What It Is and How It Works – Forbes Advisor INDIA

Life insurance is designed to financially protect your loved ones in the event you pass away. If you’re shopping for life insurance and decide you need coverage throughout your entire life, permanent life insurance guarantees lifelong protection and comes with a cash value component.

Although permanent life insurance is more expensive and often complicated than term life insurance, there are some cases where it can make sense to purchase this type of policy.

What Is Permanent Life Insurance?

Permanent life insurance policies generally provide lifelong coverage and the opportunity to build cash value, which accumulates on a tax-deferred basis. You can tap into the policy’s cash value while you’re alive. Permanent life insurance is more expensive than term life because of the coverage length, cash value and policy charges.

If you’re shopping for the best life insurance, permanent life insurance might be the best fit, depending on your goals.

Permanent Life vs. Term Life Insurance

There are two main differences between term life and permanent life insurance: Permanent life insurance generally lasts the rest of your life and it has a cash value component, while Term life insurance doesn’t. Instead, term life insurance works this way:

• Term life insurance has a set period of level premiums during which your rate is locked in, such as 10, 15, 20, 25 or 30 years.
• You can renew the policy yearly but at a much higher price after the level term period.
• You may be able to convert a term life policy to permanent life insurance.

Term life insurance is a good choice for many families. Life insurance needs are often finite, allowing you to match the length of the term to your need for life insurance protection. For instance, someone aged 35 might decide to buy enough coverage to replace their income for 30 years.

Term life insurance is the most affordable type of life insurance, so you can get the most bang for your buck.

Many term life policies have a term life conversion option to convert the policy to a permanent one if you discover you need permanent coverage later. The life insurer will tell you the policy choices when you convert. Your rate will be based on the age at which you convert and your original health class. You won’t need a new life insurance medical exam to do a term life conversion.

As you weigh out your options, remember there is no one-size-fits-all solution. A financial advisor can help you figure out where life insurance fits into your overall financial plan.

Do I Need Permanent Life Insurance

Permanent life insurance is good for people who want to build cash value. It’s also better than term life insurance for people who want to make sure there is a death benefit payout for their loved ones no matter when they die.

Typical goals that lead people to permanent life insurance include:

• Need for lifelong life insurance protection because of people financially dependent on you.
• Want to fund a life insurance trust.
• Desire to leave a financial legacy to heirs.
• Desire to capitalize on the cash value or investment component of a permanent policy.
• Want to make sure your loved ones get money to pay final expenses and funeral costs.

Term life insurance is your better bet if you want the most affordable life insurance coverage. Term life may also be better if your main objective is to pay off your mortgage or replace your income during peak earning years. But term life insurance is not a good choice for funding a trust or other goals that require a payout no matter how long you live.

Cash Value Within Permanent Life Insurance Policies

A portion of the money goes toward a cash value account when you make premium payments on a permanent life insurance policy. Once you build up cash value you can borrow against it or withdraw it. But if you’ve depleted your cash value and there’s not enough money within the policy to cover policy charges, you may have to pony up more premiums in order to prevent the policy from lapsing.

The loan amount and interest will be deducted from the death benefit if you pass away if you took out a loan from the cash value that you haven’t paid back.

If you decide you no longer want a permanent policy, you may be able to walk away with some cash value. If you terminate the policy, the insurer will give you the cash value minus any surrender charge.

Types of Permanent Life Insurance

There are multiple types of permanent life insurance that vary in terms of how cash value builds and how much flexibility policyholders have.

Whole Life Insurance

A whole life insurance policy has fixed and guaranteed premiums, rate of return on cash value and death benefit. The cash value component increases over time based on your interest rate. You can withdraw funds or take out a loan against the cash value.

There are several reasons consumers purchase whole life insurance over other types of permanent policies. First is its predictability due to the guarantees within the policy.

Another advantage of a whole life policy is that you usually have the opportunity to earn dividends every year. Dividends allow policyholders to share a part of the profitability of a mutual insurance company. While dividends are not guaranteed, you can take the money as cash, use it to pay your premiums, or plow it into your cash value.

