There’s a long-standing debate over the best type of life insurance coverage to have, term life or permanent life insurance. Most life insurance agents who work for big-name life insurance companies usually recommend permanent life insurance, while most life insurance agents who are brokers (represent many different insurance companies) recommend term life insurance, as do many Certified Financial Planners.
Jump ahead to these sections:
- Overview: Term vs. Permanent Life Insurance
- Types of Term and Permanent Life Insurance
- Term vs. Permanent Life Insurance: Payouts and Payment Schedule
- Term vs. Permanent Life Insurance: Costs
- Term vs. Permanent Life Insurance: Who Are They For?
- Pros and Cons of Term vs. Permanent Life Insurance
- Should You Get Term Life Insurance, Permanent Insurance, or Neither?
Why the big difference of opinion about which is better? To thoroughly answer that question, this article will focus on a few key areas including payouts or payment schedule, costs, who each product is intended for, and the pros and cons of each. We’ll conclude by answering which is the best product for you, or if neither is.
Let’s start first with an overview of term life and permanent life insurance.
Overview: Term vs. Permanent Life Insurance
Term life insurance and permanent life insurance are at opposite ends of the product spectrum in the life insurance world. But, you must remember that they’re both members of the life insurance family and share some commonalities:
- Monthly or annual premium payments
- A stated face amount of life insurance, which is specified in the policy
- A death benefit payable to beneficiaries named in the policy
The commonalities end there. A closer look at term and permanent life insurance reveals two significant differences: the length of time an insured is covered and cash value accumulation. Let’s examine each.
Length of time
How long will the coverage stay in force for each type of policy? The answer lies in their names.
Term life insurance stays in force for a specified term, such as 10, 20, or 30 years. If the insured dies during the fixed term, a death benefit will be paid to whomever they named as the beneficiary. If they outlive the term, the policy expires worthless.
Permanent life insurance stays in force permanently, as long as premiums are paid on time. For example, a 20-year-old could purchase a permanent policy and still have it in force at age 80 and pay the same monthly premium. There is no limit to how long premiums being paid keeps a policy active, though most policies will endow at age 100 (pay the death benefit to the insured when they reach age 100).
Cash value
When you pay your monthly premium for your term insurance policy, 100 percent of the premium (minus administrative fees) goes towards paying for the life insurance policy. There is no cash value (savings portion) with a term policy; it's pure life insurance coverage.
When you pay your monthly premium for your permanent life insurance policy, a portion of your premium payment goes toward the life insurance coverage, and part of your payment goes toward the policy's cash value (similar to a savings or investment account). The cash value is credited with interest or investment gains (or losses), accumulates over the years, and can ultimately be borrowed after a specified term passes.
For example, let's say you pay $100 per month for your permanent life insurance policy. $35 would be applied towards the life insurance portion of the policy, and $65 would go towards the policy's cash value account (the premium payment amount will depend on your age when the policy was issued). The cash value can be withdrawn or borrowed, as specified in the policy.
Types of Term and Permanent Life Insurance
There are several types of term life insurance:
- Level term life
- Annual renewable term life
- Decreasing term life
- Convertible term life
Types of permanent life insurance include:
- Whole life
- Universal life
- Indexed universal life
- Variable universal life
Term vs. Permanent Life Insurance: Payouts and Payment Schedule
Both types of life insurance policies, term and permanent, pay out a death benefit to a beneficiary when the insured individual passes away. The death benefit may not be the same as the policy's face amount, such as when a person dies while they have an outstanding loan balance on their whole life insurance policy. Outstanding loans are always subtracted from the face amount of the policy.
The payout for universal life also has a slight twist; Universal life's Option A pays out the face amount of the policy minus any outstanding loans, whereas Option B pays out the face amount of the policy plus the policy's cash value. Many people prefer Option B because their beneficiary gets a bigger payout, and the life insurance company doesn't get to keep the cash value when the insured dies.
Payouts from both types of policies can be paid to the beneficiary as a lump-sum payment, or they can elect to have it paid out over a specific period, such as ten years.
