How to Choose Between Term and Permanent Life Insurance
How to choose between term and permanent life insurance
Buying life insurance today is a super simple process that can be done without ever stepping foot inside of an office in most cases. There are hundreds of carriers and thousands of options to choose from.
However, having seemingly endless choices for coverage can make deciding which policy best fits your needs a challenging task. One of the first decisions you will make is deciding what type of coverage you need. There are two basic forms of life insurance: term and permanent.
What is term life insurance?
Term life insurance provides a death benefit to your beneficiaries for a predetermined amount of years - typically 10, 20, or 30 years. After the set amount of time the coverage expires and you would need to either buy a new policy or renew your current policy. While term life insurance is designed to provide temporary coverage, there are a few options that will keep you from losing coverage completely once the term contract expires.
Return of Premium Rider - A return of premium rider allows you to get back all of the premiums you have paid over the life of the insurance contract. This could be a great option especially if you are young and healthy. The amount of premiums you receive won’t equal the amount of coverage you had while the policy was in force but it is nice to know that if you make it to the end of the term (hopefully you do) you can get all of your money back. Every company does not include a ROP as an option so be sure to talk with an advisor first if you are in the market for a term policy.
Conversion - In some cases the insurer will allow you to convert a portion of the death benefit to a permanent life policy at the end of the term contract. Converting your term could be extremely helpful especially if you are nearing retirement age as the contract is expiring. When seniors near retirement age they may not need a six figure life insurance policy anymore because they tend to have less debt than when they first purchased the policy. Converting a small portion of their term to permanent coverage would be helpful for paying off medical costs and funeral costs later on.
What is permanent life insurance
Permanent life insurance is a type of life insurance policy that stays in effect throughout your entire life. As long as the premiums are paid the policy will never expire. Most permanent policies come with a cash value account where you can accumulate savings over time. As you pay your premiums, some of that money will accumulate in the cash value account with a small interest rate. As the cash value in the policy grows over time it can be used to pay premiums, borrow against, or cash out entirely and cancel the policy.
There are three main types of permanent insurance:
Whole life insurance - Permanent coverage with a cash value account that can be used for savings.
Universal life insurance - Universal life policies are known for their flexibility. You still get permanent coverage and a cash value account but the cash in the account is determined by how well your investments perform. You are also able to adjust how much premiums you pay and even the death benefit in some cases.
Variable life insurance - This type of permanent coverage gives you the most flexibility but that flexibility comes at a cost. You still get the permanent coverage and a cash value component that you can invest any way you like. The downside is that if those investments don’t pan out, the losses can decrease your death benefit.
Term vs Permanent
Now that we’ve touched on the basics let's take a closer look into the pros and cons of each policy type.
Term life insurance is much less expensive than permanent and you can get a lot more coverage in most cases. Term is typically used to cover large debts or replace income. It is certainly the best bang for your buck but the trade off is if you reach the end of your term and (hopefully) don’t die, you may have just spent 20 or 30 years paying for a plan you never used. The only exceptions are if the plan comes with a conversion or return of premium option.
Term life insurance may be a great option for those who:
- On a tight budget and need lower premiums
- Need to cover large debts like student loans or mortgages
- Need to replace loss of income
- Are either young or are in good health (it can be difficult to get approved for a large term policy as you age and health declines)
- Only need coverage for a short amount of time
The largest barrier to entry for permanent life insurance coverage is the cost. In some cases premiums can be as much as 3 to 5 times more expensive than term. The benefit of locking in that price point is that it will never change and there is a cash value account that you can access. That cash account can also be used to help supplement retirement income as you prepare for your golden years.
Permanent life insurance may be the best option for those who:
- want coverage that will last your whole life instead of a temporary period
- want to use the cash value account for savings or investment purposes
- want to save on premiums later in life by locking in a price when they are young and healthy
Which type of insurance is best for you?
The type of life insurance that best fits your needs is going to vary based on your current financial state and your future plans. If you have a young family your needs will be vastly different from someone who is getting ready for retirement in a few years. In any case, making the decision to protect your family with a life policy can prevent financial crisis and provide a legacy when you are no longer here to care for them. Understanding the differences between term and permanent coverage is a great place to start your research but we encourage you to speak with a licensed financial professional to help determine the best course of action for you and your loved ones.