One of the first and most important responsibilities embraced by every breadwinner is life insurance. As soon as you have loved ones depending on your income and sharing the obligation of your debts, you can provide them with guaranteed protection from the potentially devastating financial losses that could occur in the event something happens to you. Should they lose your support, life insurance will immediately pay your beneficiary the cash value of the life insurance policy, with no taxes owed, providing a lifeline to resolve debts and pay living expenses.
Which kind of life insurance is best?
While recognizing that you need life insurance to protect your family is easy, knowing which kind of life insurance coverage may be the best for your individual situation is a bit more complicated. In this article, we’ll examine the two most important forms of life insurance, along with a few suggestions to help you choose the right life insurance coverage for you and your family. Note that the information in this article applies to life insurance policies that are sold to individuals, rather than to group life policies.
Term Life and Permanent Life (or Whole Life) Insurance
As soon as you begin shopping for life insurance coverage, you will encounter policies that are described as term life insurance and permanent life insurance. The latter type may also be referred to as whole life insurance or cash value insurance.
You will also notice right away that quotes for permanent coverage are much higher than those for term life insurance. However, as with everything in life, permanent life insurance policies cost more for a reason; so the question is whether term life insurance or whole life insurance will deliver more risk management value for your family situation and personal financial obligations.
Talk to a Life Insurance Specialist
What is term life insurance?
As the name implies, term life insurance is a policy covering a specified period or term, such as one year, five years or 10 years. Coverage is in force during the term of the policy, and coverage expires at the end of the term. At the end of the specified term, the insured individual may wish to renew the policy for another term, although the premium could be higher because the insured is older and other underwriting circumstances that can affect the premium cost may have changed.
Term Life Insurance is the Most Affordable
As of this writing, a typical quote for a 20-year policy for a 35-year-old non-smoker is about $30 per month for $500,000 of coverage. Permanent life insurance policies may have premiums that are five to 15 times higher than term life insurance.
Term Insurance Can Address Financial Life Stages
One of the advantages of term life insurance is simplicity. The insured can choose a term based on financial milestones that are readily apparent. For example, the goal may be 10 years of coverage until children finish college or are old enough to be support themselves. Another goal could be 15 years of coverage so that a surviving spouse will not be left with a mortgage or other large debts.
It is important to note that the premium in a term life policy is applied only to the coverage with no cash value component. While this makes the premium lower than other forms of life insurance, there is no residual cash value or other investment value to a term life policy.
Level Term and Decreasing Term
Level term refers to life insurance policies with a death benefit that remains the same for the full term of the policy. This is the best choice if the insured wants survivors to claim the same amount, such as $500,000, whether the death occurs in year one or year 10 of the term.
Decreasing term life insurance gradually reduces the potential death benefit over the entire term of the policy. This may be the best choice if the purpose of the policy is to retire a mortgage or other large debt, the amount of which is gradually decreasing as it is paid down.
More Specialized Forms of Term Life Insurance
- Annual renewable term insurance is a one-year term life policy with the premium based only on coverage in the year for which the policy is purchased. The following year, the same individual will likely pay a slightly higher premium, based on advancing age. This type of policy is sometimes called increasing premium term insurance.
- Group term life insurance is a form of term life insurance where one contract is issued by the insurance company covering multiple insured individuals. Group term life insurance policies may be available through an employer or a professional association, providing the members of the group with extra features or advantaged pricing.
- Accelerated underwriting (AU) term life insurance may speed up the process of applying for coverage by forgoing a medical examination and using existing medical records to evaluate an applicant for term life insurance. A healthy individual, younger than 60, with no pre-existing medical conditions and in good shape financially can probably qualify for accelerated underwriting.
- Return of Premium Term Life Insurance. While term insurance generally has no investment or cash value, as noted, some insurance companies are offering products that include a return of premium feature, which returns a portion of the premiums paid if the end of the term is reached and there has been no claim against the policy. The return of premium feature is priced into the moderately higher cost of these life insurance policies.
- Final expense insurance, sometimes called burial insurance, covers some of the costs incurred upon the death of the policyholder. These costs may include mortuary services, funeral arrangements and burial costs. Surviving family members can be overwhelmed by the costs of embalming or cremation, the purchase of a casket, a burial plot, a headstone and internment services. This kind of life insurance may also enable the beneficiary to cover outstanding medical, legal or other debts of the policyholder. Final expense insurance is often the best fit for policyholders whose age or health make standard term life insurance policies less available or affordable.
It is important to note that term life insurance is not automatically renewed at the end of the term, but may require a return to the start of the underwriting process, with an updated medical examination and other actuarial inputs that may result in higher premiums with increasing age.
What is a permanent life insurance policy?
Permanent life insurance, also referred to as whole life insurance or cash value insurance, provides coverage for the entire lifetime of the insured, as long as the premium payments are kept current. The most important difference between term life insurance and permanent life insurance is that permanent life insurance can build cash value, which the policyholder can access and use during his or her lifetime and which survivors or other beneficiaries can inherit. Accordingly, this investment aspect means that the premium cost of permanent life insurance or whole life insurance is typically higher than term life insurance.
