Permanent Life Insurance
What Is Permanent Life Insurance?
Permanent life insurance is a life insurance plan that does not expire as long as the policy is in force.
Permanent life insurance differs from term life insurance in that term life insurance covers the insured for a specified period (5, 10, 15, 20 years, etc.). When the term ends, so does the coverage, unless the policy owner purchases a new policy.
Unlike term policies, permanent life insurance policies feature a savings component as well as a death benefit. As the policy owner makes premium payments, not only does the life insurance remain in force, the cash value portion of the policy builds through interest payments, mutual insurance company dividends or, in the case of a variable policy, market appreciation.
Types of Permanent Life Insurance
The two most common types of permanent insurance are whole life and universal life insurance. Variations of universal life include variable universal life as well as indexed universal life.
How Does Permanent Insurance Work?
A whole life policy will have set premiums. The cash value will accumulate and, typically, earn a low rate of guaranteed interest. The insured will be covered for their entire lifetime.
A universal life policy features a more flexible premium schedule and the potential for the savings portion to earn market rates of interest. In a variable universal life policy, the savings portion can be invested in variable sub accounts. While this does expose the savings to risk, it also presents an opportunity for the policy owner to earn a much higher rate of return.
Indexed universal life will feature a savings portion that will be linked to the performance of an investment index. Often, the rate of return is capped in exchange for some form of principal protection.
The policyholder may access the cash value of a permanent life insurance policy in a couple of different ways. As the cash value grows on a tax-deferred basis, the owner may access the money through what is known as a policy loan. The policyholder borrows money against a portion of the accumulated cash value. There are no tax consequences and the payment schedule is flexible. If there is an outstanding loan when the insured dies, the amount of the loan is deducted from the death benefit.
A policyholder may also simply withdraw the cash. However, this is taxable if the earnings portion is withdrawn. A policyholder also has to be careful to not withdraw too much of the cash value thereby causing the insurance coverage to lapse.
Permanent Insurance vs. Term Insurance
The biggest difference between permanent and term insurance is cost. Term insurance is ideal for younger families who are in need of life insurance coverage, have limited budgets, and need coverage for a specified period.
A 20-year term policy for $1 million for a married, 30-year-old male with two small children would be relatively affordable and provide ample income replacement in the event of his death. However, at the end of the 20-year term, he would then be 50. If he wanted to continue the policy, the premiums would be much higher.
While permanent insurance is more expensive than term, a permanent policy will accrue a cash value with each premium payment. The cash value is accessible to the owner either through a policy loan or withdrawal. Unlike a term policy, which could be compared to “renting” insurance, a permanent policy will be, eventually, paid in full.
Permanent Life Insurance Pros and Cons
Pros: As the name suggests, the insurance is always in place. As long as the policy is maintained through premium payment or maintaining the necessary cash balance, the insured will be covered even if they become uninsurable. Also, the premiums will not increase with the insured’s age. Lastly, some types of permanent insurance are excellent cash accumulation vehicles and can help supplement retirement savings.
Cons: Premiums for permanent life insurance are much higher than those for term life insurance. Underwriting is more involved. Rates of return on the cash portion of a policy may be lower than for outside investments due to the higher administrative costs associated with an insurance policy. If the cash value of an insurance contract exceeds a certain level, the policy may become a modified endowment contract. If this is the case cash withdrawals and death benefit proceeds may be federally taxable.
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