Permanent Life insurance is not one kind of life insurance, it is any kind of life insurance that is meant to provide coverage for someone’s entire life. This is in contrast to term life, which is only meant to provide protection for a specific length of time such as 10 years or 20 years. All permanent life insurance has a cash value component, but growth of cash value occurs in different ways depending on the policy type. Different types of permanent life insurance are very different in terms of policy features, and potential long term cost. It is very important that you fully understand the similarities and differences before you make any purchasing decision.
Types of Permanent Life Insurance
The most common form of permanent life insurance is whole life insurance, which as the name implies is meant to be in force for the whole life of the insured. Other types of permanent life are universal life, variable universal life, variable life, and sometimes adjustable life. A brief synopsis of the types is as follows:
- Whole life insurance– The original kind of life insurance, this is a level premium policy that pays dividends and is meant to be in force for the entire life of the insured person. This type of policy is meant to grow cash value steadily for the entire lifetime of the insured person and can be used as a low risk investment. Equal premium payments are made into this policy for the lifetime of the policy unless it is a single pay policy.
- Universal Life Insurance– Universal life insurance is much more complex and can have either a fixed or changing death benefit amount, and it also generally has a flexible premium payment requirement. Policy payers can pay extra premium into the policy to build cash value, or if there is plenty of cash value they can skip premium payments. Instead of dividends, universal life insurance pays interest on the cash value, and the actual cost of the life insurance goes up over time as the insured person ages.
- Variable Universal Life Insurance– This policy is much like universal life insurance. It has a minimum level face amount, flexible premium payments, and a cash value account. The difference is that instead of paying interest, the cash value is invested into investment funds similar to mutual funds. The growth of the cash value is directly tied to the growth or decline of the investment accounts which are invested in the stock market and bond markets.
- Variable Life Insurance- This is very similar to variable universal life insurance, but it typically has less flexibility in how premium payments are made. Some companies offer variable life insurance as a separate product from variable universal life insurance, and some do not. Similar to a VUL policy, the variable policy has investments divided into different sub-accounts, which are similar to mutual funds. Ultimately the cash value of the policy is tied to the performance of these funds.
- Adjustable Life Insurance– This is a less common type of life insurance. Essentially it is a hybrid between a universal life and whole life policy. It offers policy owners the ability to adjust certain aspects of the policy such as the face amount, the length of the guaranteed period, and to make flexible premium payments. Similar to a whole life policy, it can pay dividends, and allows many of the same traditional life insurance features and riders. This is an excellent explanation of adjustable life.
Why Purchase Permanent Life Insurance
The most obvious reason that people purchase permanent life insurance is to ensure that they are protected for the full duration of their lifetime and not worry about outliving the length of their term policy. This ensures that they are able to pass money on to their children or heirs, or donate to a cause of their choice. They can also fund a charitable foundation, pay back debts, or provide living expenses for a significant other. There are also other more complex reasons that someone might need permanent life insurance coverage. They can include:
Tax Free Wealth Transfer
For high net worth individuals, permanent life insurance can help them pass wealth on to future generations. Life insurance payments are generally tax free. By naming children as beneficiaries, people are often able to use life insurance to transfer wealth to the next generation without it being subject to estate tax. In practice, this transfer does not usually happen directly. More often life insurance is used to fund an irrevocable trust, which is then administered by a trustee for the benefit of the beneficiaries. Other complex strategies exist and can be exploited by estate attorneys and advisors (it is an entire profession), but suffice to say that life insurance is very useful for avoiding estate taxes.
To Use as an Investment
Permanent Life Insurance has a cash value component which is expected to grow over the lifetime of the policy in most cases. Not only is it expected to grow, but it also has a positive expected return (the cash value will be greater than the amount of money paid in) at some point in the policy life. Universal life insurance can not legally be sold as an investment, but some advisors will imply that it is a valid investment without explicitly saying that it is. You should not trust anyone who sells universal life as an investment. Variable universal life is invested in market funds and can yield a higher return, but also comes with a lot of risk.
More often, whole life insurance is offered as a very safe and stable way to invest money for a long time. Whole life insurance pays dividends which grow over time. These dividends can be used to offset premium payments, purchase more paid up whole life insurance, pay back loans, or be taken as cash.
As the cash value of the policy grows, it can be used kind of like a savings account. You can take money out in the form of a loan, or withdraw the money as a partial surrender. You can also surrender the entire policy for the full cash value (minus any surrender charges). Before you take money out of a policy, make sure that you understand the surrender schedule of charges, and the interest rate on policy loans. While the cash value grows, the policy is also providing the death benefit protection of the face value.
Life insurance can also be sold as part of something called a viatical settlement. Purchasers are looking to profit off of the payment made when the insured person passes away. While this market exists, it is not a preferred outcome of purchasing life insurance.
