Maybe you’re getting married, expecting your first child or just working to build a moat around your financial plan. These are all good reasons to consider life insurance.
When you’re ready to buy life insurance, you’re bound to have many questions. For starters, what is life insurance? How much coverage do I need? Do I want term insurance or a permanent policy? (We usually recommend a mix of both.)
When making big decisions for your family and finances, it always helps to sketch out the advantages and disadvantages of life insurance and the different kinds of insurance you can buy before signing on the dotted line. Life insurance comes in many shapes and sizes and each has different advantages and disadvantages. But there are two primary types of life insurance: permanent and term.
Here are the advantages and disadvantages of each type of life insurance.
TERM LIFE INSURANCE ADVANTAGES
It can be inexpensive. Term insurance allows you to get the most death benefit at the lowest cost. When you’re younger this is often a great option for people who need a large death benefit, but can’t afford the higher premiums that come with permanent life insurance.
It may be convertible. The cost of life insurance is based primarily on your age (when you buy the policy) and your health. Certain term life insurance policies allow you to convert to permanent insurance in the future without having to take another health exam. That means you’ll be able to switch to permanent insurance in the future based on your health today.
TERM LIFE INSURANCE DISADVANTAGES
It’s temporary. Hopefully you will outlive your term life insurance policy. But when you do, it will expire and you get nothing.
It can become very expensive. With level term, the amount you pay each year stays the same. But the cost of the most inexpensive policies you can buy (known as annually renewable) will increase in the future. Eventually, it can become very expensive.
If you buy the wrong policy, you could get stuck. With some policies, it may not make financial sense to make changes if your needs evolve over time. It’s important to do your research because many policies will offer the option to make changes as your needs grow. A financial professional can help you think through the advantages and disadvantages of different types of life insurance.
PERMANENT LIFE INSURANCE ADVANTAGES
It never expires. As long as you pay your premiums, your permanent policy will pay a death benefit. Hopefully that will be when you’re 102.
It’s an asset. In addition to the death benefit, a permanent life insurance policy (sometimes called whole life insurance) builds cash value as you pay your premiums. The policy becomes an asset that you own, allowing you to access the cash value throughout your life.
It can be a stable part of your financial plan. All life insurance plays an important role in your family’s financial plan because it provides stability and protects against the loss of income. But the cash value of permanent life insurance can be very useful as a source of funding for things throughout your life. In retirement, it can be a stable source of income for years when the markets decline. That’s because, with most policies, the cash value keeps growing regardless of the market’s ups and downs.
It has tax benefits. The death benefit of life insurance is typically tax-free. In addition, the cash value grows tax-free over your lifetime. You can also typically exchange a life insurance policy for other policies (perhaps an annuity or long-term care) without paying tax.
PERMANENT LIFE INSURANCE DISADVANTAGES
It’s often more expensive for the same death benefit. Because permanent insurance never expires and builds cash value, it’s typically more expensive for the same amount of death benefit that you’d get with a term life insurance policy. Because of that, people often buy a mix of term and permanent insurance.