In this Insurance 101 blog we’re covering one of the most common questions asked by people shopping for insurance – what’s the difference between Term Life Insurance and Permanent Life Insurance?
What is Term Life Insurance?
Term Life Insurance covers you for a set period, usually from 10 to 40 years, although term insurance to age 65 or 100 is also available. If the policyholder dies within the term specified in the policy, their beneficiaries will receive the amount of the policy as tax-free cash.
Term insurance has limited features available, but two of the most common ones are convertible and renewable:
- Convertible means that at specified times, the policyholder can convert the policy to a permanent policy. Upon conversion, the client will pay the rates appropriate for their age at the time of conversion, but they will not have to provide evidence of their insurability.
- Renewable means the insurance company must give the option for the client to renew (re-buy) the insurance at the end of the term, without the policyholder having to provide evidence of their insurability.
These two features are important because they give the policyholder the option to stay insured if their health status changes. For example, if Jeff buys a 10-year term insurance policy at age 30, then develops a serious illness like cancer or MS at age 35, he may choose to exercise his convertibility option to lock-in his insurance for life. He will face an increase in premiums (he is older and permanent insurance is more expensive) but if he still needs the insurance, he should convert as it is unlikely he will be offered it again, given his health situation.
Some additional options include an accidental death benefit, which pays an additional benefit if you die because of an accident, and a waiver of premium benefit, which allows you to stop paying your premiums but remain covered if you become disabled for a minimum amount of time, such as six months.
What is Permanent Life insurance?
Permanent Life Insurance is insurance that covers you for as long as you live, or as long as the policy is in force (which is usually for life, unless you stop paying the premiums). If the policyholder dies while insured with permanent insurance, their beneficiaries will receive the amount of the policy as cash tax-free. In addition, there may be an additional amount payable, known as a ‘cash value.’
Permanent insurance often has a savings component known as a cash value. The longer you pay into your policy, the more the cash value inside the policy grows. You can use the cash value in your policy in different ways:
- You can borrow against it and use the funds as you wish
- You can cash-in the cash value
- You can assign it as collateral for a loan
The 2 main types of permanent insurance are Whole Life and Universal Life. We will explain more about the differences in future editions of Insurance 101, but the main difference is that Whole Life policies are usually Participating, which means the policyholder is entitled to receive dividends (not guaranteed) which can be used in various ways. The same options available for term insurance are usually available for permanent insurance.
So, which is better?
Like many financial products, there is no one best fit for everyone.
Typically, term insurance products are less expensive in the short-run, which makes them attractive for young people or others with limited budgets.
Because of the ‘investment’ component inside a permanent product such as Universal Life, there are often greater degrees of flexibility in terms of taking premium holidays, borrowing funds from the policy, or receiving a higher death benefit than what has been paid for using the insurance premiums alone. However, many people prefer to adopt a ‘buy term and invest the difference’ approach, which is great if you truly have the discipline to invest the difference, not spend it. Also, permanent products may be more cost effective in the long term as rates are locked-in at the time of purchase.
Finally, because your health may change, there’s always a possibility that you will not be able to buy more term insurance at a cost-effective price when the original term comes up. Most term insurance products give the option to renew without providing medical evidence, although the renewal will be based on your age at conversion, and will therefore be much higher than the rates at the time of purchase.
The best solution may be to talk to an advisor who can evaluate your personal situation and recommend a policy that is best for your specific needs.
To get a free insurance needs analysis, try out the new InvisorGPS™.
Or if you’d like to request an insurance quote, you can do so here.