Life Insurance - Term vs. Permanent

The proper use of life insurance can be a crucial link in improving your family's financial future.

Like the names suggest, the difference between term and cash value (more commonly called "permanent") life insurance is that term insurance covers the insured for only a specified period, whereas permanent insurance covers the insured until the insured dies. In other words, with term coverage, a death benefit is paid only if the insured dies within the specified period. Permanent insurance remains effective throughout the life of the insured, so the death benefit will be paid whenever the insured dies, as long as the policy is in force. Generally speaking, all types of life insurance policies are "in force" as long as the premium payments are up to date. Also, a new type of life insurance contract has been developed, generally referred to as "return of premium" term life insurance. As the name suggests, it is temporary coverage, and if the insured doesn't die within the term, the premiums are returned. Although this concept sounds appealing, my examination of these policies utilizing real cases suggest they are generally not a good financial option. While the premiums in these policies are lower than the premiums in permanent policies, they are higher than the premiums in "regular" term policies, and what is returned to the policyholder is never more than the actual premium payments.The life insurance industry may make return of premium policies more financially attractive in the future, so keep this option in mind.

Be aware of interesting insurance industry statistics: Only about 2% of all term life insurance polices ever pay a death benefit, whereas almost 20% of permanent policies pay a death benefit. This disparity is not because term policies are bad and permanent polices are good, it is simply a reflection of the proper uses and costs of life insurance.

Many wonder whether one type of life insurance is "better" than another. There is no automatic answer, as what is appropriate life insurance coverage depends upon an individual's particular circumstances. As a general rule of thumb, term insurance (temporary) ought to used to provide protection for temporary problems. As examples, if an individual has purchased a house with a mortgage, or a child has been born and the parents want to ensure that the child can attend college, how will these obligations be met if the primary income earner dies prematurely?  A big question, but the concerns illustrate temporary problems which will be extinguished when the mortgage is paid off or when the child is out of college. These are the type of funding problems that term life insurance can nicely address. On the other hand, permanent insurance generally ought to be used to provide protection for permanent problems. For example, if one's desire to acquire life insurance relates to a wish to pass wealth to children, or to a charity, or to provide liquidity for estate settlement purposes, then these are considerations which are permanent in nature. Usually, permanent life insurance is a better option to address those types of concerns.

However, the "temporary concerns equal term life and permanent concerns equal permanent life" formula is a bit simplistic, as additional factors are usually involved in the acquisition of life insurance. For example; a family may have a very large death benefit need, but can only afford term life insurance; or, the temporary problem may be small enough, or may last long enough, that permanent life insurance may make more sense.

At young ages, the annual outlay to keep a term life insurance policy in force is MUCH less than for a permanent policy with the same death benefit. Most of the premium cost in a term policy is the cost associated with the statistical likelihood that the insured will die within the term. It is not likely that a 30-year old healthy man will die during the following 20 years (a common term life coverage period). In fact, it is statistically VERY unlikely that he will die within that period. That simple fact explains why an insurance company can provide that 30-year old healthy man with hundreds of thousands of dollars of death benefit coverage in exchange for just hundreds of dollars per year in premium.

However, never forget that the likelihood any insured will die within a specified period increases as the insured gets older, and the likelihood of death increases very significantly as the insured gets much older. Therefore, the premium requirements of the term policy have to increase, eventually reaching the point at which term coverage may become cost prohibitive.  Look at an individual with the desire to acquire life insurance because he wants to leave his son $1,000,000 at the time of his death. While he could get the coverage in a term policy for certainly no more than $1,500 per year when he's 45 (and healthy), he will find the cost of acquiring that $1,000,000 policy is likely to approach $80,000 per year when he gets into his late 80s, and if he lives longer, the annual cost of a term life insurance policy will go up even further. Of course, this scenario assumes he will be healthy enough to get continued coverage throughout his life, because any significant health incident along the way may make future acquisition of life insurance impossible -- at any cost. On the other hand, if the insured had acquired a permanent life insurance policy when he was 45, his annual premium payments, although much higher than the requirement in the term policy, should remain level and he should not be required to pay more as got older. So, as long as he maintains the policy, his beneficiary will receive the death benefit when he dies -- whenever that death occurs. This hypothetical illustrates why permanent problems are generally better addressed by the use of permanent life insurance.

Please keep in mind that everyone's situation is unique, and insurance needs should be reviewed with a competent professional, one who understands your needs and goals. Life insurance may be critical to your family's financial future, so make sure you get proper, objective, advice before you make any decisions to purchase a policy.