Term vs. Permanent Life Insurance: What's the Difference?
There are 2 main categories of life insurance. The first is term, which provides coverage for a set period of time. It's typically cheaper upfront but gets more expensive with each renewal. Permanent insurance, on the other hand, provides coverage until the policyholder passes or they cancel the plan. This type of policy is more expensive in the beginning, but locks in a rate for the duration of the plan. The type of policy that's right for you depends on many factors including your age, health, financial situation, desired level of coverage, and whether you want a guaranteed payout.
Term Life Insurance
For those interested in an easier and more affordable option, term insurance is the go-to policy.
Staying true to its name, term insurance is only available for a set period of time, often 10, 20, or 30 years.
These are designed to protect those who are young and healthy against premature death and are not meant for the elderly or those with serious conditions. Most insurance companies avoid offering these policies to people over 75, so anyone who has this plan eventually needs to get permanent insurance if they wish to keep their coverage past a certain age.
One of the major benefits of term insurance is that, while these plans expire, the premiums are almost always much lower than for permanent plans. So, while you're required to renew or get a permanent plan to maintain your coverage, you're almost guaranteed to pay less up front. This can be a good option for those who earn a lower income but expect to make more in the future and eventually get a permanent plan. The downside? By the time you want a permanent policy, your age or health might make your premiums higher than they would've been if you bought the plan sooner.
Another key difference is that term insurance is strictly a death benefit plan, so it doesn't accrue value as you pay. If the person insured passes away within the coverage period, the beneficiary will be paid according to a predetermined amount. However, if the person insured is still living at the time the term ends, all coverage and associated benefits will cease. At that point, a new policy can be agreed upon, usually with increased premiums based on your current age and health. Under the broader umbrella of term life insurance, there's a selection of more specific plans with their own unique features.
Permanent Life Insurance
Permanent life insurance—also known as cash value life insurance—has more complicated policy layouts and more expensive premiums upfront. Although that may be a downside to some, permanent policies don't expire, meaning there's none of the hassle of renewing or finding a new plan.
What's more, permanent policies lock you into your premium for the duration of your coverage, though your age and health at the time of purchase do impact this rate. Policyholders who get plans when they're ill or older pay higher premiums based on the assumption that they don't have as long to make payments. On the flip side, premiums will be lower for those who are young and in good health, but you're expected to be paying for a longer period of time. One benefit is that you may end up paying less overall than if you started with cheaper term insurance and transitioned to permanent coverage later in life.
On top of set premiums, permanent plans guarantee a payout at death and include cash value with the benefit. Cash value is essentially a savings or investment account that accompanies your policy. The type of account you have depends on your plan, and there are 3 primary policies to choose from.
Whole life insurance is often viewed as the classic option for those looking for a policy that guarantees a payout when they die. While it's often the most expensive type of life insurance, this plan can give those insured more confidence that their family will be financially secure.
Your whole life insurance plan will include a savings account. These accounts are yours to do with as you please and they can be accessed at any time without penalty. Accounts can be funded in 2 different ways:
- You invest in it through a set percentage of your premium. Basically, some of the money you pay for your policy comes back to you through your savings account.
- The company pays you a percentage from their annual profits.
The biggest difference between whole and variable life insurance is that variable insurance takes the cash value of your plan and places it into investments instead of savings. The money in your account will fluctuate based on the market, and your death benefit will too. This means it's possible to make a lot of money with this policy—but lose a lot as well. This is often a less attractive option given the uncertain nature of the market, but it could work for people who are more comfortable with taking financial risks.
Because of the flexibility it offers, universal life insurance is one of the most popular options in the marketplace today. While a whole life insurance policy is fixed in terms of its premiums and benefits, UL insurance offers policyholders the chance to change their premiums and benefit over time. UL insurance is broken up into 3 different policy types, giving you even more flexibility.
Guaranteed universal life (GUL) insurance
The GUL policy is obtainable without a medical exam, which is great news for those in poor health who need coverage. However, there are caveats to this policy that prevent it from being a true permanent insurance plan and make it more of a permanent-term combination.
The primary feature of a GUL is that this policy lasts until a set age—90, 95, 100, 110, or 121. Only those who choose a policy for age 121 guarantee that their cash value and death benefit will be paid out in full. Those who choose a lower age option might ultimately pay less but only receive what the benefit has grown to at the time of their death.
Variable universal life (VUL) insurance
VUL combines the investment-heavy design of variable life insurance with the flexible premiums of universal policies. But this plan is complex and isn't recommended for the average consumer. It targets high-income investors and those who are already insured. And just like standard variable insurance, your death benefit will fluctuate based on your investments.
Indexed universal life (IUL) insurance
IULs are relatively new in terms of life insurance, offering policyholders protection from losses in investments. These are complex policies, but you can get a better understanding if you have a grasp on what a stock index is. A stock index measures a section of the market to get an idea of the trends and compare returns on investments.
Rather than investing your money into individual stocks, the IUL links your investment account to a particular index. If that index goes up, then the interest you earn from your insurance company will increase. If the trend continues throughout the course of your coverage, your loved one will receive bigger benefits.
But what if the index goes down? This is where an IUL provides more protection than a VUL. IULs have set interest rates in the event of a market crash, so while you might not necessarily make more money, you can't get a negative return on your investment.