One of your biggest concerns in life is probably how your family would be taken care of if you were to die. What’s not as straightforward is what type of insurance policy you should get to help protect them if that were to happen.
Permanent life insurance, sometimes called whole life insurance, is one of the options on the table, and it’s exactly what its name suggests: permanent. If the policy is in place when you die, it will pay a death benefit, whether you live to be 65 or 105. That’s what makes it different from the other main type of policy, term life insurance. Term will expire, and usually without being worth a dime.
Think of the difference between the two as like getting a home. Term life insurance is like renting. You pay rent each month and when your lease is up, you stop paying, move out and walk away with nothing financially (except maybe your security deposit). With term, you pay premiums each month for coverage that spans a certain period of time. If you’re still alive when that term is over, you don’t have to pay your premiums anymore, but there will be no death benefit for your beneficiaries.
Permanent life insurance is like buying a home. With each mortgage payment, you build equity in your home until you own it outright. When you pay the premiums on your permanent life insurance, you’re building value in your policy while you’re still alive, and you’ll get a death benefit as long as the policy is in place. For those reasons, permanent life insurance is typically more expensive than the same amount of term insurance for the same person.
HOW DOES IT WORK?
Permanent life insurance is very flexible, which means it can also be complicated. But let’s take a fairly simple whole life insurance policy to explain how it works.
First, figure out how much of a death benefit you want and then apply for that amount of coverage. The application process typically includes a health screening.
Then figure out over what length of time you’d like to pay your premiums. Think about it in terms of a home loan, where you might get a 15- or 30-year loan. With life insurance you typically have many options. For instance, you could choose to pay until you reach a certain age, like 65 or 90, or over a certain number of years.
Just like with a home loan, the shorter the duration, the more you’ll owe each year for the same amount of coverage. Whole life insurance is like a fixed-rate mortgage — the premiums never change. But there are other types of permanent life insurance policies where the premiums do change.
Once the policy is in effect, if you die, the company will pay your beneficiaries the full death benefit. But let’s assume that you live for a long time. Your policy will accumulate cash value every year. In a whole life insurance policy, that cash value will never go down (unless you take the money out — which reduces the death benefit).
Even though they aren’t guaranteed, many insurance companies also pay dividends, which can allow your cash value to grow more quickly and may also increase your death benefit. You could also choose to use your dividends to pay your premiums. Doing that means you may not have to pay as much each year; it’s even possible that at some point, you may not have to pay anything at all. But that also means you won’t accumulate as much cash value.
WHAT CAN YOU DO WITH THE CASH VALUE?
Because your policy builds up cash value, it gives you access to money if you need it. The most common way to access your cash value is to take a loan against it. Think of it like a home equity loan. You could take the loan directly from your insurance company or you could use the policy as collateral for a bank loan. One thing to consider if you do this: Your heirs would have to pay back any loan if you were to die (if your loan is from the insurance company, the company will deduct the loan balance from the death benefit).
You could also surrender (i.e., cancel completely) some or all of the policy someday and take the cash value in its entirety (think of it like selling a house). You would lose your death benefit though, and doing this can have tax implications. So if you go this route, it’s best to work with a financial planner or professional.
WHO SHOULD CONSIDER PERMANENT LIFE INSURANCE?
Because permanent life insurance is more expensive, often people will buy a mix of term and permanent life insurance. Some term policies will also allow you to convert them to a permanent policy in the future without having to take another health screening.
If you’re interested in a death benefit that won’t expire and want the ability to accumulate cash value, you should consider permanent life insurance.
If the policy is in place when you die, it will pay a death benefit, whether you live to be 65 or 105.
If want to get a better idea of how much life insurance you need, online calculators like this one can help.
Loans taken against a life insurance policy can have adverse effects if not managed properly. Policy loans and automatic premium loans, including any accrued interest, must be repaid in cash or from policy values upon surrender, lapse or the death of the insured. Repayment of loans from policy values upon surrender or lapse can trigger a potentially significant tax liability and there may be little or no cash value remaining in the policy to pay the tax. The policy will lapse if loans become equal to the cash value while the policy is in force and additional cash payments are not made.