What is the Difference Between Term and Permanent Life Insurance? Everything You Need To Know
Life insurance comes in two basic types — term and permanent (also known as whole or universal life). Term life insurance lasts for a set period of time. Permanent life insurance can last a lifetime.
In this article, we'll help you answer the question: Is term life insurance or permanent life insurance better for me?
But first, let's dig deeper into the two major kinds of insurance coverage.
What Is Life Insurance?
The ancient Romans actually developed the first life insurance policy before the time of Christ. In Roman burial clubs, members pooled money to help pay for each other's funeral expenses and provide support to the surviving family members.
Modern life insurance emerged in the early 20th century and was almost immediately popular. Now a mature industry, life insurance helps protect the financial futures of millions of American families. Consumers can buy either term or permanent life insurance.
What is Term Insurance?
A term life insurance policy guarantees a death benefit if the insured passes away during the specified term. A term policy usually lasts 10, 15, or 20 years. These policies have no value after the term expires.
The policy's cost depends upon a variety of factors, including the term, insured's age, and health.
What is Permanent Insurance?
Permanent life insurance combines a death benefit with a savings account, and it never expires.
Broadly speaking, permanent life insurance comes in two varieties, whole life and universal life. A whole life policy provides consistent benefits and premiums. A universal life policy offers flexibility. We'll discuss these in more detail later.
Both whole life and universal insurance allow you to borrow against the value of the savings portion of the policy.
What is the Difference Between Term and Permanent Life Insurance?
There are five key differences between term life and permanent life insurance:
Length of Coverage: Term life insurance covers you for a specified period of time, somewhere between one year and 30 years. Permanent life insurance never expires.
Cost of the Premium: Term life offers much lower premium costs than permanent life insurance. However, the cost of a term life policy typically increases if you choose to renew the policy after the initial term period. Permanent life insurance costs stay the same in perpetuity.
Death Benefit: Both term life and permanent life insurance pay a death benefit to the beneficiary whenever the insured dies as long as the policy has not expired or lapsed due to non-payment.
Cash Value: Permanent life insurance includes a benefit known as cash value. This benefit is basically a savings account that you can cash in or borrow against. Term life policies do not carry a cash benefit.
Convertibility: Some insurance companies allow you to convert a term life policy to a permanent policy. You cannot, however, convert permanent life insurance to a term policy.
What Are the Pros and Cons of Term Life Insurance?
What Are the Pros and Cons of Permanent Life Insurance?
FAQs About Term Life Insurance
Does Term Life Insurance Always Pay Out?
Term life insurance is a legal contract. If an insured person passes away during the policy's term, the insurer must pay the death benefit to the beneficiary.
Only in exceptional circumstances usually spelled out in the contract might the insurer not have to pay. These circumstances could include homicide, death during an extreme hobby such as skydiving, or death during the commission of an illegal act.
Do You Get Your Money Back if You Outlive Term Life Insurance?
If you cancel or outlive your term life insurance policy, you do not get any money back unless you have a "return of premium" rider.
Term life insurance is pure insurance. It contains no savings or investment component. You may, however, be able to convert the policy to a permanent life policy.
Is Term Life Insurance Paid in a Lump Sum?
Most term life insurance policies send a check for the total death benefit to the beneficiary. The beneficiary may be able to request payment in a different format, but that should be discussed with your insurance agent.
Typically, the beneficiary must inform the insurance company as soon as possible after a death occurs. The company usually needs a copy of the death certificate. It takes them about 30 days to process the claim and send the check.
Who Receives Life Insurance if the Beneficiary is Deceased?
When you purchase a term policy, you can name either a sole beneficiary or multiple beneficiaries.
If you name a sole beneficiary and that person passes away before you, the insurance company will probably pay the benefit to your estate. In that case, it may go through probate court and be subject to the terms of your will and/or state.
If you name multiple beneficiaries and one of them predeceases you, then their share of the policy will usually pass to the other beneficiaries as specified by you in your policy.
What Should You Consider Before You Buy Term Life Insurance?
First, consider how much coverage you need. One way to do this is simply to add up the amounts you owe, such as your mortgage, other loans, and maybe children's tuition. Then subtract the amount your family could cover from other sources. The difference is what you may consider as the amount you “need” to insure. From there you might factor in the costs of future goals you and your spouse have.
Second, decide whom you will name as your beneficiary. If you are married, your primary beneficiary will probably be your spouse. Other individuals, you might name include adult children, child's custodian, a family member, or a trust as the beneficiary. Don’t forget to consider your overall estate plan and the impact this may have on your beneficiaries.
FAQs About Permanent Life Insurance
What are the Types of Permanent Life Insurance?
Permanent life insurance comes in several types, the most common being universal and whole life. Universal life insurance has some flexibility in the premiums and the benefits. It is indexed to the market, with investments tracking market performance. Whole life is more common than universal but less flexible and may grow more slowly.
Can you Take Money Out of Permanent Life Insurance?
Yes, you can withdraw money from a permanent life insurance plan while you are still living. There are basically four ways to do this — surrender the policy, take a cash withdrawal, borrow against the cash portion, or use the cash value to pay the premiums.
Income tax law may affect which of these choices is best for you, so it's wise to check with your tax preparer or financial advisor before making a withdrawal.
What Reasons Will Life Insurance Not Pay?
As with a term policy, Life insurance companies may only deny payment in unusual circumstances such as committing fraud on the application or dying by murder, suicide, or an act of terrorism.
How Long Do You Have to Pay Life Insurance Before it Pays Out?
It depends on the individual policy. Death benefits may pay out immediately, or you could face a 1-2 year waiting period. It often takes at least 10-15 years to build up the cash value portion of a permanent policy.
What Should You Consider Before You Buy Permanent Life Insurance?
Permanent life insurance can be more complex than a term policy. Be sure you understand exactly what you are buying and the benefits you gain.
Similar to term, you’ll also want to consider how much coverage you need and who you will name as beneficiaries. See FAQs for Term Life Insurance above.
You should only invest in products you understand, so be sure to ask your agent and your wealth management advisor to explain the policy to you before you buy it.
Which Is Better — Term or Permanent Life Insurance?
As with most things, it goes back to your goals and what you’re trying to accomplish. We often look at life insurance as a way to help preserve your family’s wealth in case the unthinkable happens, not necessarily to help plan for retirement.. As Dave Ramsey says, "Life insurance has one job: It replaces your income when you die." If you’re already retired there’s often little income to replace. For this reason, term life insurance might be a better investment. It can be uncomplicated, inexpensive, and does the job you need it to do when you need it.
How Should Life Insurance Fit Into Your Financial Plan?
Life insurance is something you hope never pays out. Ideally, you'll live a long and healthy life, leaving a legacy of faith and generosity behind you. To protect your family in the event of your death, however, it may be a good idea to invest in life insurance.
Before talking with an agent who can sell you a policy, it's a good idea to consult with your wealth manager who can help you decide how life insurance should complement your overall financial plan. Contact Cooke Wealth Management today to discuss what role life insurance might play in your plan.