It’s not a pleasant thought. But, if people rely on you financially, wheter you’re a parent or business, owner, you must think about how they’ll be taken care of after you pass. Insurance is there for such a purpose. However, life insurance comes in different shapes and sizes.
A permanent life insurance policy, which includes whole life insurance, is one of the choices available. And, it’s exactly what’s advertised: it’s permanent. No matter what age you are when you die, the policy will pay a death benefit. This is what distinguishes it from the other main policy type; term life insurance. With that option, the policy lasts for a specific period and there’s no value when it expires.
You can compare these two life insurance policies to your living situation.
Like renting, term life insurance works the same way. Once your lease is over, you stop paying, move out, and leave having earned nothing — with the possible exception of your security deposit. When you pay a term policy’s monthly premium, you’re covering yourself over a certain timeframe. Your beneficiaries will not receive any death benefits if you are still alive at the end of that term.
Owning a permanent life insurance policy is like purchasing a home. Until you own your home outright, you build equity with every mortgage payment you make. Homeownership is a valuable asset that you can sell, or pass along to your family. Paying your policy premiums while still alive allows your policy to build value. As a result, your policy becomes a valuable asset. Because of all this, permanent life insurance costs more than the same amount of term insurance.
Basic Features of Permanent Life Insurance
One of the most important features of permanent life insurance is the cash value portion. During the course of your policy, you make regular premium payments, which is called accumulating cash value. You can typically borrow against your policy’s cash value if needed. And, this also accumulates on a tax-deferred basis.
It’s also important to note that the cash value differs from the policy’s death benefit. Your designated beneficiary will receive the death benefit. But, the cash value of your plan accumulates over time. In the event of cancellation of a life insurance policy, you’ll receive the cash value accrued. Be sure to check before canceling your policy, though, as you may be assessed a surrender charge for ending your policy early.
Furthermore, permanent life insurance lasts your entire lifetime, guarantees money for end-of-life or retirement planning, and offers death benefits that can increase over time. Some policies may even allow you to borrow against your coverage and make payments according to your needs.
How Does Permanent Life Insurance Work?
Despite its flexibility, permanent life insurance can also get complicated. To explain how a whole life insurance policy works, let’s use a fairly simple example.
First, decide on how much death benefit coverage you need. You’ll probably want to do this with the help of a financial advisor. Next, apply for the amount of coverage you need. Just note that a health screening is usually part of the application process.
Afterward, decide how long you’re willing to pay your premiums. Consider it the same as getting a 15- or 30-year loan for a home. Be aware that there are many options are available. For example, depending on your lifestyle, you may be able to pay until the age of 65 or 90. Or, you could select a certain number of years.
In the same way that a home loan increases with duration, you’ll pay more per year for the same amount of coverage with a shorter term. Premiums for policies like whole life insurance are fixed, just like fixed-rate mortgages. However, there are some permanent life insurance policies where the premiums do change.
The policy will pay your beneficiary the full death benefit upon your death once it is in effect. But what if you live a long time, like until you’re a centenarian? Cash value will accumulate as your policy ages. What’s more, this cash value will never decline — unless you withdraw money from the policy, which also reduces the death benefit.
Although certain insurance companies pay dividends, you might be able to increase the value of your cash value if you reinvest those dividends. In addition, you can pay the premiums with dividends. That means you don’t have to pay as much every year; in fact, you might eventually end up paying nothing. The downside is that the cash value won’t accumulate as much.
Who Should Consider Permanent Life Insurance?
Permanent life insurance is typically purchased for the following reasons:
- People are financially dependent on you, thus requiring lifelong life insurance protection.
- Funding a trust for your heirs.
- Interest in leaving an inheritance for heirs.
- Want to invest in an insurance policy’s cash value or investment component.
As long as you keep the policy, the cash value accumulates tax-deferred, providing lifelong coverage. This is why term life insurance tends to be less expensive than permanent life insurance.
Depending on the terms of the policy, you may have to pay a surrender charge if you decide to cancel the policy.
People who don’t need long-term coverage should not purchase permanent life insurance policies. A term life policy would be a better and more affordable option if you need life insurance to cover your working years in order to replace your family’s income or pay off a mortgage.
Your choice of policy type will be determined by the level of investment risk, the flexibility of the policy, and affordability.
Types of Permanent Life Insurance
Permanent life insurance policies come in a variety of forms. Their main differences are in the premium payment process and the growth of cash value over time.
Whole Life (or Ordinary Life)
Whole life insurance could be a good fit for you if you value predictability in your life over time. Besides the guarantee of a guaranteed death benefit, the cash value of your policy is guaranteed to rise. In addition, the premiums will never increase for the rest of your life.
