Term life insurance is a temporary form of life insurance coverage. It only pays a death benefit if the insured dies during a specified period of time — typically from one to 20 years.
Many term policies, however, are guaranteed renewable; the policy owner has the option of continuing the coverage after the initial term expires, albeit at a higher premium.
Advantages and Disadvantages of Term Life Insurance
Term life insurance is easily affordable for the young and healthy. Young families can purchase large amounts of term life insurance for premiums working families can pay easily. Term life is an excellent way to protect a family against the loss of a breadwinner while they raise children. As you get older, though, term life gets more expensive. It does not build cash value, and if you cancel the policy or the term lapses, you have paid premiums but have derived no benefit. If you hold the policy too long, you may pay more in premiums than your beneficiaries would collect in death benefits. Only a small number of term policies ever pay a death claim. Term insurance is not generally appropriate for permanent death benefit needs, such as estate planning or final expense insurance.
Permanent Life Insurance
Permanent life insurance is designed to pay a death benefit no matter how long the insured lives. Because the eventual payout of the death benefit is a certainty, insurance companies must set aside significant reserves against the eventual death benefit payout for each policy they sell. Premiums are set high enough to cover the risk of the insured dying this year, plus the necessity to build a cash reserve. That cash reserve also allows premiums to remain level or manageable in later years. The reserves the company sets aside form the cash value of the policy.
Types of Permanent Life Insurance
Permanent life insurance comes in two basic forms: whole life and universal life. Whole life insurance features a guaranteed premium which is level for life, or for a shorter period if the insured wants a “paid-up” policy before a certain age, with no more premiums due. The death benefit is also guaranteed level, and cash value growth is guaranteed at a specific interest rate. At age 121, the guaranteed cash value is scheduled to equal the death benefit, the policy endows, and the insurance company pays the sum to the policy owner. Universal life insurance features a guaranteed death benefit, but does not guarantee cash value growth. Premiums are flexible — you must just keep enough in the insurance policy’s cash value to cover the premiums for the year. If the cash value reaches zero, the policy will lapse.
Advantages of Permanent Life Insurance
Permanent life insurance provides a tax-free death benefit to provide liquidity at death, no matter how long the insured will live. It is an excellent vehicle to pay estate taxes, final expenses, and to help divide an illiquid estate among heirs. Meanwhile, policy owners can borrow against the cash value in their insurance policies for any reason. Some plans are sold to accumulate money to supplement retirement income or to save money for college while providing a death benefit at the same time. The cash value accumulates tax-free, in most instances, and loans against the policy are tax-free as long as the policy remains in force. Some policies come with a rider that guarantees the policy will stay in force — and accumulate cash value — in the event of disability.
Disadvantages of Permanent Life Insurance
Permanent life insurance requires much higher premiums per dollar of life insurance protection than term insurance policies, at least in the early years of the contract. Families on limited budgets may not be able to purchase the entire amount of protection they need unless they purchase at least some term insurance. Additionally, it can take years for the cash value in life insurance policies to equal the amount the policy owner has paid into the policy.