Term or Permanent Life Insurance – How do you know if you have the right coverage?

Here’s a quick look at all of the options: Term, Whole, Variable and Universal 

Few people who have bought life insurance — or even window-shopped for it – have escaped the debate over term vs. permanent insurance.

And the wrong kind of life insurance can do more damage to your financial plans than just about any other financial product today. So, the first and most important decision you must make when buying life insurance is: term, permanent or a combination of both? Let’s look at each.

Term life policies offer death benefits only; so if you die, you win (so to speak). If you live past the length of the policy, which is quite probable, you or more specifically your family members get no money back.

Term policies or better stated temporary policies are cheap and for a very good reason – they are a “cash cow” for the life insurance companies with less than a 2% chance any given policy owner will die and “cash out” during the life of his or her term.

PERMANENT LIFE INSURANCE IS MORE EXPENSIVE

And for a very good reason – If kept long enough it is guaranteed to pay out to your beneficiaries. Permanent life policies offer death benefits and a "savings account" (also called "cash value") so that if you live you get back at least some of and often much more than, the amount you spent on your premium. You get this money back either by cashing in the policy or by borrowing against it. Look at permanent life insurance as a forced savings account for life.

As you might expect, permanent life insurance premiums are more expensive than term premiums because some of your premium dollars are put into a savings program. The longer the policy has been in force, the higher the cash value, because more money has been paid in and the cash value has earned interest, dividends or both.

The debate is all about that cash value. If you buy a policy today, your first annual premium is likely to be much higher for a permanent life policy than for term. Is this a bad thing? Not necessarily if your goal is long term savings towards retirement and the inability to never outlive your life insurance policy (currently up to age 121).

LET LIFE INSURANCE LIVE

However, the good news is premiums for permanent life stay the same over the years, while the premiums for term life can increase over time. That extra premium paid in the early years of the permanent policy gets invested and grows, minus the cost of insurance (COI) the life insurance company takes back. The gain is tax-deferred if the policy is cashed in during your life. (If you die, the proceeds are usually tax-free to your beneficiary.) And you are allowed to borrow against your cash value should you ever need an infusion of cash or you wish to retire and supplement your retirement income.

The question or debate you always hear is, "Buy term and invest the difference." The fact is it really depends on how long you keep your policy. If you keep the permanent life policy long enough (and in the unlikely event the market ever fully rebounds), that’s the best deal. But "long enough" varies depending on your age, health, insurance company, the types of policies chosen, interest and dividend rates, and more. The reality is that there is not a simple answer, because life insurance is not a simple product. If you wish to unravel the mysteries of what life insurance policy is good for you and your family, just give us a call. And yes, there are some times we point out that a life policy may not be in your best interests.

SIMPLE GUIDELINES

Even with all of these variables, there are some simple guidelines you can follow. The key is how long you plan to keep the policy. If the answer is less than 10 or 20 years, term is clearly the solution.

If it is more than 20 years, permanent life or a combination is probably the way to go. The big gray area is in between. Here is where we can help to run the term vs. permanent analysis for you. Of course, this assumes you keep the policy in force. Most people drop their policies within the first 10 years, but if you do your homework now, that shouldn’t be the case for you.

HOW TO CHOOSE

Categorize your insurance needs by their use. If you need $60,000 for college and your youngest child will graduate in three years, you need $60,000 of term insurance as a short-term hedge against your death, thus insuring that your child can finish his or her education. Meanwhile, if your estate will owe $200,000 in taxes at your death or you are gearing up for retirement, you probably need permanent insurance, because you’re not likely to die in the next 20 years (you hope). You also may want to re-evaluate your estate plan, but that’s a different issue discussed elsewhere on our website.

And, there are many cases with a combination of both temporary and permanent life insurance makes sense and works best.