Permanent Life Insurance
Permanent life insurance policies provide lifelong coverage as long as you pay the premium. They guarantee a death benefit for your beneficiaries and provide a savings component that is invested.
Permanent life insurance explained
Permanent life insurance can provide peace of mind by financially providing for your beneficiaries after your death. As the name suggests, permanent life insurance policies provide lifelong coverage as long as you pay the premium. They guarantee a death benefit for your beneficiaries — whether you die immediately after purchasing coverage or when you’re 105 years old.
How permanent life insurance works
Permanent life insurance is a broad term for life insurance policies that remain active indefinitely. Most permanent life insurance policies combine a death benefit with a savings or investment component, known as cash value. The policy guarantees the payment of a specified death benefit for a specific period.
The cost of a permanent life insurance policy varies widely depending on factors like age, health, lifestyle, and how much coverage you're looking to buy. Most permanent life insurance policies allow you to choose how long you want to pay premiums. You can make a lump-sum payment, pay until you reach a certain age, pay for a certain number of years, or pay for your entire lifetime. A portion of your payment goes toward the death benefit, another portion covers the policy fees and changes and the rest goes toward your policy's cash value.
How to use the cash value of a permanent life insurance policy
Your life insurance company generally invests your cash in a low-yield investment and as you continue to pay premiums on the policy and earn interest, the cash value grows tax-free over the years. There are several ways to tap into the cash value while you're alive:
Take out loans
Once the cash value is a certain size, you can borrow money from the insurer and use it as collateral. Policy loans don't require credit checks or qualifications since the insurer holds the money to cover the loan. While the loan doesn't have a specific repayment period, it will accrue interest until it's paid in full. The interest rate may be fixed or variable, but it's often lower than a traditional bank loan.
If you fail to repay, and the unpaid interest plus the loan amount exceeds the size of the cash value, your policy will lapse, and the insurer will terminate your coverage. If you die before fully paying back your loan, the insurer will deduct the loan amount from the death benefit your beneficiaries receive.
Once you've accumulated enough money in your cash value account, you may be able to use it to cover your premium payments, which can come in handy if you’re struggling to pay them. However, if you use all your cash value to pay your premiums and can no longer pay them on your own, your policy will lapse.
You also have the option to withdraw some or all the funds from your cash value account. Depending on your policy and the size of your cash value, making a withdrawal reduces the death benefit payout to your beneficiaries. You can withdraw the amount of money equivalent to the amount you've paid in premiums tax-free, but if the cash value amount is higher than the premiums paid, it will be subject to income taxes.
While some policies are reduced on a dollar-for-dollar basis with each withdrawal, others have higher withdrawal penalties and will reduce the death benefit by a greater amount than what you withdraw. For example, for every $1 you take out, your death benefit may go down by $2.
Surrender the policy
If you decide to cancel or surrender your permanent life insurance policy, you’ll receive the cash value of the account — minus a surrender charge if you terminate the policy within the first several years after buying it. The surrender charge is a way for the insurer to cover the cost of issuing the policy. It usually starts at 10% if you cash in your investment in year one, and it goes down to 1% if you cash it in during year nine. In most cases, canceling your permanent life insurance policy after 10 years won't result in any surrender fees.
The cash you receive from the surrender fee is subject to income tax if it's above basis. The insurance company will also subtract any unpaid premiums or outstanding loan balances. And remember, you're relinquishing the death benefit when you surrender a life insurance policy, which means your beneficiaries will receive nothing from the policy when you die.
Types of permanent life insurance
There are several types of permanent life insurance policies. All these policies are meant to last for the remainder of your life, but they differ in how their premiums are paid and how the cash value grows over time. Here are the most common types of permanent life insurance:
Whole life insurance
Also known as traditional life insurance, whole life insurance is the most common type of permanent life insurance. It offers a guaranteed minimum rate of return on your cash value, death benefit amount and fixed premium that will never go up, regardless of market conditions. Over time, the cash value of your policy increases, and you have the option to withdraw funds or borrow against it. The rules on how and when you can do this vary by company and policy.
Universal life insurance
Universal life insurance is also known as adjustable life insurance because of its flexibility in paying premiums and options for investing the policy's cash value. A standard universal life insurance policy allows you to choose how much you pay — so long as it falls between the minimum and maximum premium amounts. The cash value grows depending on the type of policy you buy. Your options include the following:
- Guaranteed universal life: This policy has a guaranteed death benefit and minimal cash value. The cost of coverage is significantly lower than that of standard universal life insurance, and it has fixed premiums for the length of the policy.
- Variable universal life insurance: This policy lets you invest the cash value in the market via subaccounts. With variable universal life insurance policies, you’ll choose from several investment options in your policy's sub-accounts, and your policy's cash value will fluctuate depending on how these investments perform.