Earning dividends is another valuable feature of participating in a whole life insurance policy. Dividends can also enhance your death benefit while allowing you to grow your cash value. And, your policy’s guarantees give you a minimum death benefit and cash value.
Policyholders receive dividends as a way for the company to share its positive results with them. After the second policy year in a participating policy, it’s possible to receive dividends — but there’s no guarantee. Inflation can erode the amount of your policy coverage (and more) if dividends are left in the policy.
The ability to purchase variable life insurance through a prospectus is linked to a portfolio of underlying investment options and can vary the death benefit and cash value. You can choose from several different investment options to allocate your premiums. Usually, this is with stocks, bonds, or a fixed account that guarantees interest and principal.
Individuals who wish to assume investment risk in order to earn higher returns may benefit from this type of insurance. Investing through Variable Life transfers much of the risk of the insurance company to the policyholder. However, higher cash values and death benefits are possible with good investment performance. On the flip side, cash value and death benefits would decrease if the investments perform poorly.
When compared to whole life and variable life, universal life has variable premiums. In turn, this lets you pay higher payments when you have extra money or lower ones when you don’t.
Following your initial payment, universal life lets you pay premiums almost whenever you like — but only up to certain minimums and maximums. Furthermore, you can adjust the death benefit more easily with a whole life policy compared to a traditional policy.
There is one significant exception to the guarantee of annual returns for cash values for universal life policies. Any one of the following factors can prevent you from accumulating cash value: an increase in administrative costs, changes in mortality assumptions, the underperformance of the insurance company’s investment portfolio, or insufficient premium payments.
Also available is what’s known as universal life with secondary guarantees — also referred to as a “no-lapse guarantee.” Typically, an ordinary universal life policy may lapse because interest rates don’t meet projections or insurance costs increase. With the “secondary guarantee,” your policy won’t lapse even if all the above factors take place.
In addition to providing lifelong coverage at considerably lower rates than other forms of permanent insurance, universal life with secondary guarantees also provides lifelong guarantees. It’s because of this reason that these policies are favored for estate planning.
In order to pay estate taxes, your heirs shouldn’t quickly sell assets when you pass. Unlike term life insurance, universal life insurance with secondary guarantees provides a guaranteed death benefit for life. There’s also the flexibility to adjust your premiums, something that could be valuable due to the changing estate tax rates each year.
Variable Universal Life
With Variable Universal Life insurance, you can choose to allocate premium dollars to a variety of investment options, enabling you to create risk-reward profiles that suit your financial needs. People who are looking for maximum flexibility should choose these policies.
In the event your insurance needs change in the future, Variable Universal Life usually allows you to increase or decrease your coverage amount. Additionally, you may choose to pay a lump sum, which are subject to IRS limitations, to increase your policy’s cash value. You might also be able to skip a scheduled premium payment if you are short on cash during an emergency. In this case, the cash value will be used to keep the policy active.
The kind of insurance you need may change as your goals and risk tolerances change as well. With that in mind, tax-free transfers are possible between the investment divisions of Variable Universal Life. As a result, you can make your decision according to your needs, not based on the consequences of the tax.
The Benefits of Permanent Life Insurance
Regardless if you select is whole life, universal life, or variable universal life, there are several reasons why you should consider a permanent life insurance policy.
Permanent life insurance earns cash value.
Death benefits are provided by most types of life insurance policies — and they’re generally tax-free for the beneficiaries. Cash value, however, is a unique feature of permanent life insurance. And, that’s on top of the protection provided by the death benefit.
Policy loans are also available for borrowing cash value from the policy. This makes permanent life insurance more liquid. It should be noted, though, that outstanding loans will reduce both the cash value and death benefit.
Permanent life insurance provides lifelong coverage.
As long as the premiums are paid, a permanent life insurance policy will only terminate when the owner surrenders the policy or if the insured dies. At a given age, such as 100 or 121, some permanent policies may mature. For example, if you were to live to 100, premiums are no longer necessary and the death benefit will be paid.
While some policies pay out the cash value or death benefit, others simply disburse the cash value at maturity.
Whole life insurance premiums never change.
Permanent life insurance, such as whole life insurance, does not have a fluctuating premium. Regardless of the insured’s age, the declared premium remains the same when the policy is issued.
As an example, the death benefit after the death of a $50,000 policy issued with a $500 annual premium is still $50,000. The death benefit remains the same regardless of an insured’s age. The premium also doesn’t change. No matter how long the policy stays in force, that $500 premium remains unchanged.
