Permanent Life Insurance Vs. Whole Life Insurance? What’s the difference?
There are differing opinions when it comes to who should buy a permanent policy, and who should buy a term policy. Our Life Insurance Basics post is a great place to start if you are unsure where to get started when considering life insurance. This will be a short breakdown of the basic types of permanent policies.
Topics we’ll cover:
- What is permanent life insurance?
- What are the types of permanent life insurance policies?
- Who should consider a permanent policy?
What is a permanent life insurance policy?
As with all life insurance, a permanent life insurance policy is designed to pay a death benefit to a chosen beneficiary when you die. A permanent policy is set up to be in force for your entire life. This is different from a term life insurance policy, which is designed to expire in a set number of years. With this policy, your annual or monthly payments can be either fixed or variable depending on the policy you chose.
However, the premium payments applied to a permanent policy will be split into two buckets. One bucket will pay for the cost of insurance, and one will go into a tax-deferred cash value bucket that is designed to grow over time and eventually make payments toward the cost of insurance. The biggest difference between permanent life insurance policies is how the current premium payment is determined, and how the cash value component will grow over time.
What are the types of permanent policies?
Whole Life – With a whole life policy, the annual or monthly premiums are fixed for the entire life of the policy. The policy’s cash value will grow at a specified rate (usually with a guaranteed minimum) over the life of the policy. Depending on the provider of the policy, there may also be dividends or returns to help reduce premiums or grow cash value.
Universal Life – A universal life insurance policy has flexible premiums, and the face amount can be changed without issuing a new policy. The owner of the policy can pay a minimum amount to cover the cost of insurance. They can pay the target premium on the policy which is very similar to a whole life policy. They can also pay over the target to make up for previous underpayments or to build cash value. Since they have flexible payment options, these tend to be underfunded. This can lead to very high premiums as the owner of the policy ages and can lead to policy lapses late in life.
Indexed Universal Life Insurance – These policies usually have flexible payment options. The rate of return on the cash value of these policies is tied to a pre-agreed market index such as the S&P 500. These policies are less risky than variable life insurance policies since the cash value isn’t actually invested. The rate applied to the cash value will be 0% if the index is negative at the time of crediting.
Variable Life Insurance – Variable life insurance invests the cash value of the policy in a fund of your choosing. There are usually additional fees for the management of this investment. Your premium, investment options, and death benefit can usually be changed at any time. As the cash value is invested in the market, there is the potential for market gains and market losses.
Final Expense – This is a type of whole life policy that is more easily approved, or guaranteed to issue. They are designed to cover end-of-life expenses. They usually have face amounts of $50,000 or less. The low barrier of approval usually means there is a higher cost of insurance than may be provided in a traditional policy.
Who should consider a permanent policy?
The length of the need is the most important factor to consider when comparing insurance policies. For most families, buying term insurance that will last until there is no longer a need for insurance makes sense. This leads to the very common strategy of “Buy Term and Invest the Rest.” The thought behind this is if you invest in available tax-deferred options, a family can reach a point where they no longer depend on the insured’s income, and no longer require life insurance. There are several situations where the need may not go away:
- High Net Worth Individuals – There may be a need to use a permanent life insurance policy to offset estate taxes. Permanent life insurance may also provide an avenue for tax-deferred growth to individuals seeking non-traditional options.
- Caring for Special Needs – Families who are caring for those with special needs will need to consult advanced planning professionals to ensure that these policies will not interfere with other support.
- Seniors with limited savings – Final expense policies may help offset final expenses for seniors with limited or no savings.
The decision to purchase a permanent life insurance policy should be well researched, and other options to achieve the same goal should always be presented and considered.