To Divide an Estate Equally
Sometimes it is not practical to divide an estate equally. One large item can sometimes comprise the majority of the estate, such as a painting or a piece of real estate. Of course the next generation can sell this and split the cash, but it takes the item out of the family legacy. One way to handle the imbalance among multiple heirs when joint ownership is not practical (bickering or one person wanting to sell the item for cash and one wanting to keep the item are common problems) is to give approximately equal value in life insurance proceeds to one person and the actual item to another. If an estate has one disproportionately valuable item, life insurance is a great way to balance the scales.
Donate To Charity
Another use for life insurance is to make a large donation to a charity. Many people want a legacy, and to them that means starting a foundation or scholarship fund. Life insurance can allow someone to leave a much bigger legacy to a charity than they otherwise would be able to give. It at least guarantees the intended sum going to charity, where creditors or tax agencies can not reach after death.
You Want to Purchase Insurance for a Baby
You can purchase life insurance on the life of your baby, and it has more benefits than you may think. You can only purchase a permanent policy with a baby as an insured person, term is not an option. The benefits are locking in insurance coverage for life, and giving your baby a source of savings from the very start of their life. By the time the baby is an adult and can own the policy, the dividend payment will usually pay the entirety of the policy premiums or can provide a legitimate sum of money as income. Insurance on the life of a child can also prevent against the economic harm of a child passing away, such as medical bills and funeral arrangements.
Why Not to Buy Permanent Life Insurance
Permanent life insurance is not necessary for everyone. When compared to term life, permanent life insurance can require way more money paid into the policy as premiums. Term life insurance can be an excellent choice for many people looking for protection for a limited amount of time. For a relatively small annual premium, middle aged people can buy hundreds of thousands or even millions of dollars of protection. They may not be able to afford whole life insurance coverage of equal amounts, and they may not need protection later in life. Oftentimes later in life retirement savings will care for a surviving spouse, and kids are grown and independent and no longer rely on a parent to earn income. If passing money on to children is not a priority, term life can be a fine solution to provide protection.
In fact there is a group of pop culture financial advisors such as Suze Orman who strongly recommend against permanent life insurance. Their advice is not necessarily wrong, but is not tailored to any specific situation. As general advice, it is sound. However there are good reasons to buy permanent life insurance for certain people, such as those in the special circumstances mentioned above. Below we discuss some of the reasons why you may not want to purchase permanent life insurance.
There are Better Investments
As an investment, whole life insurance has a lower expected return than a strategy called “buying term and investing the difference“. This strategy calls for buying the same amount of coverage that you would have purchased in a whole life policy, but instead purchasing it as a term policy. If you take the difference in premium between the whole life policy and the term policy, and invest it in the “market”, over time the expected value of the investment account grows higher than the expected value of the whole life policy surrender value.
While some types of permanent life insurance such as a variable policy attempt to reconcile this difference while also providing permanent coverage, the fees attached to the policy still lead to a lower expected return on cash investment. What proponents of this strategy often ignore, is that the risk associated with the stock market is much higher than the risk associated with a whole life insurance policy from a highly stable and reputable company, so total returns are not everything when considering investment options.
Fees on Universal Life Policies Grow Absurdly High
At Life Ant, we do not recommend universal life policies for anyone. While a tiny percentage of highly sophisticated buyers may have a legitimate strategy and reason to purchase a UL policy, most people including the life insurance agents who sell these policies do not. Universal life works like an interest bearing account attached to a permanent term insurance policy. Every year, as the insured person ages, the price of the insurance goes up. When the insured person is in old age, the price of the insurance coverage becomes astronomical. It can quickly deplete the cash value of the policy and make the owner surrender it without getting any cash or any life insurance benefits to their beneficiaries. Universal life policies work best when they are funded extremely highly in the first few policy years.
Variable universal life policies also have additional fees for the funds. These funds typically mimic mutual funds, but the fees are much higher than mutual funds. While the funds may perform better than the guaranteed interest rate in the standard UL polices, VUL policies can also lose money in unfavorable market conditions. Having a market drop cause your policy to lapse after a lifetime of saving into the policy is a very real risk, and a risk that quite frankly is not ethical to bear in a life insurance policy. A whole life policy or a term policy with an investment account saving the difference is almost always a must smarter proposition than a universal policy. If you do want to buy permanent life insurance, be very weary of a recommendation for a UL or variable policy.
Permanent life insurance is a viable option for some people, mostly high net worth clients. It is also a consideration for people who want a conservative but dependable investment, or those with specialized needs. For the larger majority of people, term life insurance provides much more affordable protection. People can get more coverage for less money, and usually people can buy a long enough term policy to cover them for as long as the protection is helpful.