Depending on the policy, you may be able to withdraw some of the money.
As already mentioned, the cash value can be used to pay premiums. For instance, the premiums you pay can be stopped or reduced if unexpected expenses arise. In such a case, it’s possible to use the cash value in the policy to pay the premiums — just as long as you have enough accumulated that you have to continue.
Moreover, you can use the cash value to generate an additional retirement income source. Or, you can access the money to handle a sudden illness or other unexpected emergencies. You could even stash away the cash value to take care of the interest you will have to pay down the road.
The tax benefits of permanent life insurance.
Both term and permanent life insurance provide their beneficiaries with tax-free death benefits. But, term life insurance doesn’t offer these perks:
- As with most retirement vehicles, like an annuity, a permanent life insurance policy’s cash value grows tax-deferred.
- A dividend or surrender of coverage will not be subject to income taxes. The exception is if the amount you receive exceeds the premiums that you paid.
- The policy loan is tax-free — as long as the policy remains in force. Also, the loan amount and interest cannot exceed the cash value of the policy. Unlike other types of loans, policy loans aren’t taxed since you don’t have to repay them to your insurer.
But, that’s just scratching the surface. Let’s take a look at the other benefits of permanent life insurance.
- Your family can use the death benefit funds to replace your income, stay in the family home, cover college tuition, or pay final bills and expenses.
- If want to pass an inheritance on to the next generation, you can use permanent life insurance to protect your heirs’ assets.
- Investing in permanent life insurance policies is a safe option because most of them offer a guaranteed interest rate.
- Young people who purchase permanent life insurance can enjoy affordable premiums that can stay with them throughout their lifetime.
- If you own a business, funds can be used to ensure the continuation of operations when you die, contribute to non-qualified retirement plans, or assist the exchange of business ownership.
The Disadvantages of Permanent Life Insurance
Although it has its advantages, there are three main problems with permanent life insurance policies: the costs (typically 10-15x more expensive than term), the possibility of a lapse, and the inability to convert them into another type.
Permanent life insurance policies, in addition to these three downsides, have more complex terms than those of term life alternatives. As such, customers might have difficulty interpreting the contract. Lastly, they may not provide a good return on investment due to the higher premiums.
- In comparison to term life insurance, the biggest disadvantage of permanent life insurance is its cost. In many cases, people aren’t required to have insurance beyond a certain point. As a result, it’s often more beneficial to purchase a term insurance policy so you can convert it if you end up needing coverage for a longer period of time.
- Your policy may be canceled if you do not pay your bill or cannot make payments any longer. In the event that your policy is canceled, you may need to purchase another one, so you are essentially starting over –possibly at a higher premium.
- The longevity of a permanent policy is both a plus and a minus. Let’s say you realize that you no longer need the policy. Since you’ve already paid premiums you would lose everything you have already contributed.
Is a Permanent Insurance Policy Right for You?
An individual may want to consider a permanent life insurance policy for a few reasons. Some reasons include:
- Estate planning purposes. By buying life insurance for your loved ones, you can avoid paying hefty estate taxes. Your beneficiaries will usually not be taxed when your life insurance policy matures. In other words, you can use the funds from your life insurance policy to pay estate taxes while leaving them money for their use after you have passed.
- Leaving a legacy to your loved ones. If leaving a legacy is important to you, then an insurance policy can be left to a family member, charitable organization, or nonprofit.
- Paying off debt. The coverage of a permanent life insurance policy can help pay off debts such as your mortgage, medical bills, and other debts like student loans. That means the burden of these financial obligations will not fall on your family.
- Maintaining your business after your death. Buy-sell agreements, which can be funded by a permanent life insurance policy, could be the key to buying out shares of a business. Taking out a life insurance policy for an employee lets the business stay afloat if a founder, executive, or other key manager passes away.
- Providing for your spouse or dependents. In the event of your untimely death, you might leave your family in financial ruin. Thus, life insurance policies can help them pay the bills on time, pay the mortgage and rent, and attend to other financial responsibilities.
The Bottom Line
Due to the complexity of life insurance, customers sometimes mistakenly purchase policies that aren’t best for them. At the same time, financially protecting your loved ones and building wealth can both be achieved through the right type of permanent life insurance.
It is important to determine your own needs and budget when it comes to permanent life insurance. Make sure you understand what you’re getting, and what you’re not, before selecting a permanent life insurance policy. You also should determine whether a whole life, universal, or variable is preferable.
And, one more thing. Always make sure that the insurance company you purchase the policy from is financially strong. You can verify this by checking the company’s assigned credit rating from AM Best, Moody’s, Standard & Poor’s, and Fitch,