Additionally, the growth of the cash value component of the policy is tax-deferred. You’ll pay a tax on gains if you surrender the policy and take the cash value. You won’t pay tax on the portion you take that was from your premium payments.

As with any life insurance policy, the death benefit to your beneficiaries is paid tax-free.

Whole life insurance also has some downsides:

• Compared to term life insurance and even other types of permanent policies, whole life insurance tends to be the most expensive.
• The interest rate you earn on your cash value is likely less than what you could gain if you invested your money another way.
• Whole life insurance policies don’t offer the same type of flexibility you can get with a universal life insurance policy. With a whole life insurance policy, you can’t alter your premium payments or death benefit.

Universal Life Insurance

Universal life insurance (UL) policies often offer more flexibility than whole life insurance policies. You may be able to adjust your premium payments and death benefit within certain parameters.

The cash value gains within a universal life insurance policy will vary depending on the type of UL policy you buy:

• Guaranteed universal life insurance: A guaranteed universal life insurance policy has a set minimum rate of return on cash value.
• Indexed universal life insurance: An indexed universal life insurance policy ties your cash value to the performance of an index, such as the S&P 500.
• Variable universal life insurance: A variable universal life insurance ties your cash value to investment subaccounts that you can choose and manage. It has more risk but also has more potential upside if your investments perform well.

Your choice of universal life insurance will be based on how much investment risk you want and how much you desire to manage subaccounts.

Universal life insurance tends to be less expensive than whole life insurance policies, but still more expensive than term life insurance.

Additionally, universal life insurance may not have fixed costs within the policy. The premium you pay is split among the cash value account, the cost to insure you and policy charges and fees. But many policy costs increase as you age. If you’ve dipped into your cash value, you might be stuck paying more premiums to cover the charges and keep your policy in force.

Burial and Final Expense Insurance

Also known as funeral insurance or final expense insurance, burial insurance, is a small whole life insurance policy with a death benefit. These policies are generally sold without a medical exam and you can’t be turned down. People with health issues and/or with tight budgets tend to buy this type of permanent life insurance to cover their burial or funeral costs.

Burial or final expense insurance is designed only to help your beneficiaries cover funeral costs and other miscellaneous expenses after you die. It has a high cost based on the amount of coverage you get.

Burial insurance is not intended to help your family pay for other financial priorities such as college tuition, mortgage payments or daily living expenses.

Survivorship Life Insurance

Survivorship life insurance is sometimes called “joint life insurance” or the “second-to-die” life insurance. It’s usually a whole life insurance policy. It differs from other permanent life insurance policies because the policy insures two people—usually a married couple. Once both spouses have passed away, the policy pays out the death benefit to the beneficiaries.

Survivorship life insurance is often used to fund a trust so that beneficiaries can pay estate taxes and other estate settlement expenses.

Survivorship life insurance is generally less expensive than buying two separate policies on the same people. This is especially true if one of the people to be insured has medical problems.

Additionally, a survivorship policy is easier to qualify for than a policy for one individual. Insurers are less concerned if one applicant is less insurable due to health issues since both policyholders must pass away before the policy pays the death benefit.

But this type of policy doesn’t work well if both spouses rely on one another financially. Also, if you and your spouse decide to divorce, you may want to undo the policy. If this is a concern, some insurers may allow you the “right to split” the policy into two individual insurance policies.

Permanent Life Insurance Pros and Cons

Pros

Policy typically doesn’t end, as long as you pay your premiums.
Cash value lets you tap into your policy’s value while you’re alive.
Variety of permanent life policies means you can choose the policy type that makes sense for you.
Some permanent life insurance policies allow you to pick the policy’s investments.

Cons

More expensive than term life insurance.
Some policies charge high internal fees that eat into your potential cash value.
Likely not a good choice if you need life insurance for only a specific period of time.