Term vs. Permanent Life Insurance


Few people who have bought life insurance have escaped the debate over term versus permanent insurance.  And the wrong kind of life insurance can do more damage to your financial plans than just about any other financial product today. So, the first and most important decision you must make when buying life insurance is: term, permanent or a combination of both? Let's look at each.

Term life policies offer death benefits only, so if you die, you win (so to speak). If you live past the length of the term policy, you (or, more specifically, your family members) get no money back and no death benefit.  Permanent life policies offer death benefits and a "savings account" (also called "cash value") so that if you live, you get back at least some of, and often much more than, the amount you spent on your premiums. You get this money back either by cashing in the policy or by borrowing against it.

Permanent life insurance is more expensive (or is it?)

As you might expect, permanent life insurance premiums are more expensive than term premiums because some of the money is put into a savings reserve. The longer the policy has been in force, the higher the cash value reserve, because more money has been paid in and the cash value has earned interest, dividends or both.

The debate is all about that cash value. If you buy a policy today, your first annual premium is likely to be much higher for a permanent life policy than for term.  However, the premiums for permanent life stay the same over the years, while the premiums for term life increase, or the term policy will terminate or end, if you're still alive at the end of the term. That extra premium paid in the early years of the permanent policy gets invested and grows and builds cash value. The earnings are tax-deferred and can be borrowed against tax free.  When you use borrowed funds (collateralized against the cash value) the cash value still continues to grow.   If you die, the proceeds (net of the collateralized loan) are income tax-free to your beneficiary or estate.

The saying you always hear is, "Buy term and invest the difference." The fact is, it depends on how long you keep the policy and IF you do "invest the difference".  If you keep the permanent life policy long enough, that's the best deal.  But "long enough" varies, depending on your age, health, insurance company, the types of policies chosen, interest and dividend rates, and more. The reality is that there is not a simple answer, because life insurance is not a simple product and there are other differerences you may not even be aware of.

Guidelines to live by when buying

Even with all of these variables, there are some guidelines you can follow. The key is how long you plan to keep the policy.  If the answer is less than 10 years, term is clearly the solution.

If it is more than 20 years, permanent life is probably the way to go. The big gray area is in between. Here is where you need an expert to run the term vs. permanent analysis for you and expain all the differences and alternatives. Of course, this assumes you keep the policy in force. Most people drop their policies within the first 10 years, but if you do your homework now, that shouldn't be the case for you.  Statistically, only about 2% of term policies issued are still owned when the insured passes away.

How to choose

Categorize your insurance needs by their use. If you need $60,000 for college and your youngest child will graduate in three years, you need $60,000 of term insurance as a short-term hedge against your death, thus insuring that your child can finish his or her education. Meanwhile, if your needs are long term or you want to guarantee a legacy to your beneficiaries, or if your estate will owe estate taxes at your death, you probably need permanent insurance, because you're not likely to die in the next 20 years (you hope). You also may want to re-evaluate your estate plan, but that's a different issue.  There are other "money issues" that you should understand before making a decision which type of life insurance (or combination) is best for you.