A vital component of financial planning is ensuring that your loved ones are financially protected in the event of your death. That means that you need a life insurance policy that you can count on being in force when you die. A permanent life insurance policy can guarantee this, as it is designed to stay in force for the duration of your life. Considering the average cost of a funeral is between $7,000 to $10,000, life insurance can be a valuable investment to make a difficult time a little easier for your family.
All life insurance policies provide a benefit that is payable upon your death to your family members or other beneficiaries, which can be used to pay for funeral and living expenses. However, there are a few different types of permanent life insurance available in the marketplace today, and the right type of policy for you will depend upon various factors, such as whether you are looking to accumulate cash value or simply use the death benefit.
What is permanent life insurance?
As its name implies, permanent life insurance lasts for the duration of your life. Unlike term life insurance that only remains in force for specific increments of time (normally 10, 20 or 30-year periods) permanent insurance has no expiration date, so you receive the benefits of coverage for as long as you live after you buy the policy.
Permanent life insurance policies also provide another key benefit in addition to the lasting death benefit. These policies build up cash value over time that grows tax-free and can be withdrawn at any time to pay any type of expense, such as retirement expenses or college tuition.
The death benefit that comes with a permanent life insurance policy is normally paid out in either a lump-sum or with a series of payments. For example, the death benefit may be paid out over a period of five or ten years. Life insurance death benefits are always exempt from income taxes, although any interest that is earned on an unpaid death benefit will be taxable. If the death benefit is paid out over a period of time as described previously, then the portion that the insurance company retains will earn taxable interest.
If you decide to cancel your life insurance policy, then you are guaranteed to receive the cash surrender value of the policy. This is equal to the amount of cash value in the policy minus any surrender charges or other administrative costs that may be charged by the life insurance company.
How does permanent life insurance work?
As mentioned previously, with permanent life insurance there are two key components. First, there’s the death benefit that is payable to your beneficiaries when you pass away. Then there is the policy’s cash value. As you make policy payments, the cash value will build up over time and can be used to pay for any type of expense that may arise, such as medical bills, home improvements or even a vacation. You can withdraw your policy’s cash value in the form of a policy loan that will charge interest on the amount that you borrow. But you don’t have to financially qualify for this type of loan like you do for other types of loans because you are essentially borrowing your own money. Therefore, factors such as your credit score are irrelevant here. However, it’s important to note that any money you withdraw that you don’t repay comes out of your death benefit, leaving your loved ones with less income.
Advantages of permanent life insurance policies
Once you buy a permanent life insurance policy, you can keep it for the rest of your life. This is beneficial because you won’t have to worry about renewing it like you would with term life insurance. With term life insurance, you might have to undergo medical testing at the end of each term, which could raise your rates. You don’t have to worry about that with permanent life insurance. You will only be required to take one medical examination when you first take out the policy, but never again after that. Once you have medically qualified for coverage and the policy has been issued, it will remain in force for the duration of your life, regardless of any health problems that you may have afterwards.
Moreover, permanent life insurance offers cash value to go along with a death benefit. This gives you an investment vehicle by which you can withdraw the cash value of it if you need the money for unexpected expenses. In most cases, the policy owner will only get the death benefit or the cash value, unless he or she purchases an additional rider that will give the beneficiaries any remaining cash value in the policy in addition to the death benefit.
Disadvantages of permanent life insurance policies
As an investment vehicle, permanent life insurance isn’t a one of the more lucrative options available in the financial marketplace. With most permanent life insurance policies, you will generally receive a mediocre return on your investment. Given that your premiums are going to be more expensive, it might not be the smartest option for some. For example, if you need a large amount of death benefit protection to cover a specific expense for a specific period of time, then you will probably be better off buying a term policy and investing the money that you save in an IRA or other type of investment.
Types of permanent life insurance
There are four types of permanent policies. Here’s a look at them:
- Whole life insurance: This is the most popular form because it guarantees you a minimum rate of return on your cash value. Your beneficiaries also receive a death benefit upon your passing. In some cases, your policy might provide you with dividends you can cash out or use to pay your policy premiums.
- Universal life insurance: This policy gives you more flexibility through the life of the policy. For instance, you can increase the death benefit or decrease the cost of your premiums once you have built enough cash value. The amount of interest that the policy pays will rise and fall in tandem with general interest rates.
- Variable universal life insurance: Similar to universal life, you have the flexibility of changing your death benefit at any time. Furthermore, you gain greater flexibility in how you invest your funds, but this could also reduce the death benefit if you incur losses.
- Indexed universal life insurance: This is the newest type of permanent life insurance available in the marketplace today. The interest that the policy earns is tied to the performance of an underlying financial benchmark, such as the Standard & Poor’s 500 Index. When the index rises during a given crediting period, the policy will pay a proportional amount of interest into the cash value. If the index declines, then no interest will be credited, but the cash value will not decline in value. Indexed universal life insurance policies have the same types of flexibility as universal and variable universal policies.
The cost of permanent life insurance
Life insurance costs depend on a variety of factors such as your age, gender, how much coverage you want and whether you use nicotine. Some insurance providers also require a medical exam, especially if you decide to purchase a policy with a higher death benefit. The larger the death benefit, the greater the cost of the premiums that you will pay. Permanent life insurance is always more expensive than term life insurance because of the cash value that it accumulates. The difference between term and permanent insurance can be compared to the idea of renting (term) versus owning (permanent) your life insurance policy.
Who should buy permanent life insurance?
Permanent life insurance is good for someone in great health who doesn’t want to worry about renewing their policy (as they would with term life insurance) down the road when medical checkups could raise their life insurance rates. Moreover, this type of insurance is also a smart bet if you don’t mind spending more on your policy in order to receive the flexibility of cashing out the value down the road.
Using these factors, a 30-year-old female could pay $23 a month for a $25,000 benefit whereas a 50-year-old male could pay $59 monthly for the same policy.
Frequently asked questions
Is term life insurance or permanent life insurance better?
Both are beneficial depending on your priorities. A permanent life insurance policy is going to be smarter for those who are younger who want to lock in their rates for the rest of their lives. Furthermore, permanent life insurance gives you the option to borrow against the cash value of your policy. Meanwhile, term-life insurance is also smart if you’re younger and need a larger death benefit.
What are the different types of permanent life insurance?
There is whole life insurance where you receive a minimum return for your policy payments and your beneficiaries receive a death benefit. With universal life insurance, you have the option of decreasing or increasing your death benefit. Finally, with variable life insurance, you have more control over where you invest your money and the ability to change your death benefit. Indexed universal life insurance allows you to participate in the upside of the financial markets with no downside risk.
How does cash value work?
As you make your payments, your money goes to paying the cost of the premiums plus the underwriting costs on the insurance side, and then the rest goes into your cash value. Over time, this accumulates, allowing you to borrow against your death benefit if you need money for emergency expenses. If you don’t pay it back when you pass away, the insurance company deducts the unpaid balance of the loan from your death benefit.