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Term life insurance vs. permanent life insurance: Is cash value the best value?

By Posted : October 27, 2017

Deciding between term life insurance and permanent life insurance, also called cash value life insurance, depends on your preferences, life situation, and finances.

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The main difference between the two is that term life insurance covers you relatively inexpensively for a set period; permanent life insurance covers you at a much higher cost for the remainder of your life.

How do term and permanent life insurance work?

Term life insurance offers the most amount of coverage for the least amount of money. The most common reason to buy life insurance is to replace a person's income in case of early death, and term life insurance provides the most return for your premiums.

Term life offers policies in periods, such as 10, 15, 20 and 30 years. That means once you reach that time, your policy lapses unless you renew the policy. A word of warning: the policy will cost a lot more money if you renew your policy later. Why?

You'll be that much older. Your age and health status are two important factors in the cost of life insurance. You might be able to convert your term life to permanent life depending on your policy. (Find out more at "6 reasons why you should convert term life insurance to permanent life insurance.")

Permanent life insurance offers protection for your entire life (as long as you pay your premiums) and more flexibility than term life insurance.

However, it usually comes at a much higher price. One feature that makes permanent life insurance different is its ability to gain cash value. A portion of the money you pay into your premium goes into a cash value portion that grows over time and becomes available for your use after a certain period.

Having cash value means you can tap into your permanent life insurance policy if you find you need money later. Some people may even use money from a permanent life insurance policy to help with retirement.

How does cash value work?

The portion of your payment that goes toward the policy's cash value is large in the beginning but decreases slowly as time passes. That's because permanent life insurance payments are made up of two parts: the regular insurance premium, which is comparable to the premium amount for the same coverage in a term life policy, and the cash value, or "overpayment" amount. The insurance company invests the overpayment money and later uses it to pay for the higher costs of insurance as you get older. In this way, the company can keep your premiums the same instead of increasing them over time. This cash value amount becomes available for your use later.

The cash value component of a policy can work differently and be used for different reasons depending on the type of permanent life insurance you choose.

Types of permanent life insurance

There are four main variations of permanent life: whole (or ordinary) life, universal (or adjustable) life, variable life, and variable universal life.

  • Whole life insurance is a predictable policy that provides a guaranteed benefit, a guaranteed earnings rate on your cash value, and a level premium. You may also earn dividends based on how well the company performs. Whole life is the most basic kind of permanent life insurance.
  • Universal life insurance is a flexible option that lets you vary your premium payments. After the first premium, you can usually make payments at any time. If you have extra money, you can pay more. If you can't afford to make a payment, you can skip it or pay less. The cash value portion usually operates similarly as with whole life insurance. A problem with universal life is that if you don't make enough payments, or the company does not perform as expected, your policy could lapse. Newer types of universal life policies include guarantees that this will not happen, so be sure that you explore this option. Universal life can be one of the cheapest forms of permanent life insurance.
  • Variable life insurance allows you to invest your policy premiums. The problem with this is that if the investments perform poorly, the death benefit and cash value will decrease. On the other hand, if the investments do well, the death benefit and cash value can greatly exceed those of a normal policy. Variable life is one of the riskiest forms of permanent insurance, although its rewards can be great as well.
  • Variable universal life insurance, as its name implies, is a combination of variable and universal life insurance. It allows you to vary your payments, invest your policy premiums, and vary your coverage amount. Variable universal life insurance is the most flexible type of permanent life insurance and can be either risky or predictable, depending on how you use it.

There are multiple types of permanent life, so decide which one fits your needs.

Term life vs. permanent life: which is better?

Buying life insurance is a highly personal decision. There is no perfect fit for everybody.

When deciding to go either term life or permanent life, you will want to think about why you need life insurance and what you want to get out of it. Let's take a look at which scenarios work best for each type of policy.

Term life might be the better fit if:

  • You want the cheapest life insurance coverage.
  • You want to make sure your family is protected for a specific number of years. For instance, you have 20 years left on your mortgage and your children will be out of college by then. In that case, you may want a 20-year term-life policy to cover that period.

Permanent life could be the right choice if:

  • You want a life insurance policy that isn't limited to a period, and its death benefit is guaranteed.
  • You want life insurance with cash value.
  • You have a lifelong dependent that will need care after you die. This might include a child with special needs.

After you've decided which type of life insurance policy you want, make sure to shop around to find the right policy for your situation. Research each insurance company's records. You can do this by researching online reviews and checking their financial records. (See Insure's "Best Life Insurance Companies.")

Once you're comfortable with multiple insurance companies, request quotes for the same policies. This includes any riders or extras that you want on the policy. Get quotes from multiple companies and figure out which one makes the most sense for you.

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