Universal Life (UL) Insurance
Universal life insurance is a form of permanent life insurance that has a cash value component and provides lifelong coverage as long as premiums are paid. Universal life insurance differs from whole life insurance in that universal life allows the policyholder to raise and lower the premiums, so it can save money compared to whole life. However, if the policyholder underpays for too long or if investments in a universal life insurance policy underperform, the death benefit can be reduced, or the policy can lapse.
Variable Life Insurance and Variable Universal Life (VUL) Insurance
Permanent life insurance policies offer many other options for policyholders who want to fine-tune their premium or death benefit to fit their investment or tax situation. For example, a variable life insurance policy allows the policyholder to increase the premium or the cash value, while a variable universal life policy includes the option to increase or decrease the death benefit. The variable universal life (VUL) policy is somewhat more speculative, offering more cash value growth, but is open to market losses, which could shrink the death benefit. The foregoing differences are definitely options that should be discussed in detail with both financial and insurance advisors.
Again, the main difference between term life and permanent life insurance is the application of the premium. Term life premiums cover only the death benefit, while permanent life insurance premiums cover the cost of the coverage, with fees for the management of a more comprehensive policy, and of course contributions toward building the cash value.
Controlling Cost by Balancing Risk
With a traditional whole life policy, both the premium and the death benefit are intended to stay the same for the entire coverage period, which is usually the life of the policyholder. Naturally, the claims for life insurance rise as the policyholders age, and ultimately every policy will have a claim for the death benefit; so insurance actuaries balance this rising risk by charging the same premium for the lower risk of a younger policyholder, and then holding that premium throughout the policy.
Saving Early Gains for Later Claims
During the early years of permanent life insurance policies, the insurance company is likely to collect more in premiums than it is paying out in claims These gains are invested in stable markets, which provide the cash value growth needed to fund future claims, to return growth for policyholders, and in some cases, to even pay dividends.
Insurance regulations also require that these excess funds, technically referred to as overpayments, must become available to the policyholder as a cash value asset, similar to a savings account. When the cash value growth of a permanent insurance policy is sufficient, the policyholder can access the cash value component of the account by taking out a loan, although the loan reduces the death benefit until it is repaid.
Superior Features Come with a Price
Permanent life insurance, also known as whole life or cash value insurance, offers coverage for the entire life of the policyholder and provides an investment opportunity. However, these superior features come at the price of higher premiums than those charged for term life insurance, and permanent life insurance is not a high-performing investment for most people because rates of return are low when compared to other investments, and premiums are high.
Most individuals who choose permanent life insurance are attracted by the features that align with their financial situation and future planning, such as the level premiums and the opportunity for tax-deferred savings.
What is a convertible level term life insurance policy?
A convertible term level term policy has a provision, known as a rider, that gives the policyholder the option to convert to a permanent life insurance policy. If the insured never exercises the option, the policy continues coverage as a traditional term life insurance policy until the end of the term. If the policyholder does choose to exercise the option, he or she can convert to a permanent life insurance policy based on original financial and health information without the need for a new application and underwriting process for permanent coverage.
Comparison of Term Life and Permanent Life Insurance Policies
| Term Life Insurance | Permanent Life Insurance | |
| Guaranteed Benefit | Yes | Yes |
| Permanent Coverage | No | Yes |
| Monthly Premium | Lower | Higher |
| Premium Cost | Level or decreasing, Lowest rates | Level, 5 to 10X term life rates |
| Term of Coverage | 1 to 30 years | Entire life of policyholder |
| Cash Value Component | No | Yes |
| Loans Available? | No | Yes |
| Eligible for Dividends? | No | Yes |
| Medical Exam Required? | Yes | Yes, unless converting from term |
| Risks | Insured can outlive policy, Cost rise with age | Higher premium costs, High premiums over many years |
| Best Suited For | Uncomplicated finances, Specific term coverage | Complex finances, Lifelong coverage |
Which form of life insurance is the right choice for you?
Every situation is different, so you should discuss your financial and family situation with an insurance professional. However, for most people, these basic guidelines will apply:
Choose term life insurance when:
- You don’t expect to leave behind a mortgage or other large debts
- You will have enough savings to retire or protect your heirs
- You will not have to support both a surviving spouse and children
- You want the most affordable form of life insurance
Choose permanent life insurance when:
- You have a higher income and net worth
- You want a cash value component for your portfolio
- You have a lifelong dependent, such as a disabled child
- You can use the policy’s death benefit for estate taxes
The Bottom Line
Term life insurance is the more practical choice for most people, as it combines affordable premiums with the ability to match coverage terms to life stage milestones. Permanent life insurance can be the best choice if you prefer lifelong coverage with the option to use the cash value component for flexible investment and tax benefits.
Whether you choose term life or permanent life insurance, getting and keeping the right life insurance coverage is one of the most important financial decisions you will make as a head of household. For all those who must depend on you until they can take care of themselves, life insurance will give you the security of knowing that your loved ones are protected from life’s most serious financial risk.
