In recent weeks, I’ve written articles designed to help you figure out whether you need life insurance, and if so, how much. Once you’ve taken those steps, the next decision will be whether to go with term or permanent insurance.
What’s the Difference Between Term and Permanent Life Insurance?
Term life insurance. Term life insurance is pure insurance – you pay for the death benefit and nothing more. It covers a temporary need, with “terms” ranging from one to thirty years.
Permanent life insurance. Permanent life insurance, also called whole life, is life insurance and a savings or investment account. It provides, you guessed it, permanent coverage, assuming you keep up with the premiums.
The two types cost very different amounts. Whereas a term policy might run $15 to $30 per month per $100,000 of death benefit, a permanent life policy could cost ten times as much. While that may sound like an ironclad argument for term life insurance, there are some situations where a permanent policy may make sense.
The Cases for Permanent Life Insurance
A Permanent Need. Maybe you’ve heard the phrase, “Buy term and invest the difference.” The idea behind that advice is to buy a term life insurance policy and then invest all the money you’d save by not going with the permanent policy.
People who champion that approach say you could probably end up with far more money by investing in a good mutual fund compared with how much the cash portion of a permanent life insurance policy would be worth over the same amount of time.
Besides, they say, you only really need life insurance while your kids are young. And by the time they’re grown, all the money you’ll earn in that good mutual fund will be plenty for the surviving spouse should either of you die.
There are three potential problems with that advice. First, you may end up buying term and spending the difference. Second, in recent years it hasn’t exactly been easy to make money in the stock market. There are plenty of investors who would have been very happy with a low yet steady positive return, which is what the cash accounts on many permanent policies have delivered. And third, if you experienced either of the first two problems, you won’t have plenty of money for a surviving spouse.
A Desire for More Retirement Savings. If you are contributing the max that you’re eligible to invest in tax-advantaged retirement accounts, and want to save even more for your later years, you may want to consider a permanent life insurance policy. While the money you pay in premiums goes in after you’ve paid income taxes on it, the money in the policy’s cash account grows on a tax-deferred basis.
When you retire, if you want to use some of the cash value for living expenses, there are even ways to take that money out of the policy without paying income taxes, such as borrowing the money and repaying the loan with a portion of the death benefit upon your death. Dividends earned from the policy may even cover the interest payments on the loan.
Estate Planning. If you’re wealthy enough that a portion of your estate may be subject to estate taxes upon your death, you may want to consider a permanent life insurance policy. You may pay far less in premiums than your estate would owe in taxes, enabling the taxes to be paid with the death benefit, leaving more money for your heirs or charities.
For another argument in favor of whole life policies, read this article by a personal finance writer I respect.
So, Which to Choose?
Once you’ve determined that you need life insurance, the most important priority is to buy enough insurance to cover your needs. Young couples with kids usually need a lot of insurance and have many other expenses. For those reasons, term is usually the best way to affordably get the right coverage. However, as this article points out, there are some circumstances where a permanent life insurance policy may make sense.
If you’re in the market for life insurance, look at your needs and your budget, and then make an informed decision. You may decide to cover most of your needs with a term policy, but supplement that with a smaller permanent policy.
What are your thoughts on permanent life insurance? Do you agree that there may be some circumstances where it makes sense? Why or why not?
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Jerry,
You don’t say how much life insurance you are purchasing or how old you are. I did a quick look-up of term life for $500,000 for a 50 year old male and would be able to get it for about $750/year.
$125,000 (1/4th of the death benefit) for a 25 year old male is about $1740/year (25 years younger!!!) . So while I agree that term life goes up… you’re still paying much less than you would if you started younger and kept the same rate. And if you would have invested the difference over that 25 years you will have much much more than you would have with the cash value of the whole life policy.
Yes, whole life costs a great deal more than a term policy — but there are two important qualifiers that recommend whole life.
First, there’s a “fixed cost” advantage with whole life. Term insurance will periodically increase your premium payments over the course of your life. I had a term policy that started at just $40 a year — but 15 years later, they wanted $300 for the same amount of coverage. I cancelled it. By contrast, I have a whole life policy that is 25 years old and it still only costs me $55 for the same amount of coverage.
Second, it is important to remember that the cost of Whole Life can be much cheaper if you start when you’re young. Buying Whole Life at 50 years plus is far too expensive. But a young adult can “lock into” a very reasonable set Whole Life insurance premium payment at age 25 and reap the benefits of that same fixed cost when he/she is 55, 65, and 75+.
Thanks for writing, Ray.
I’m not saying that a whole life policy is the route to a secure retirement. I absolutely believe in an investment process that begins with an asset allocation analysis, takes a long-term perspective, etc. Just trying to stand up for what has become a favorite punching bag of certain financial writers and argue that it MAY be a helpful tool for some people in some circumstances.
If you’ve already got permanent life insurance and get some type of illness that would make you uninsurable, you have no choice but to keep your permanent life insurance.
I also wouldn’t use the recent years of the stock market to justify buying this product either. Systematic investing over long periods of time in a diversified portfolio should beat the cash accounts in any permanent life insurance policy.
I’ve read a couple of Dan Solin’s books and do agree with most of what he says, especially on investing. We just disagree on this issue.
Greg – Thanks for writing. I assumed a lot of people would take issue with this article. There’s a lot of negative sentiment toward permanent life insurance, and as I said, I believe term is the way to go in most cases. The main point I want to clarify is that I wasn’t recommending permanent life insurance INSTEAD of term. I was only trying to show some cases where it may make sense and suggesting that it may be an appropriate added safeguard ALONG WITH a term policy.
I appreciate your column and generally agree with most things you write. But I have to disagree with you on this. Perhaps I am not understanding your point fully.
“you may end up buying term and spending the difference” – Are you implying that whole life insurance would be a type of forced savings? That, IMO, is a horrible reason to by whole life. Better to work on the bad spending behavior than to invest in a bad product.
“In recent years it hasn’t exactly been easy to make money in the stock market.” – There are many other financial products that will give low positive returns with a lot less fees. Also, I would contend one will still make better returns over a long period of time.
“if you experienced either of the first two problems, you won’t have plenty of money for a surviving spouse” – Surviving spouse will have plenty of money because you would have been able to by 5x the death benefit for 1/10th of the price.
Just my 2 cents.