Permanent life insurance is a financial product that provides lifelong coverage and builds cash value over time. Unlike term life insurance, which expires after a set period, permanent life insurance remains active as long as premiums are paid. This type of insurance comes in two main forms: whole life and universal life, each offering its features and benefits.
Despite the benefits, permanent life insurance may not be ideal for everyone. It's particularly beneficial for those with higher incomes, specific lifetime needs and an interest in accumulating cash value alongside insurance coverage.
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Key Takeaways
Permanent life insurance is best described as lifetime life insurance. It has no expiration date as long as you pay your premiums. It also builds cash value.
Permanent life insurance policies tend to be expensive. Premiums can be as high as 25 times more than term life insurance.
There are two primary types of permanent life insurance: whole and universal.
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How Permanent Life Insurance Works
Permanent life insurance refers to a life insurance policy that doesn’t expire — coverage lasts the policyholder's entire lifetime. It has a cash value that the policyholder can borrow against or withdraw. However, choosing this type of life insurance means paying a higher premium.
Permanent life insurance may be a good option, depending on your needs and circumstances. Understanding the various qualities of permanent life insurance will help you determine whether this type of policy suits you.
Lifetime coverage
The policy doesn’t expire as long as you make premium payments. There are three ways for the coverage to end.
- First, you may decide to cancel your coverage and collect the cash savings your policy has accumulated.
- Second, you may cancel the policy and surrender the cash value in exchange for a reduced death benefit. Some companies allow policyholders to convert to term life insurance.
- Third, the policy lapses. It’s possible to reinstate coverage.
High premiums
Since permanent life insurance also accumulates cash value, premiums tend to be more expensive than term life insurance. The difference in rates can be as high as 25 times more.
Premiums for permanent life insurance stay level over time. Unlike term premiums, the rates don’t increase as you age.
Cash value
Part of the premiums goes toward the cash value component. The insurer invests these funds in low-risk investment vehicles, so the value appreciates at a fixed rate.
The cash value is typically tax-deferred. Additionally, you can borrow against it or withdraw the available amount in a time of need.
Dividends
Depending on the policy you choose, you may get dividends. That means the profits earned through the policy are returned directly to you.
You can use the dividend in various ways. You can take it as cash or use it to pay premiums or outstanding loans against the cash value component. You can also use dividends to buy paid-up additions.
Permanent life insurance is only permanent as long as you pay your premiums. Failure to make the necessary payments could lead to the cancellation of the policy.
You can opt to cancel or surrender your policy voluntarily, but you may only receive a reduced cash value. This is called the cash surrender value. The amount you’ll receive is based on the cash value minus surrender fees. If you have outstanding debts against the policy, these will also be deducted.
Cost of Permanent Life Insurance
The cost of permanent life insurance is not a one-size-fits-all figure; it varies based on individual needs and circumstances. Several factors come into play when determining the premiums for this type of policy, and understanding them can help you make an informed decision that aligns with your financial goals.
- Age: Generally, the younger you are when you purchase a policy, the lower your premiums will be.
- Health Status: Medical exams often influence rates. A healthy individual is likely to receive more favorable premiums.
- Coverage Amount: The higher the death benefit you choose, the higher your premiums will be.
- Policy Type: Different types of permanent life insurance, such as whole or universal life, may have different cost structures.
- Additional Riders: Adding optional features or riders to your policy can also affect the cost.
- Payment Frequency: Whether you choose to pay your premiums monthly, quarterly or annually can influence the overall cost.
- Investment Performance: For policies with a cash value component tied to investments, the performance of those investments can impact the cost.
Tax Implications of Permanent Life Insurance
Understanding the tax implications of permanent life insurance can help you make the most of its financial benefits. Here's a breakdown of the key tax aspects:
- Tax-Free Death Benefit: One of the standout features of permanent life insurance is the tax-free death benefit. When the policyholder passes away, beneficiaries receive this payout without any federal income tax deductions, ensuring that your loved ones get the full financial support intended.
- Tax-Deferred Cash Value Growth: The cash value component of your policy grows on a tax-deferred basis. This means that you won't owe any taxes on the gains as long as they remain within the policy. This tax-deferred growth can significantly boost the cash value over time.