- Indexed universal life insurance: With indexed universal life insurance, the cash value's growth is tied to the performance of an index. Some of the common indices include the S&P 500, NASDAQ 100 and Russell 2000. You tell the insurer the percentage of the cash value that should go into each investment, and the insurer keeps track of the performance.
Variable life insurance
With a variable life insurance policy, premiums can be level or vary, depending on the policy. The money can be invested in a particular set of securities, such as index funds, bonds or money market funds. Since the cash value growth correlates to broader market trends, your policy may grow faster.
However, there's no guaranteed minimum cash value, so if the market dips, you'll bear the investment risk. Also, variable life insurance policies often come with higher fees. The death benefit for variable life insurance can fluctuate over time, but it still has a guaranteed minimum amount.
Joint life insurance
Joint life insurance is a single policy that covers two people for one premium. Bundling two policies into one can be used for estate planning or covering a spouse who doesn't qualify for their own policy. It's split into two types: first-to-die policies pay out after one policyholder dies, and survivorship life insurance (also called second-to-die) pays out after both policyholders die. Joint life insurance doesn't work well if the spouses rely on one another financially, and if you and your spouse ever divorce, you may want to undo the policy.
Permanent vs. term life insurance
The difference between permanent and term life insurance comes down to cost and length of time. Term life insurance is a policy that offers coverage for a specified period of years, such as 10, 20 or 30 years, and if the insured dies within the time frame, their beneficiary receives the death benefit. If the insured person is still living when the term dies, you won’t receive the premiums you paid unless you have a return of premium (ROP) rider. ROP ensures that you’ll receive a refund of the monthly payments at the end of the term if you outlive it, but it increases your premiums.
Unlike permanent life insurance, term life insurance policies don't carry any cash value, meaning they don't accrue savings over time, and you can't borrow against it. While term life premiums are generally lower than permanent life insurance, you must renew the policy at the end of each term to keep the coverage going. At every policy renewal, you’ll pay higher premiums, and you might even have to undergo medical testing to prove insurability.
Both permanent and term life insurance policies offer financial protection for your loved ones, so the kind of life insurance you choose will depend on your unique situation.
A permanent insurance policy is an excellent option if you have a large estate, a child with an illness or special needs who will need long-term care, a business you want to keep alive or a spouse or dependents that you want to provide for after you die. Permanent life insurance is also ideal for seniors who have outlived their term life insurance coverage or don't have enough savings to pay for final expenses, such as medical care and funeral costs. You can choose term life insurance if you want:
- Life insurance coverage for a specific period. A term life insurance is ideal if you have major time-sensitive financial obligations, like a child's education, student loans, a wedding, a mortgage or living expenses for several years.
- The most affordable coverage. If you're young and healthy, and want to make sure your family is taken care of if something happens to you — but you don't have a lot of extra money to invest in a permanent life insurance policy — term life insurance is the best option for you.
- Permanent life insurance but can't afford it right now. Many term life policies come with the option to convert to a permanent life insurance policy later without the need to re-qualify. The deadline for conversion varies by policy.
Benefits of permanent life insurance
There are several benefits of permanent life insurance:
- Tax advantages. The death benefit of a permanent life insurance policy is typically tax-free, and the cash value grows on a tax-deferred basis. This means any money you withdraw from it won't get taxed as long as the withdrawn amount is less than the amount you've already paid.
- Lifelong coverage. Unlike term life insurance, permanent life insurance covers you for the entirety of your life, so you won’t ever have to renew your policy or worry about it expiring.
- Cash value benefits. As your cash value grows, you can take a policy loan against it, use it as collateral for a third-party loan or simply withdraw the cash value to supplement your retirement income. If you don't withdraw or take out a loan, the cash value will eventually be worth enough to pay the premiums for the rest of your life. Also, if you can no longer afford the premiums, you can close the account and receive the equity, which is the amount in your cash-value account and its interest.
- More payment options. Some permanent policies allow you to set up a limited pay feature in which you’ll pay higher premiums for a shorter span, but once you pay those premiums, you’ll never have to pay any more.
- Guaranteed payout. Unlike term life insurance, a permanent life policy offers a guaranteed payout. A permanent insurance policy doesn't end before your death, so you can rest assured knowing your loved ones will receive a tax-free death benefit — regardless of when you die.
Disadvantages of permanent life insurance
The single biggest drawback of permanent life insurance is cost. Generally, permanent life insurance can cost up to 15 times more than a comparable term life policy. Additionally, permanent life insurance isn't always a good investment, as most cash value accounts cap the returns, which limits how lucrative these investments can be.
Permanent life insurance key takeaways
Permanent life insurance is a great way to ensure that your loved ones will be taken care of after you die. While it's typically much more expensive than other policies, permanent life insurance provides lifelong coverage and accumulates a cash value that you can borrow against, withdraw or use to pay premiums. There are several types of permanent life insurance policies to choose from depending on your budget, financial goals and coverage needs.