptly named because it is to be kept by the policy owner for their “whole life.” It has many features that are the foundation of most permanent life insurance policies. Some of those features are:
Lifetime coverage: As long as you pay your premiums on time, your whole life policy will never lapse. The life insurance company that issued your policy is obligated to pay a death benefit to your beneficiaries named in the policy.
Cash value: Cash value is the defining feature of whole life insurance. A portion of every dollar you pay in premiums is allocated to the cash value component of your whole life policy. This component functions as a savings account in that the money put into the cash value of your policy earns interest, as long as it hasn’t been withdrawn or borrowed from the policy.
In addition to earning interest, the life insurance company that issued the policy can also declare that a “dividend” be added to the cash value accounts of their policyholders. This dividend is essentially a profit-sharing bonus the company gives to their customers, at their discretion.
Interest that is added to the cash value of a whole life insurance policy is not taxed like it is with a bank savings account until it is withdrawn from the policy. If any cash value is distributed to the policy owner in the form of a policy loan, dividends and interest that were credited to the cash value are not taxed.
Fixed premiums: This is also a very popular feature of whole life insurance. Once the premium amount has been established by the life insurance company, that premium will never increase. The only exception is if the policy owner increases the face amount of the policy.
Universal life insurance
Universal life insurance is very similar to whole life insurance in some respects. It also accumulates cash value that the policy owner can withdraw or borrow, and coverage will last for a lifetime as long as they pay their premiums on time and the policy hasn’t lapsed.
However, universal life differs in several areas that can work both to the advantage and disadvantage of policy owners:
Flexible premiums: Universal life insurance initially has a stated premium when the policy is first issued. Still, as time goes on and the policy's cash value grows, that cash value can be applied towards the premium. This feature can provide the policy owner some relief if they're finding it difficult financially to pay the premium out-of-pocket. The downside is that once the cash value drops to a certain level, there won't be enough money to pay the premiums, and the policy will lapse.
Variable interest rates: The interest rate that the life insurance company credits to a universal life policy will vary depending upon prevailing interest rates in the marketplace. It is often tied to the current interest rates of Treasury-Bills (T-Bills), which will fluctuate.
Two death benefit options: Universal life has two distinct death benefit options: Option A and Option B.
Option A pays the face amount stated in the policy, minus any outstanding policy loans. Any cash value remaining in the policy at the time of the insured’s death is forfeited to the insurance company.
Option B pays the face amount of the policy and pays any cash value contained in the policy. While this appears to be an option that everyone would want, bear in mind that the premiums for a policy with death benefit Option B are substantially higher than those for Option A.
Variable universal life insurance
Variable life insurance is a form of permanent life insurance that became very popular in the 1980s. During this time, mutual funds were performing extremely well. In turn, policy owners wanted their cash value to grow faster and larger by participating in the market and not relying on insurance companies to determine the interest rate to be applied.
Cash value grows in variable life policies through “subaccounts,” which are in all actuality mutual funds. These funds consist of stock funds, bond funds, or money market funds, which can be conservative or aggressive. While this sounds like a great feature, and it can be, it also needs to be stated that there is the element of market risk with variable life insurance.
While whole life and universal life have guaranteed minimum interest rates which will keep the policies from lapsing, variable life doesn’t have that particular feature. That means that if the stock or bond markets perform poorly, the cash value in any given year could conceivably suffer a loss. Worst case scenario: you buy a variable life policy at the wrong time when the market is dropping sharply, and you end up losing all of your cash value. Unlikely, but it can happen.
Final expense life insurance
The last type of permanent life insurance we’ll look at is final expense life insurance, also known as “burial insurance.” Its purpose is to pay for final expenses associated with the death of the insured, namely things like the casket, funeral service, burial plot, headstone, etc.
What’s unique about this type of permanent insurance is that it comes in two types: simplified issue, and guaranteed issue.