Premium payment schedules are also similar for term and permanent life insurance policies, with one exception. Permanent life insurance premiums, particularly universal life insurance, can use the cash value to pay the premiums, as long as there is an ample amount of money in the cash value portion of the policy.
With every type of term life insurance or permanent life insurance, if the premiums are not paid on time, the policy will enter a grace period and will lapse without value if the premium isn’t paid during that period (usually 31 days). If the insured dies during the grace period, the beneficiary still receives the death benefit minus the past due premium amount.
Term vs. Permanent Life Insurance: Costs
This is a significant difference between term life and permanent life insurance.
Term life insurance is the most inexpensive type of life insurance available because it is purely life insurance; there is no cash value. This allows the life insurance company to offer term life insurance for a much lower price than whole life or universal life insurance.
Whole life insurance carries the highest premium amounts of any type of life insurance because the death benefit is permanent and at a fixed rate. Some of the premium payment goes into the policy's cash value account.
Age and health will affect the cost of both types of policies. Like health insurance and disability income insurance, life insurance becomes more expensive each year you get older. Because of this, financial advisors recommend that people buy life insurance as early in life as they can to take advantage of the lower premiums.
When they apply for life insurance, a person's health can also affect the cost. For example, a healthy 30-year old could pay $100 per month for a term or whole life insurance policy but could be charged more (rated) by the insurance company and pay $125 per month because of an underlying medical condition, such as high blood pressure.
Term vs. Permanent Life Insurance: Who Are They For?
Earlier in the article, we alluded to the fact that term life insurance is temporary life insurance because it expires after a set period and that permanent life insurance is meant to stay in force permanently.
Why would anyone buy temporary life insurance? Answer: To meet a temporary need. For example, someone who just took out a 30-year mortgage may want to protect their family financially by taking out a 30-year level term insurance policy. Similarly, a family with young children may take out a 20-year level term policy so the kids’ college education could be paid for if one of the parents died before the children graduated from college.
Why do some people buy permanent insurance? Answer: to build cash value for their future. Using our person with the new 30-year mortgage, that individual may want to keep their premiums level for the rest of their life, build some equity within the policy over time, and then use the accumulated cash value to partially fund their retirement or pay for their grandkid’s education.
Pros and Cons of Term vs. Permanent Life Insurance
Let’s look at the biggest pro and the biggest con for each type of life insurance policy.
Term life pro: Cost. For someone who is looking for the least expensive life insurance policy they can find, they’re perfect term life candidates.
Term life con: Can expire worthless. According to a Penn State University study, 99% of all term life insurance policies never pay out a death claim because most people will let the policy lapse and not keep it for the specified term of the policy.
Permanent life pro: Cash value. Even if someone wants to stop paying on their permanent life insurance policy, they can “surrender” the policy and receive a portion of their cash value after making their last premium payment. Therefore, the policy pays out when the insured passes away or when the policy is surrendered. Either way, permanent life insurance eventually pays out.
Permanent life con: Cost. Permanent life insurance, particularly whole life, is substantially more expensive than term insurance. For example, a 30-year old male could pay $25 per month for a $100,000 term life insurance policy, yet pay $75 per month for the same face amount of whole life insurance.
Should You Get Term Life Insurance, Permanent Insurance, or Neither?
Term life insurance is your best bet if you temporarily need insurance, like covering a mortgage or student debt.
If you want to have level premiums for the rest of your life and accumulate cash value with your policy, permanent life insurance would be the way to go.
If you’re young, like a recently graduated student, unmarried and without children, have zero debt, and aren’t worried about who ends up responsible for funeral costs, you probably don’t need either term or permanent life insurance.
Consider Getting Both Term and Permanent Life Insurance
A closing thought: consider buying both types of life insurance, term and permanent. Many people buy a term policy to cover a temporary need, but they also buy a permanent policy because they believe they’ll need some life insurance for the rest of their life, and they want to lock in the premium. If in doubt, a life insurance agent or financial planner can help you find the best life insurance to meet your particular needs.