Two Categories of Life Insurance
Most people make the distinction between two major types of life insurance as Term and Whole Life, but the more accurate terms are: Term and Permanent life insurance. Those are the two broad categories of life insurance; whole life is just one type of permanent life insurance. Sometimes “whole life” and “permanent life” are used interchangeably. With the advent of several unique product designs in the past 10 or 15 years, there are many variations of permanent life insurance which will be described below.
Term Life Insurance
Briefly defined, term life insurance is a product designed to last for a specific period of time. The most common term products are as follows: 10-year, 15-year, 20-year, and 30-year. There are other term periods, but very few carriers offer them. Most carriers offer guaranteed level term insurance. Basically, this means the premiums are guaranteed never to increase during the term period. Also, the face amount will not decrease over the course of the term period. Some products are only guarantee the premium for the first 5 or 10 years. Be careful to avoid these products since they the cost is only marginally less than guaranteed level term. Also, there are products with decreasing face amounts, but these products are typically packaged as “mortgage life insurance” and they are intended to decrease as one pays down their mortgage (see post on Mortgage Life Insurance).
Permanent Life Insurance
Permanent life insurance is designed to last for one’s entire (whole) life. Often times, permanent life products, such as whole life or universal life, build “cash value” over time. The premiums pay for the basic cost of insurance, but they also can build equity in a separate savings account. The accumulated savings can be “borrowed” under specified conditions. In whole life products and some universal life products, the insurance company invests money into fixed income securities. There are also variable products that allow the policy-holder to invest the money into various funds, depending on their risk tolerance. Similar to an 401(k), the funds can be diversified into several funds. There are many “moving parts” in permanent life insurance, so it is important to fully understand how the product works and how much certain fees (such as management fees) cost. The purpose here is not to provide an in-depth analysis of permanent life insurance, but simply provide an overview.
A Hybrid Product: Term to age 100
There are newer permanent products that are not designed to build cash value, but strictly to provide permanent life insurance protection. Sometimes these products are labeled “term to age 100”. These products can be useful in situations where the insured doesn’t want to risk losing their insurance too soon. For example, a 30 year-old might want a term period longer than 30-year, but without the savings vehicle of most permanent products. An experienced agent can help customize a product that extends beyond 30-years. Sometimes, people simply like the idea of having some life insurance in force for their entire life. This can be accomplished by splitting policies between term and permanent or “laddering” policies.
The Best Choice for Most
Many financial advisors feel it is better to “buy term and invest the rest”. This strategy is highly recommended during prosperous time — when investing in the market consistenly brings high returns. In today’s market, however, there has been a resurgence of whole life products. primarily due to their reputation as solid, safe cash accumulation vehichles. However, there are still those (such as Clark Howard and Dave Ramsey) who are fiercly opposed to any permanent life insurance, regardless of the economic climate. I tend to agree with the general message put forth by such consumer advocates, mostly because permanent insurance is oversold to people who really just need term insurance.
For the vast majority of people, term life insurance is the best product. It is very affordable and provides the needed protection for loved ones while they are dependent on your income. Some agents will refer to term life insurance as temporary insurance. They are correct in that term insurance provides protection on a “temporary” basis, but this has a negative connotation. Usually this term “temporary” is followed by the analogy of renting your life insurance versus owning your life insurance, as the agent pitches the advantages of permanent life insurance. I think this is a poor analogy because it assumes the premium spent on term insurance is wasted, while the premium spent on permanent insurance is building wealth. Buying term insurance accompanied by a sound investment stategy is often the best approach.
I believe there are situations where permanent life insurance makes sense. For very high income earners looking for tax-protected growth of their investments, a permanent life insurance product can be an excellent vehicle. There are other instances where permanent life insurance is a good option, but that is a topic for another post.
For questions about term and permanent life insurance, please call Greg Sanders at 678-236-1600 or visit www.insuranceadv.com