Today's question isn't whether you should have life insurance (hint: you should), but whether purchasing the more expensive type of policy, permanent life insurance, ever makes sense. Not sure what the difference is? Let’s start there.
Types of Life Insurance
The two types of life insurance are term life and permanent life. Permanent life has two sub-types: whole and universal.
Term Life Insurance
Term life insurance policies have a set term (hence the name) during which benefits will be paid out. If you outlive that term, the policy ends and no money is paid out. The idea is to have a safety net in place until you’re no longer supporting dependents, your debts are paid off, and your savings would sustain a spouse left behind for the remainder of his or her life. This is the type of life insurance most people should have.
Permanent Life Insurance
Permanent life insurance (subtypes include whole and universal life insurance) doesn’t have an expiration date or, for policies that do, it’s generally capped at 120 years old. Even the longest-lived American of all-time (from right here in the Lehigh Valley) didn’t make it to 120 years. So, essentially, no matter how old you are when you pass, the death benefit will be paid out to your surviving beneficiaries.
These types of policies also have something called the cash value. It’s this aspect that makes some consider a permanent life insurance policy as an investment. The cash value is not the same as the death benefit. In fact, it can be utilized while you’re still living. You can take out a loan against the cash value, cancel your policy and claim the entire cash value (though cancellation fees may apply), or utilize the cash value to pay your policy premiums. There may be other ways to leverage the cash value depending on how your policy is written.
Sounds like a good deal. What’s important to note though, is that your beneficiaries receive only the death benefit when you pass. Any remaining cash value goes back to the insurance company. That means it’s critical that you’re strategic about utilizing that cash value while you’re alive, or you’ll lose a portion of your investment and likely net a loss overall.
In summary, permanent life insurance policies are often made to sound like a safer, though more expensive, bet than term life insurance. The reality is that what’s paid back to you and your beneficiaries before and after you pass can still vary based on several factors. For most people, term life insurance is all that’s needed and much more affordable.
So Why Pick Permanent Life Insurance?
In some special situations, a permanent life insurance policy is the better option. One of the most common is when you don’t expect your dependents to ever become independent, such as in the case of a lifelong disability. You need to make sure your child will have continued care for the rest of his or her life, and a permanent life insurance policy can ensure the costs of that care are covered no matter when you pass.
Another reason you may consider a permanent life insurance policy is as an option for investing when the traditional tax-advantaged investments are already maxed out. The money in your policy grows tax deferred and, while it’s not the best investment vehicle, if you’re already maxing out contributions to your 401(k), IRA, and other tax-advantaged investment accounts, it’s an avenue worth exploring. However, this is only going to apply to very high-income earners. You’ll want to get advice for not just this decision, but your entire financial picture from a certified financial planner and/or tax expert before going this route.
Finally, you may just want the peace of mind in knowing your beneficiaries will be taken care of no matter what. If the expensive premiums fit into your budget, purchasing a permanent life insurance policy will give you that peace of mind.