Galveston Life Insurance
Term vs Permanent Life Insurance
The most important decision you make when buying life insurance is which type to get: Term, Permanent or a Combination of both.
Term Life Policies
Term life policies are typically pure life insurance coverage and offer death benefits only. Term life policies are less expensive than permanent life insurance, however if the insured lives past the “term” of the policy (10 years, 15 years, 20 years or 30 years), the beneficiary or beneficiaries will not receive a death benefit.
Permanent Life Insurance
Permanent life insurance policies will remain in force and current as long as premiums are being paid. Since the death benefit of any life insurance policy is tax-free to the beneficiary, many people use permanent life insurance as a wealth transfer vehicle. Permanent life insurance tends to be more expensive than term life, however permanent life insurance is the appropriate route for people looking to pass on money to their heirs tax-free. Permanent life insurance (whole life, universal life, equity index universal life) has other benefits as well. For example, permanent life insurance has a savings account or cash value included in the policy so that the owner of the policy can borrow against it at much lesser rates than from a typical loan from a bank. The owner of the policy can choose to repay the loan they took from the cash value of their life insurance or choose to not pay it back and subtract that amount from the death benefit in the event of the insured’s passing. The longer the policy has been in force, the more the cash value will grow, because more money has been paid in and the cash value has earned interest, dividends or both.
Although the premium for term life is less expensive, the premiums for permanent life will remain the same, while the premiums for term life will increase once the term is over. That extra premium paid in the early years of the permanent policy gets invested and grows. The gain is tax-deferred if the policy is cashed in during the insured’s life. If the insured dies, the proceeds are tax-free to the owner of the policy’s beneficiary.
The saying you always hear is, “Buy term and invest the difference.” The fact is, it depends on how long you keep your policy. If you keep the permanent life policy long enough (and the market ever fully rebounds), that’s the best deal. But “long enough” varies, depending on your age, health, the types of policies chosen, interest and dividend rates, and more. The reality is that there is not a simple answer, because life insurance is not a simple product.
Guidelines to Live by When Buying
Even with all of these variables, there are some guidelines you can follow. The key is how long you plan to keep the policy. If the answer is less than 10 years, term is clearly the solution.
If it is more than 20 years, permanent life is probably the way to go. The big gray area is in between. Here is where you need an expert to run the term vs. permanent analysis for you. Of course, this assumes you keep the policy in force. Most people drop their policies within the first 10 years, but if you do your homework now, that shouldn’t be the case for you.
How to Choose
Start by assessing your needs with the DIME method. DIME is an acronym for debt, income, mortgage, and education. How much debt do you have in credit cards or student loans?
What is your annual income? Multiply that number by 10 or 20 for the number of years the insured would like to see their beneficiary receive that income. Do you have a mortgage? And finally, what is the estimate of your children’s education expense? Are they going to a state school like The University of Texas or Texas A&M where tuition is up to $10,000 annually or will they attend a private school like Vanderbilt where tuition is near $60,000 annually. Remember, your most important asset is your ability to produce income. People insure their home and their car but their most important asset is their ability to bring in a salary.
Categorize your insurance needs by their use. If you need $60,000 for college and your youngest child will graduate in three years, you need $60,000 of term insurance as a short-term hedge against your death, thus insuring that your child can finish his or her education. Meanwhile, if your estate will owe $200,000 in taxes at your death, you probably need permanent insurance, because you’re not likely to die in the next 20 years.
Once you figure out your needs, it’s time to choose the type of policy that makes most sense for you.
Term insurance is relatively easy. You can buy term insurance that stops after 10 or 20 years, or that can be continued beyond age 70. You can choose for your premium to increase each year (annual renewal term) or to remain at the same amount for a fixed number of years.
Most term policies offer both a current payment schedule and a maximum rate for each year. Most term policies are convertible to permanent without evidence of good health.
Types of Permanent Life Insurance
The real wild card in terms of price is permanent insurance, because most policies have guaranteed and non-guaranteed portions. There are three main types of permanent insurance.
Traditional Whole Life: This type offers the most guarantees. The annual premium is guaranteed, and there are minimum guaranteed cash values and death benefits. Most whole life policies these days are “participating,” meaning that the dividends they earn can be used to increase the cash value and/or death benefits, decrease the premiums or be refunded in cash. If you are a conservative investor and also have trouble saving, traditional whole life makes sense.
Universal Life: If you need premium flexibility, especially in the early years of the policy, universal life is for you. Universal life insurance was developed in the 1970s, when insurance-industry regulations changed to allow insurers to be more competitive with other financial-services providers.
Universal life insurance is more flexible than traditional whole life, because premiums can vary from year to year and sometimes can even be skipped. Universal life has maximum guaranteed premiums and minimum guaranteed cash values and death benefits. Instead of dividends, universal life policies earn interest at the credited interest rate determined each year.
Equity Index Universal Life: Very similar to universal life, however the cash value grows based on what the index (like S&P 500) is doing. EIUL’s are nice because you can enjoy the gains of the index but are protected from the downside as you will never lose your principle.