One of the most common pieces of advice given about life insurance is to avoid permanent life insurance policies and purchase a term life policy instead. You may be wondering why exactly this is the case, or if there’s ever an instance where you should purchase a term life insurance policy. Here’s what you need to know about permanent life insurance and why it isn’t always the best decision.
What Is Permanent Life Insurance?
Permanent life insurance is a type of life insurance that covers you for your entire life without expiring. Your premium costs stay the same for your entire life without increasing. Most permanent life insurance policies also have a cash value component, which you can use as a financial asset.
Types of Permanent Life Insurance
There are a few different types of permanent life insurance available. The two most common types of permanent life insurance are whole life insurance and universal life insurance. There are also variable life insurance policies and variable universal life.
Whole Life Insurance
With a whole life insurance policy, your premiums stay at the same amount until you pass away. You’ll also have a cash value component that grows at a guaranteed rate throughout the course of your life. Many people choose whole life insurance because it is marketed as a very financially stable product. Whole life insurance is unique in the life insurance world because it is eligible for dividend payments, which are meant to be a distribution of profits from the life insurance company. Dividend payments get many of the tax benefits associated with life insurance such as not being taxable until dividends exceed total premiums.
Universal Life Insurance
Universal life insurance gives you the option to adjust the amount you pay in monthly premiums. The insurer will give you a payment range, and you will have the option to pay any amount in you want as long as it does not create a modified endowment contract or cause the policy to run out of cash. The cash value component has a guaranteed growth rate, but it’s also tied to the performance of the stock market. This gives you the potential to earn more over time. You’ll also typically have the option to use your cash value to pay your monthly premiums. There’s also a version of universal life insurance called indexed universal life, which ties your cash value to an index like the S&P 500 instead of the overall market. In this case, there are generally standard minimum and maximum returns.
Variable Universal Life Insurance
Variable universal life insurance is very similar to universal life insurance in that the premiums can be adjustable. However, instead of having the cash value tied to the interest rate market, you’ll be able to choose from a variety of investment options. This gives you more control over the way your policy grows. The investment options are similar to mutual funds, and called subaccounts. These subaccounts typically invest in stocks and bonds as underlying assets. Just like mutual funds, the subaccounts have prospectuses and investment objectives and disclose how they invest. Savvy investing within a variable life policy can get you the tax-deferred benefits of life insurance and grow money much more quickly than whole life or universal life insurance.
Guaranteed Issue Final Expense Life Insurance
Guaranteed issue life insurance is also technically a form of permanent life insurance. However, it works very differently than other permanent life insurance policies. Guaranteed issue final expense life insurance does not require a medical exam, and is designed to cover funeral expenses. The death benefit is relatively low, so it’s not a good option if you need to pay down debts or support a family. It also tends to be more expensive per dollar of coverage than traditional life insurance policies.
What Are the Disadvantages of Permanent Life Insurance?
While permanent life insurance might sound like a good idea on paper, there are actually many disadvantages to this type of life insurance. Most people don’t actually need permanent life insurance. They can get much better value for money by investing in term life insurance instead.
Permanent life insurance is much more expensive than term life insurance, particularly for those that are relatively young and healthy. Most people won’t actually need life insurance for their entire life, so a permanent policy isn’t the best use of money. Typically, you’re using your life insurance policy to pay for your funeral expenses, pay down any existing debt, and support your family after you pass away. However, many of these expenses will change as you get older. Most people pay down their mortgage or student loan debt after a certain period of time. Kids grow up and get jobs, so you’ll no longer need to support them. You might also be building savings, which your family can use for your funeral expenses. It makes more sense to determine exactly how long you’re going to need insurance and purchase a more affordable term policy instead. This will also allow you to save or invest the money you would have spent on a permanent life insurance policy.
Many people opt for a permanent life insurance policy because of the cash value component, considering it a long-term investment. However, there are much better long-term investment options available for most people. Putting your money into an IRA or 401(k) account is much more stable, and it will be much easier to access later in life should you want to use it for retirement. Permanent life insurance policies can also be very complex and difficult to understand, which can be confusing for beginner investors.
Since permanent life insurance policies are so expensive, it can be difficult to keep up with the payments. Your finances will likely change quite a bit over the course of your life with things like new jobs, children, and other big life changes. If you miss a life insurance payment, your policy could lapse – which means you’d need to start all over again with a new policy and you’d lose access to your cash value.
Popular financial advisors like Suze Orman and Dave Ramsey are famous crusaders against permanent life insurance. Their argument is a popular refrain to “buy term and invest the difference”. This means that if you put the difference in price between a permanent policy like whole life insurance, and term life insurance, into an investment account it will grow faster than whole life insurance in value and you will end up with more money.
Are There Any Advantages of Permanent Life Insurance?
There are a few situations where you might consider investing in permanent life insurance. However, it’s worth restating that permanent life insurance isn’t the best choice for most people.
You may need permanent life insurance for certain situations such as estate planning, paying estate taxes, funding a trust, or dividing an illiquid estate evenly. You might also want to consider permanent life insurance if you have completely maxed out your possible 401(k) and IRA contributions and want to continue building your wealth. This is because the death benefit is usually tax-free, which allows you to contribute to your estate without high tax rates. The cash value also grows tax-deferred, and withdrawals get FIFO tax treatment, and loans are tax-free so you can access your cash in an advantageous way. If your permanent life insurance policy pays dividends, those are usually tax-free as well.
Final Word on the Drawbacks of Permanent Life Insurance
For most people, permanent life insurance simply isn’t the right choice to protect your family. It’s very expensive and isn’t the most effective form of investment. Term life insurance is much more affordable and can still provide the coverage your family needs. If you’re struggling to decide where to invest your money, consider talking to a financial advisor to learn more about your investment options as well as potential life insurance coverage.