Life Insurance: Term or Permanent?
We get questions from clients all the time asking about life insurance. What type should I get? How much coverage should I purchase? Where should I get a good policy?
There are two types of life insurance: term and permanent life insurance. Permanent life insurance can be broken down into several other categories: whole, universal, variable or variable-universal. Permanent life insurance is just that, permanent, as long as you continue to pay the premium. Because you can’t outlive the policy, it also tends to be the more expensive type of insurance.
Term insurance has a fixed duration. It will expire after a number of years (10, 20, 30, etc.) depending on the policy you purchase. We find the most cost-effective coverage for families is often term insurance. Term insurance allows a family to get a lot more coverage for the premium paid.
The difference in premiums between a term policy and a permanent policy can be significant. Of course, the premiums will be dictated by your age, health and how long you need coverage. You may easily pay 5 times as much in premium for one quarter of the coverage. Nerdwallet.com has a good breakdown on the difference between permanent and term policies. Below is a snippet from the article comparing premiums for two policies with the same death benefit for a 30 year old man and woman:
All else being equal, the difference in premium between a term and permanent policy is generally driven by two factors: term insurance expires after a set number of years and the permanent provides a benefit that allows for the accumulation of “cash value” in the policy. The cash value is nothing more than a portion of the premiums you pay and builds as you pay more premium over the year. Permanent insurance providers make this cash value available to you, to borrow agains or to even pay future premiums. This cash value will often grow at a dividend rate defined by the insurance company.
Since we do not sell insurance, we do not have a financial incentive to recommend one policy over another. However, we do find that for couples who want to have coverage in case their loved one passes prematurely, term insurance can be a good fit. It can provide cost-effective coverage allowing the surviving partner to take care of their financial needs for a period of years after death. We don’t recommend overbuying on insurance, but having enough to allow the surviving partner time to make the necessary adjustments to being on their own financially, is important.
The amount of coverage is fully dependent on the persons specific situation. However, multiplying an individuals income by the number 5 (as in 5 years) can be a rule of thumb for how much coverage they may want to consider. To be clear, permanent insurance has some very good applications for tax benefits during estate planning, special needs assistance for a loved one or for wealth distribution strategies. In these latter examples, term insurance may not provide adequate coverage. Individuals should discuss their situation in detail when talking with an advisor about which policy makes sense for them.