Permanent Versus Term Life Insurance
In the 1946 movie “It’s a Wonderful Life,” when George Bailey finds himself in financial straits, he tries to pull out some equity on a $15,000 life insurance policy. And no, it wasn’t term life insurance that George had. When evil slumlord Potter laughs at him because of the pitiful equity that he has in the policy, George decides he’s worth more dead than alive. Did George have the best policy? It’s hard to debate that, but one thing is certain: options have been around a long time, much longer than 1946. Choosing the type of life insurance policy can be a painstaking and long process since there are plenty of options. Term life insurance is the simplest and easiest form, and many agree that it’s the best financial decision. But others argue that the money you put in term life insurance “doesn’t work for you,” meaning that none of the money you put in will serve as equity in the long run.
Term LifeTerm life insurance is aptly named because it only lasts you for a term, generally 20 or 30 years, and that when the time is up, the money is gone -- 100 percent in the pockets of the insurance company. Those favoring term life insurance argue that it would be better to buy a cheap policy and put as much money as you can in a 401k or other type of investment.
Term life proponents say that the point of life insurance is to keep your family safe during the high risk years: when your wife is pregnant, when you have small children, and while you’re paying off your home. If you invest wisely and you’re able to pay off your home mortgage or at least put a substantial amount of equity in it, you shouldn’t have many worries when your term policy expires.
The other types of life insurance will generally give you some equity over the long term. Another similar option is return of premium, which is more expensive but allows you to get all of the amount you placed in premiums back when the policy ends. How does the insurance company actually profit from this?
Often the customer will end the policy much sooner than the 20- to 30-year term, and although he or she may get a portion back, it’s not 100 percent. This is obviously not a way to “get your money to work for you,” since you’re basically getting a 0 percent return on your money -- not much, given the rate of inflation over a 20- to 30-year period. But it does keep you safe during the high risk years.
Whole and UniversalWhole and universal life are much more expensive than term, partly because you’re not just purchasing the standard “death insurance,” but you’re basically also purchasing investments. They’re both called permanent options, and they both allow you to build equity in them. With whole life, part of the money you pay in premiums accumulate as guaranteed cash values. Unlike typical investments, the cash value accumulation is tax deferred. You don’t have to wait 30 or more years to start drawing from the accumulated amount, either: you can begin borrowing from it after a few years. Of course, the amount you pull from it means there will be less later. Universal life generally isn’t much different from whole. Although universal carry a cash value, the amount is variable while the whole is guaranteed and generally viewed as the more stable and secure of the two.
Other OptionsLife insurance is an old business, so companies have had plenty of time to mull over different options. What if the customer wants a policy that lasts longer than 30 years, but just can’t afford permanent life yet? There are hybrid options for those customers: you can purchase policies that start as term life insurance but can be altered to permanent ones later on in life. These policies will generally vary in cost, but are usually slightly more expensive than term life.
ConclusionShop around, spend some time listening to the different options, and also consider your needs and your habits. Keep in mind that the younger you are, the cheaper the premiums will be, but don’t let that rush you into making an unwise decision. If you’re the type of person who can’t be disciplined enough to let a permanent policy build equity, then maybe it’s not for you. If your high risk years aren’t from ages 25-55, then keep in mind that your needs will be vastly different from a typical family that begins a mortgage and family in their 20s or 30s. Since there are so many options, chances are that there’s something that can meet your needs.
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