The Two Best Ways to Buy Permanent Life Insurance
There are of course more than two ways to buy permanent life insurance, but in our opinion one of these two items will apply to a large swath of consumers.
And, these apply to people who need or desire permanent death benefit protection. If you only want or need temporary coverage, just purchase term insurance instead.
1. Purchase Guaranteed Universal Life Insurance
This piece of advice applies mostly to middle aged or older consumers, as this product is usually not the best fit for a young consumer.
Although life insurance comes with various benefits, its primary purpose is death benefit protection, which is where this product excels.
The purpose of guaranteed universal life insurance is to provide a death benefit for the lowest possible premium. So, you can think of it like term insurance that lasts forever (if you want it to). It is not designed to build cash value.
You don’t have to worry about poor performance or illustrations with this product, as everything is contractually guaranteed – interest rates, mortality costs, administrative expenses, etc. As long as you pay your premiums on time, you will get exactly what you signed up for.
We have quite a few more in-depth resources on guaranteed universal life insurance:
2. Get an Increasing Permanent Death Benefit and a Term Policy
There are ardent supporters of permanent life insurance that builds cash value (often insurance agents). There are also many detractors.
For detractors, one of the biggest issues they bring up is that permanent life insurance policies pay high commissions, so agents have an incentive to sell them. And this is true: for a given death benefit, a permanent life insurance policy will pay a much larger commission than a term life insurance policy.
Often, you will hear that most of the first year premium on a permanent policy is paid as a commission. If the policy is structured in what we will call an “inefficient” way, this is true.
But, permanent life insurance policies can be designed in ways to reduce commissions for a given amount of premium, to the benefit of the consumer. So, if a policy is structured in an “efficient” way, the commissions are drastically reduced (relative to the premium).
Note that we are not arguing here that you should or should not purchase permanent life insurance.
What we are saying is that if you decide to purchase permanent life insurance for whatever reason (want it, need it, etc.), you should do it in the most efficient way possible.
The way to do this is to fund your policy as much as possible without becoming a modified endowment contract. This is the opposite of the first piece of advice – in this case you are paying as much as you possibly can for a permanent death benefit.
We’ll use an example to see why it makes the most sense to do it this way, and also show how much it reduces commissions.
Many agents don’t do things this way because of the reduced commissions (or lack of knowledge).
For our example we will use a healthy 30-year-old man who needs $500,000 of coverage for the next 30 years and $275,000 thereafter, and assume he has a $300 monthly budget.
We will go over two options, as well as how the death benefits, cash values, and commissions look for each. (This section has a lot of possibly unfamiliar terms. After you read it, there are links at the bottom of the article that might help to clarify some things for you).
Option 1 (the inefficient option): purchase $500,000 of permanent insurance with a level death benefit.
Option 2 (the efficient option): purchase $104,105 of permanent insurance with an increasing death benefit and $400,000* of 30-year term insurance. This death benefit might look strange, but it was chosen in this case since it allows just the right amount of premium to be put in under tax code rules.
*Side note: depending on the company, sometimes it might make sense to purchase even more, such as $500,000 (a common expense breakpoint).
It is possible to get more coverage for very little additional premium, or even less premium sometimes (see this article: Two Tips When Buying Life Insurance).
Here is a graph that compares the death benefits for the two options:
Option 2 has a higher death benefit in most years, and most notably in the earlier years where it is likely most important.
After 30 years the term policy expires and the death benefit for option 1 was manually reduced to the smallest amount possible to still be compliant with the tax code.
No premiums are paid on any policy after 30 years, and option 2 switches to a level death benefit after the term policy expires (this makes it more efficient).
For a while, option 1 has a slightly larger death benefit, but eventually option 2 will overtake it again. Both of the policies eventually have to increase their benefits to comply with corridor requirements.
Both options satisfy the death benefit needs with some room to spare.
All in all, it looks like option 2 is the winner in terms of death benefit – it is almost always higher.
Here is a graph that compares the cash values for the two options:
Option 2 always has a larger cash value, despite the fact that less premium is paid into the permanent policy than in option 1 (a portion of the $300 per month is used for the term insurance policy in option 2).
After 30 years, when the last premium is paid for each option, the cash value for option 2 is nearly $17,000 larger! This amount will vary with the assumptions used in the illustration, but we used very reasonable assumptions in this case (we do not like to be aggressive with the assumptions).
Option 2 is a clear winner in terms of cash value.
So, when you look at both death benefit and cash value, it is pretty clear that option 2 outperforms option 1. But why is this?
Well, there are some efficiencies gained from using a term policy on the side.
But the main reason is that if you compare the commissions between the two options, you will see that option 1 has much, much higher commissions.
The increasing death benefit’s commission is about 21% as large as the commission for the level death benefit policy. And the term policy’s commission is about 9% as large as the commission for the level death benefit policy.
What this means is that option 2’s commission is 30% (21% + 9%) of option 1’s commission. In other words, option 2’s commission is 70% lower! Or, option 1’s commission is more than 3 times as large if you want to look at it that way.
Any way you look at it, this is a huge difference.
So, How Do You Know If You Are Getting a Well-Designed Policy?
Well, our completely neutral and unbiased answer is to work with us.
But, more seriously, there are actually a couple of things you could look at.
First, look at the first year cash value and see how it compares to the premium. For option 1, the first year cash value is 61% of the first year premium. For option 2, this figure is 84%, which is significantly larger.
The higher this number is, the better.
Second, see how long it takes for the policy to break even. That is, see how long it takes until the cash value exceeds the cumulative premiums paid.
For option 1, this takes about 18 years. For option 2, this takes about 9 years. So, you’d have to wait twice as long under option 1.
Are There Any Benefits to Option 1?
One possible benefit is that many modern policies have benefits for chronic illnesses, with the benefit based on the amount of the death benefit.
So, the level death benefit policy will offer a richer benefit of this type early on (until option 2 has a larger permanent death benefit since it increases over time, at which point its benefit will be larger).
Since chronic illness is more likely to happen later in life, we don’t view this as huge selling point for option 1, especially since option 2 offers more of this benefit in later years.
Finally, one more benefit of option 2 is that you have a term policy you can convert down the road if you want or need to.
The two methods we described here are essentially opposites – paying as little as possible for a death benefit with guaranteed universal life insurance, or paying as much as possible for a small but increasing permanent death benefit to make it as efficient as possible, with term insurance on the side.
Guaranteed universal life insurance is relatively simple, so there is not a lot of tweaking to do. With other forms of permanent insurance, there are numerous ways to structure policies, some better than others, so that’s where we focused most of our attention.
Usually a policy that is structured most ideally for a client will pay a lower commission, and in our example, about 70% lower. The key is to find an agent who does things this way. If you’re not sure if you are getting the best deal, there are a few simple metrics you can look at.
Even though it results in a smaller commission, we think this is the right way to do things.