- Taxable Withdrawals: If you decide to withdraw from the cash value, the amount exceeding your total premiums paid into the policy is subject to income tax. It's important to keep track of your basis (total premiums paid) to understand the tax implications of any withdrawals.
- Loans Against Cash Value: You can take out loans against your policy's cash value without incurring taxes. However, failure to repay the loan can reduce the death benefit and may result in tax liabilities if the policy lapses.
- Policy Surrender: If you choose to surrender the policy, the cash value minus the premiums you've paid is considered taxable income. This could push you into a higher tax bracket for the year.
- Gift and Estate Tax: In some cases, the death benefit may be subject to federal gift and estate taxes. Proper estate planning can often mitigate this.
For a comprehensive understanding of these tax implications, it's advisable to consult IRS Publication 525 or seek advice from a tax professional.
Types of Permanent Life Insurance
There are two main types of permanent life insurance: whole and universal. Each type has its own features, benefits and drawbacks. Universal life insurance often comes with lower premiums and greater flexibility, while whole life insurance offers more stability through guaranteed death benefits and fixed premiums. That said, both offer financial protection. The better option will depend on your specific needs and goals.
Whole Life insurance
Whole life insurance combines life insurance coverage with a savings account, offering financial protection for your entire lifetime or up to a specified age, usually between 100 and 120 years. The policy remains active as long as you keep up with your premium payments.
Main Features:
- Death benefit is guaranteed and fixed
- Fixed premiums
- Guaranteed cash value
- May grow through dividends
Types of Whole Life Insurance:
- Simplified Issue Whole Life
- Guaranteed Acceptance Whole Life
- Non-Participating Whole Life
- Participating Whole Life
- Indeterminate Premium Whole Life
- Economatic Whole Life
- Limited Payment Whole Life
- Single Premium Whole Life
Universal Life Insurance
Universal life insurance offers a more flexible approach to permanent life coverage. It allows you to adjust your premiums and death benefit based on your changing financial needs. The cash value component is often tied to market interest rates, providing the potential for higher returns. It's important to note that the growth of the cash value is not guaranteed. It can fluctuate based on the performance of the insurance company's investment portfolio.
Main Features:
- Death benefit is not guaranteed
- Premiums can be adjusted (within limits)
- Cash value can fluctuate
Types of Universal Life Insurance:
- Traditional or Non-Guaranteed Universal Life
- No Lapse Guaranteed Universal Life
- Indexed Universal Life
- Variable Universal Life
Term vs. Permanent Life Insurance
When selecting a life insurance policy, you have the choice between term and permanent life insurance. Both types offer financial protection but are tailored for different financial goals and life situations.
Similarities:
Financial Protection: Both term and permanent life insurance aim to provide financial security to beneficiaries upon the insured's death.
Death Benefit: Each type offers a death benefit, which can be used to settle debts, cover funeral expenses or provide ongoing financial support to loved ones.
Differences:
Coverage Duration: Term life insurance provides coverage for a set period, such as 10 to 30 years, and may require renewal. Permanent life insurance offers coverage for a lifetime without the need for renewal.
Premium Stability: Term life insurance premiums may increase upon renewal, while permanent life insurance premiums generally remain level for the life of the policy.
Cash Value Component: Permanent life insurance comes with a cash value component that can be invested, withdrawn or borrowed against. Term life insurance lacks this feature.
Financial Goals: Term life insurance is often chosen to cover specific financial responsibilities like a mortgage or children's education. Permanent life insurance is more aligned with long-term financial planning, including retirement savings.
Given the substantial premium rates of permanent life insurance, most people would want to purchase term life insurance. The difference in the cost can be invested. The best term policy for you provides the right coverage based on specific needs. You may opt for permanent life insurance if the reasons above resonate with you.
Pros and Cons of Permanent Life Insurance
Understanding the pros and cons of permanent life insurance can help determine whether permanent life insurance is the right choice for your financial planning needs.
Pros of Permanent Life Insurance
Lifetime Coverage
One of the most significant advantages is the lifetime coverage it provides. Unlike term insurance, which expires after a set period, permanent life insurance ensures that your beneficiaries will receive a death benefit, regardless of when you pass away.
Appreciating Cash Value
The policy includes a cash value component that grows over time. This can serve as an additional financial resource that you can borrow against or invest.