Simplified issue life insurance is permanent insurance developed for older individuals with health concerns that found it difficult to qualify for a life insurance policy when they applied in their later years. It’s called a simplified issue because there are limited health questions on the application, and no medical examination is required to qualify. However, the insurance company can deny someone applying for a simplified issue policy coverage based on pre-existing medical conditions.
Guaranteed issue life insurance is very similar to a simplified issue in that no medical exam is required, but there are also no health questions asked on the application. Because of this, you are guaranteed coverage; your insurance can't deny you unless you fall outside of the age parameters set by the insurance company (typically ages 45-85).
Because life insurance companies assume a larger amount of risk by asking a limited number of health questions and not requiring a physical exam by the applicant, final expense life insurance is the most expensive type of permanent life insurance on the market.
If you’re concerned about how long it takes to get a life insurance payout, you’ll be happy to know that final expense insurance pays out quicker and is issued quicker than most other types of life insurance.
What’s the Difference Between Permanent Life Insurance and Term Life Insurance?
As previously mentioned, the biggest competition for permanent life insurance is term life insurance.
Permanent life insurance is coverage that will remain in effect for your entire life as long as you pay your premiums. Term life insurance, on the other hand, is designed to be temporary life insurance that will stay in effect for only a specified number of years (typically 1, 5, 10, 20, or 30 years). Once that term has expired, the life insurance is no longer in force, and the insurer is no longer obligated to pay out a death benefit when the insured person dies.
Why would anyone buy a term life policy since it will eventually expire worthless if they don’t die during the term? The reason is that term life insurance is temporary insurance for a temporary need.
For example, if you take out a 30-year mortgage on a home and want to ensure its payment if you die before the 30 years is up, a 30-year term life policy would be an excellent choice because the premium payments would end when you made your last mortgage payment. It would have fulfilled its purpose of protecting your family for the 30 years you had a mortgage.
All things being equal (face amount, age of the insured, etc.), term life insurance costs considerably less than permanent life insurance.
Who Typically Buys Permanent Life Insurance?
Someone who buys permanent life insurance is typically financially established. They want to be assured they will have coverage their whole life and they want a policy that not only provides death benefits but also builds cash value over time.
How Much Does Permanent Life Insurance Cost?
The cost of permanent life insurance is dependent upon the same variables as term life insurance:
- Tobacco use
- Face amount
- Health history
As mentioned, permanent life insurance is more expensive than term life insurance, but it does contain features (permanency, cash value) that term life doesn’t provide.
What Are the Pros and Cons of Permanent Life Insurance?
The biggest pro of permanent life insurance is the cash value component. Over time, cash value grows and is accessible to the policy owner. Many people use it to supplement retirement savings, pay for children's or grandchildren's educations, or pay for emergency medical expenses or other unexpected bills that pop up.
The biggest con of permanent life insurance is the cost. The higher cost of term life insurance can make it difficult, if not impossible, for many younger people to afford. As a result, they end up buying less expensive term life insurance, hoping to buy some permanent life insurance eventually. However, they'll have to pay higher premiums later in life because the older you get, the more expensive permanent life insurance becomes.
Are There Any Good Alternatives to Permanent Life Insurance?
Perhaps the best alternative to permanent life insurance is to buy term life insurance and invest the difference in premiums in some financial instruments like an IRA or individually owned mutual funds. By doing that, you can pay lower life insurance premiums for the same amount of coverage and have the opportunity to realize higher returns by investing on your own.
Another Alternative: Convertible Term Life Insurance
One last thing to consider is to purchase convertible term life insurance coverage when you’re younger. This way, you can have lower-cost term insurance with the option to convert your term policy to a permanent life insurance policy without any evidence of insurability.
This trick can be very advantageous if your health has taken a turn for the worse over the years, but you still want to have a policy in force for your whole life. Your best bet is to consult with a professional life insurance agent who can help determine how much life insurance you need.