Life Insurance: Term or Permanent Life?

Permanent Life vs. Term Insurance: Which is better?

Often times, we hear the financial experts on the radio or television advising to buy term and invest the difference. Better yet, the majority of bloggers advise the same concept without knowing each person’s financial situation. Today, we want to breakdown the type of life insurance out in the marketplace along with detailed analysis on when a whole life policy or regular term life might make sense for your financial situation.

Permanent Life Insurance

Generally speaking, there are three common types of life insurance in the marketplace. They are:

  • Traditional Whole Life: These type of policies offer a fixed premium. That means, the policy holder pays the same annualized amount year of over year. In theory, the policy will become “paid-up” sometime in the near future. These policies may provide a dividend and policy owners must pay the premiums on-time. There is a portion of cash value that accumulates overtime with a guaranteed and projected amount. It is a safer slow and steady growth when compared to other life insurance products. The downside is that you have to keep the policies for 12-20 years in order for it to pay for itself. The main comparison for these type of policies is that they are similar to buy a home vs. renting (term insurance). The policy has fixed payments with a guaranteed insurance and cash value. Lastly, participating contracts allow for the insured to receive dividends, which can boost returns on the policy.
  • Universal Life Insurance: The policies provide a fixed interest for the cash value. The insurance side of this policy will renew annually based on your age. As such, although there is a guaranteed fixed return, the policyholder may experience an expensive renewal as he/she gets older. The insurance portion can eat into your cash value due to its more expensive renewal as you age. However, the upside to these policies is flexibility. You have the luxury to terminate the policy anytime and cash out a higher cash value when compared to traditional whole life since it takes longer to breakeven. Cost of insurance will increase and can alter payments. Thus, payments are not fixed, insurance will increase as the insured ages, and cash value will grow based on the fixed return.
  • Variable Life Insurance: These policies are similar to Universal Life in terms of renewal based on age. However, the cash value portion can be invested in the stock market. Imagine the life insurance portion renews every year, but the cash value portion will fluctuate. If you decide to terminate the policy during a peak of the stock market, it can be higher than the policies explained above. Thus, payments are not fixed, insurance will increase as the insured ages, and cash value will grow based on the market return.

The cash value are able to grow tax deferred since they are structured under a life insurance product.  This component is the most common pitch amongst life insurance agents.

Term Life Insurance

Term life is simple insurance. You purchase the policy for a given period and are insured that timeframe. For example, a person can purchase a policy for 20 years to ensure his/her children will be out of the house; thus, free-of-expense.  It is the cheapest form of insurance and the buyer is essentially “renting” coverage to insure against a potential life event (i.e. death).

You have probably heard all over the radio, “Buy term, and invest the difference”. If you truly follow this strategy, it may serve you well.  Overall, you pay less when compared to permanent life insurance. Plus, you get to keep an individual investment account that is constantly being invested.

Conclusion

What is the right strategy? It depends.

For most people, term life insurance is the most cost effective option that protects the income of the insured given potential life event. The majority of Americans should probably opt for term insurance and invest the difference. This way, they are not overpaying for insurance, but yet, protect their love ones in case the insured passes. Further, the majority of permanent life insurance policy owner’s end up cancelling before the policies actually reaps its value. In other words, it takes 12-20 year for a traditional whole life policy to breakeven.

What about permanent life insurance? When is it a viable option? Permanent life insurance should be considered once the person has exhausted all qualified retirement options (i.e. 401(k), IRAs, 529, HSAs, etc.). These traditional retirement and savings accounts allow the investor to take advantage of tax deferred growth and reduction in taxable income for the given year. Upon exhausting such traditional options, permanent life insurance could make financial sense.

Example

GenWeFinance has maxed out the 401(k), IRA, and Health Savings Account (HSA) options.  He has saved for an emergency fund and still has extra money to invest. Therefore, he opted to purchase a traditional whole life insurance policy for tax deferred growth that is almost risk-free and leave a legacy behind with the insurance protection. GenWeFinance decides to only purchase an affordable policy that will allow him to ensure proper payments for 20+ years. This way, there will be a guaranteed risk-free return once the policy hits a certain point.

GenWeFinance opted not to purchase the universal and variable life insurance products because the insurance portion gets more expensive as the policyholder ages. The biggest fear is that the potential underperforming cash value will not be able to pay for the cost of insurance later in life. Thus, the policy will implode and become worthless.  Therefore, he has opted for the traditional whole life that will guarantee fixed payments, insurance, and cash value. It will serve as another retirement or legacy vehicle for his overall financial planning.

What are your thoughts on permanent life insurance, term insurance, or buy term and invest the difference?

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