What Are the Differences Between Term and Permanent Insurance?
Term vs. Permanent Life Insurance
Understanding the differences between term and permanent insurance is very important when deciding on an insurance policy. While both are considered life insurance in general, they have key differences that set them apart. They serve many different purposes and depending on which product you choose and how you structure it, can help you achieve many different goals. All life insurance policies can be categorized as term or permanent.
Term insurance is a type of policy that gives coverage for a specified time period, usually ranging anywhere from 5 to 30 years. If the insured dies during the specified time period, the insurance company will pay out the death benefit to the beneficiaries of the policy. This is essentially life insurance in its simplest form, providing protection to a person or family in the event of a death.
Term insurance is cheaper than permanent life insurance in exchange for its lack of living benefits (although some term policies do have critical, chronic, and terminal illness riders). It is important to emphasize that once the term is completed, all coverage is expired and the policy ends. Some policies allow owners to extend the term and/or convert the policy into a permanent type policy.
Permanent insurance is a type of policy that gives coverage over a lifetime, assuming premiums are being paid accordingly. The biggest difference between term and permanent life insurance is that permanent life insurance has living benefits and can build cash value. Policy owners have access to the cash value and can borrow against it while they are alive. Premiums are more flexible than term, allowing policyholders to adjust amounts and frequency of payments more freely.
There are many different types of permanent insurance policies including: universal life (traditional, guaranteed, indexed, variable) and whole life (fixed, participating, variable, interest-sensitive).
Pros of term insurance
Term insurance is very simple to understand and compare which makes it very easy for consumers to shop around for a good price. Use our term quoting tool here, to find rates from multiple companies within minutes without having to put in personal information. Term insurance is a great tool for people who want protection for their family for a specified time period with a very low upfront cost.
It can be used to offset any major debts like a mortgage and ensures that it will be paid even if you pass away. Let’s say a relatively healthy 35 year old male just bought a new home with a mortgage loan for 15 years. He can buy a 15 year term life insurance policy with a death benefit of $750,000 for around $30 a month. If we assume the home is around $200k – $300k (average cost for a home), there is about $450k left over to help pay for any other debts, college tuition for kids, and overall lifestyle of the family in case the breadwinner passes away.
Most term policies can be extended past their initial specified term, however it may increase greatly in price. One of the biggest roles that affect insurance rates is health condition; although age, current lifestyle, and some other factors also affect it. For that reason, it’s usually a good idea to secure your best insurance rate while you are most healthy (for both term or permanent). Even if you aren’t healthy at the moment, it might be worth it to lock in your current rate before your health declines even more as you get older.
Some term policies can also be converted into permanent policies. Some companies have a conversion window within the first few years and some companies allow it to be converted at any point within the term. This is a great feature which offers a lot of flexibility and can allow you to get lifetime coverage with no additional underwriting, especially if you are in a situation with declining health.
Some term policies also have a feature which credit past premiums into a permanent policy when you convert it. Generally, the more perks a policy has, the more it will cost, and every situation is different so it’s nice to have options.
If you know your life insurance needs will fluctuate from year to year, you can also learn how to ladder life insurance to make your coverage more flexible.
Cons of term insurance
Term insurance tends to get very expensive in the later stages. Every year you extend the policy past its term, the premium drastically increases. This is because the chances of dying increase as you get older, and the company assumes that you aren’t healthy if you’re keeping the policy past the term (since a healthy person could get underwritten for a new policy). If you are looking for lifetime coverage, permanent life insurance will be cheaper in the long term. Term insurance premiums are also not flexible, meaning that you will have to pay a defined amount set by the company with limited options in frequency.
Unlike permanent policies, term policies do not generate any cash value. This means the premiums you put into your policy will not accumulate for use at a later time, instead the premiums mainly just pay for the upkeep and service of the policy itself (which is also the reason why premiums are lower than permanent policies).
Some term policies that allow you to convert into permanent policies, can also retroactively apply past premiums into the new policy. This will usually cost a little bit extra and might require you to convert it within a certain time period, like within the first 5 years.
Pros of permanent insurance
Permanent policies generate cash value allowing you to accumulate money within the policy which can be borrowed against, for whatever reason, no questions asked. It also has many more options than term, depending on the structure of the policy which can be used to maximize cash value for supplementing retirement, or maximizing death benefit for beneficiaries.
The cash value will grow tax deferred and whole life policies can also pay out dividends to the policy. These can be used to pay for premiums, withdrawn for personal use, or just left in the account to grow.
The premiums on permanent policies are flexible in that the policyholder can pay whatever amount they choose (so long as it meets the minimum to keep the policy active) and the frequency in which it is paid. This is great for policy owners because it allows them to also pay more into their policy to generate more cash value, unlike term where the premiums are locked in at one price for the duration. On the flip side of that, if money became tight suddenly, you can also lower premiums.
Permanent policies offer coverage over a lifetime. While you could keep renewing a term policy (until you reach a certain age where companies will no longer accept you), the prices will skyrocket as you get older. With permanent policies, premiums are averaged over the lifetime of the policy giving it a higher upfront cost but also making it leveled. This means you can pay the same amount in both your early and late years.
Permanent policies give access to living benefits with features such as critical, chronic and terminal illness riders, and cash value. These living benefits are important because of the fact that the average lifespan is increasing. Because we are living longer, the chances of needing assistance in old age or using an accelerated death benefit also increase.
Cons of permanent insurance
Permanent life insurance is more complicated and isn’t for everyone. If it’s being poorly funded or is poorly structured then it could end up failing to achieve its goal or purpose. For example, if you structured a policy with the end goal of maximizing cash value to supplement retirement, but then paid the bare minimum each month to keep the policy alive then it most likely will not achieve its goal. Execution and planning are key for a policy to successfully accomplish its objective.
It is a long term commitment which requires more attention. Because there are goals in mind, it’s a good idea to be meeting with your advisor every so often. At least once a year to make sure you are on the right path and everything is going smoothly. Often you won’t see benefits right away. Cash value will take a while to grow in the beginning and sometimes won’t be available within the first 2 years or so.
As mentioned before, it does have a higher upfront cost which can make it seem unappealing for people on a tighter budget. It’s also not as easy to find quick quotes to compare because of the complexities and different structures.