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?
To subscribe to this blog, just click here. Two or three times a week, you’ll receive ideas and encouragement for using money well.