Term vs. Permanent Life Insurance

You hear a lot on TV and the radio debating the merits of term insurance versus the merits of permanent life insurance policies, including whole life and universal life insurance.

Anyone who advocates 100% for or against any kind of life insurance structure is missing the point: The best kind of insurance to own is the kind that is in place when the insured dies.

And here’s the corollary to that law: The best amount of life insurance to buy is the amount you can easily afford. There is definitely a place for term insurance, and definitely a place for permanent insurance. The most important principles to bear in mind are these: Purchase the policy that:

1.) You can afford,

2.) Best fits your need, and

3.) Is most likely to be in force when you pass.

Focus on these three things, and it’s tough to go wrong.

Term insurance

Term insurance is designed to be very affordable, with a large death benefit.

The trade-off is that term insurance, as the name implies, is temporary. It is valid for a set number of years — typically 10, 15, 20 or 30 — paying during the set time period as long as you’ve kept current on your premiums.

The younger you are when you purchase term insurance the better, because the rates are locked in. But the older you are when you first buy the policy, the more expensive the premiums will be. Your health condition will also be considered when they set premiums.

For younger families who need a large death benefit at an affordable cost to protect them against the potentially catastrophic loss of a breadwinner at the beginning of his or her career, for example, term insurance is just the ticket.

Permanent insurance

Permanent insurance is designed to pay a death benefit even if you live to a ripe old age, and it does not expire as long as you keep paying the premiums. There are two basic varieties: whole life and universal life.

Whole life policies feature a guaranteed death benefit for life, guaranteed-level premiums for life, and guaranteed growth in cash value. In other words, it has a death benefit and the savings component has a fixed interest rate that builds cash value over time.

Universal life policies feature a guaranteed death benefit, along with a cash-value component as well. They sometimes offer more flexibility than a whole life policy. For example, universal life policies allow you to increase or decrease your death benefit and the policy’s cash value can eventually grow and result in a zero-cost policy, in which all premiums are paid from the cash value you’ve amassed.

Also, the interest rate on the cash value component is not fixed. Instead, it has a guaranteed minimum interest rate, but the rate can change over time based on market conditions.

Considerations

Term life insurance is the most affordable protection for young people. But at the same time, term policies are actuarially designed to lapse. Only about 2% to 5% ever pay a claim.

So, while term provides the most protection for new policy purchasers per dollar of premium, if you secure it later in life, it can be very expensive.

With permanent policies, it’s quite the opposite: Whole life policies, in particular, require a pretty big commitment for the same amount of death benefit.

Very few young families can afford permanent insurance for the total amount of death benefit they need. Term works well here, on a limited budget — at least until the kids are grown, in most instances.

A universal life policy costs more out of pocket, but if the policy owner contributes enough premium into the policy, they can build cash value very quickly. But in the long run, if you live to your actuarial life expectancy, you will get far more out of a whole life policy than you ever put into it — either via cash value or via the death benefit.