Many agents urge their clients to consider permanent life insurance, which refers to policies that provide coverage for an entire lifespan, as long as premiums are paid. Taken at face value, it’s an attractive proposition: whether the policyholder passes away immediately after purchasing coverage or 50 years down the road, his/her beneficiaries receive a death benefit. Plus, certain types of permanent life insurance policies have a component that allows you to accumulate a cash value and borrow or withdraw from that value.
Many other arguments are made by agents in favour of permanent life insurance, for example: it allows you to grow wealth on a tax-deferred basis, meaning you don’t pay taxes on any dividends or capital gains on the cash value component of your policy (until the proceeds are withdrawn). Additionally, you don’t lose coverage after a set number of years and can receive up to 100 percent of your death benefit to pay medical bills and enjoy a better quality of life in the event of heart attack, cancer, or other critical medical conditions. Finally, if a mutual life insurance company is participating in a permanent policy, that policy can pay dividends.
However, less discussed is that many of these benefits aren’t unique to this type of policy. So, why then is permanent life insurance promoted so heavily throughout the insurance industry? The answer is simple: in many cases, agents earn bigger commissions from these types of policies than others. It’s not so much about your needs, it’s about them maximizing their profit.
The biggest drawback with permanent life insurance is that policyholders pay higher premiums than those of other types of insurance. And since there is no fixed end date for the coverage, it’s impossible to estimate how much will be paid in premiums over the entire term.
Another substantial drawback of permanent life insurance is that if you decide at some point you don’t need coverage of life, you wind up paying premiums unnecessarily.
Taxes come into play too, especially if you die and leave behind outstanding loans, or if your beneficiaries decide to surrender a policy. And if that’s not enough, taking loans or accelerated benefits can reduce the death benefit that your beneficiaries receive when you pass away.
Generally speaking, permanent policies can be extremely effective for high net-worth people wanting to minimize estate taxes, but they are often problematic for the average person seeking some degree of security for his/her family.
That’s why anyone wondering how much insurance he/she needs should consider opting for term life insurance, and here’s how this type of policy works: term life policies are designed to provide coverage for a set term (typically, 10, 20, and 30 years), hence its name. Premiums are paid monthly, and if something bad happens a benefit is paid.
Term life by its nature is generally less expensive than permanent life because the insurer assumes less risk, and the younger and healthier the policyholder is, the lower the premiums will be.
Perhaps most importantly, term life provides you with a degree of cost certainty and flexibility not found in permanent policies. If you think you need coverage for only 10 years, you can choose a term that aligns with your needs and will know exactly how much you'll pay in premiums over that term. Unlike permanent life insurance whereby the holder is locked into the policy, if you decide down the road that you want to extend your coverage indefinitely, you can convert to a permanent policy–and enjoy all the benefits of that type of insurance.
Conversely, if you’ve opted for a term of a certain length and down the road decide you no longer need life insurance coverage, you’re not stuck with the policy: you can lower the coverage amount, thus lowering your premiums, without going through underwriting again, or you can cancel entirely.
So, should you get term life insurance? Term life is a terrific option if you don’t want to oblige family or loved ones to pay off debt or other expenses after you die. And although beneficiaries don’t receive any money if you’re still alive when the term ends, term policies are still a wise investment in the sense that in exchange for paying a relatively low price, you get the comfort of knowing that your kin will be covered financially should you pass away.
And the best part is, the return on the investment can be substantial. A familiar example is someone aged 30 in excellent health, faced with purchasing either term or permanent coverage from the same broker. If that person chooses a 20-year term policy, with a death benefit of $1 million for $480 per year, and dies at the age of 49, the beneficiaries receive $1-million tax-free on a total investment of just $9,120.
If the same person with the same insurer opts for a permanent policy, he/she can expect to pay $9,370 annually. The cash value of the policy will increase over time but always less than the premiums paid, and at the 20-year mark the value will be $181,630 compared to $187,400 in premiums.
With term, if the same policyholder pays $480 yearly and put the $8,890 difference in a bare bones savings account yielding just 1 percent interest annually, the result would be $196,425 after 20 years (or, if he/she invested in a plan yielding an 8 percent annual return, which is not uncommon, then the amount would be $421,064 before taxes).
Now comes the question of how much insurance you need. The basic objective with term life insurance is to match the duration and earnings of your working years. Or, the term should cover the entirety of your financial obligations or debts (if, for example, you have a 20-year mortgage, then a 20 year term policy will cover the mortgage payments, provided the premiums are paid).
While some agents argue that buying a longer term such as 30 years locks in lower premiums (the advantage being if you develop a serious illness during the term, your payments won't increase), the policy will actually cost more in monthly premiums the longer the term length is. That’s because a longer term increases the chance of your insurance company being obliged to pay out the death benefit. So, monthly premiums for a 30-year policy will be higher than a 20-year policy because the higher premiums for those last 10 years will be averaged into the rates.
In general, 10- and 20-year terms provide the flexibility that makes this type of insurance so desirable. By locking in a premium until you reach retirement age, you may well be overpaying.
To determine the optimal term length, you need to focus on why you’re buying the policy in the first place: to protect your family and loved ones if something happens to you, and also ensure that your death does not financially burden them.
One last point: regardless of how much term insurance you need, you will need to prove your insurability and that you can afford the amount of coverage you want to the insurance provider. Your age will be a big deciding factor in the term length you qualify for, and the older you are the more limits you may face. You must also carefully consider your ability to pay the premiums of a term length, because you should be able to build up enough savings and assets for when the policy expires. If you desire supplemental coverage, that must be factored into your decision-making as well.
Each insurance company has different rules about any type of policy, and consulting with an advisor is the best way to decide the two-fold question of what type of life insurance is for you and how much you need.