Continuing Death Benefit
The death benefit remains constant throughout the life of the policy, ensuring that your loved ones will receive financial support after your passing.
Option to Add Riders
Permanent life insurance policies often allow you to add riders, such as long-term care or critical illness coverage, providing additional funds while you're alive.
Tax-Free Loan Against the Policy
You can take out loans against the cash value of your policy without incurring taxes, offering a flexible way to access funds.
Flexibility
Some types of permanent life insurance, like universal life, allow you to adjust your premiums and death benefit, providing financial flexibility during different life stages.
Cons of Permanent Life Insurance
High Premiums
One of the most significant drawbacks is the high cost of premiums, which can be up to 10–25 times more expensive than term life insurance.
Cash Value Needs to Be Monitored
The cash value component requires active management to ensure it's growing as expected and to avoid any potential tax implications.
Possibility of Negative Returns
If your policy is tied to market performance, there's a risk of negative returns, which could affect the cash value
Conservative Interest Rates
The interest rates on the cash value are often conservative, especially in whole life policies, which may not offer the best return on investment.
Who Should Purchase Permanent Life Insurance
Permanent life insurance is not optimal for everyone, so it's best to consider your lifetime needs and goals before making a decision.
Below are some reasons why someone might choose to purchase permanent life insurance.
You’re a business owner
Business owners looking for a policy that offers financial protection and earns cash value may consider getting permanent life insurance. The cash value can be used to pay the insurance premiums and can also be withdrawn or borrowed against to finance business expenses.
You’re interested in estate planning
If you’re building an estate plan, you may find permanent life insurance a good investment because it provides another source of funds for your heirs. For instance, the net value of estates may be higher than the amount exempt from taxes at the time of your death. The proceeds of your life insurance policy can be used to cover the expenses.
You’re looking for additional tax-free investment opportunities
The cash value of permanent life insurance is tax-free and grows over time, making it an additional investment as you plan for retirement.
In a time of need, you can also choose to withdraw or take out a tax-free loan against your policy's cash value.
You’re the sole provider or support a lifelong dependent
Permanent life insurance can help a sole provider stay afloat during financial hardships thanks to the cash value component, which can be taken out as a loan or withdrawn.
Additionally, the death benefits can help cover medical bills or daily expenses after the policyholder’s death, offering financial support to the policyholder’s dependents during hard times.
You may need long-term care
Depending on your needs, you may add different riders to your policy, such as a long-term care rider. This is a great addition if you’re worried about the possibility of needing long-term care due to a condition or illness.
With this rider, you can access part or all of the plan’s death benefit to cover long-term care expenses.
You have significant debts
The flexibility of some permanent life insurance policies can help pay off debts. You can also reduce your death benefits and save on premiums while taking care of your debts. Additionally, the cash value that grows over time can be withdrawn to settle debts faster.
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Ensure you are getting the best rate for your insurance. Compare quotes from the top insurance companies.
How to Get Permanent Life Insurance
There are various factors to consider when purchasing permanent life insurance. Below is a step-by-step guide to help you navigate the process.
Assess Your Financial Needs
Before purchasing a policy, take a comprehensive look at your financial landscape. Evaluate your income, existing debts and anticipated future expenses. This initial assessment will guide you in selecting a policy that aligns with your financial goals.
Consult a Financial Advisor
This step is optional but can be helpful. A financial advisor can offer personalized advice, helping you understand how a policy can fit into your broader financial plan.
Compare Policies and Providers
Research various types of permanent life insurance and providers. Look for policies that align with your financial objectives and offer competitive rates.
Undergo a Medical Exam
Most insurance providers will require a medical exam. This exam helps the insurer assess your health risks, which influences your premium rates. Be prepared to answer questions about your medical history and possibly undergo tests.
Review and Purchase
Once you've selected a policy, review all the terms and conditions. Pay close attention to the premiums, the death benefit and the cash value components. Make sure you fully understand these elements before finalizing your purchase.
Frequently Asked Questions
Deciding on permanent life insurance requires consideration of various factors. Below are answers to some of the most commonly asked questions about permanent life insurance to help you make an informed decision.
About Mark Fitzpatrick
sources
- IRS. "Publication 525 (2022), Taxable and Nontaxable Income." Accessed September 22, 2023.