Term Vs Permanent Life Insurance
Beware the Myth That Term is Always Cheaper Than Whole or Universal
Term life insurance premiums start low, but often increase significantly. Permanent whole life or universal life insurance plans may cost much less over the long term.
Death-protection-only term life insurance coverage is often heralded as the least expensive way to insure one’s life. In the early years of a term life plan, that’s usually true. But if the policy is kept in force long enough, term coverage ultimately may cost more--perhaps much more--than a permanent life insurance program. As with most financial calculations, the devil is in the details.
Term and Permanent Life Insurance Compared
First, a few basics. There are two kinds of life insurance, permanent and term. The former is like owning: in time payments (premiums) usually build equity, called cash surrender value. With a term (i.e., temporary) policy, one “rents” coverage for a stated period of time, and premium payments seldom build equity.
Term premiums usually start and remain low for one to 30 years or more, and then rise, sometimes dramatically, when the “lease” renews, at the end of the stated period (term). Permanent life premiums are higher, but they usually remain level for a lifetime. Low initial term premiums are attractive to cash-strapped buyers and seem more affordable for a given death benefit, compared to whole or universal life policies, the two common forms of permanent coverage. Over the long run, however, term may prove so unaffordable compared to the permanent variety, that the vast majority of term policies are cancelled by their owners before ever paying out.
Term and Permanent Life Insurance Premium Costs--An Example
Consider a male, age 25, in excellent health, shopping for $250,000 in life coverage. A typical 30-year term policy—one whose premiums remain level for 30 years—would cost about $370 annually until the man attains age fifty-five. Then, the premiums jump significantly—to over $4,700 per year. When he reaches age 65, he will have spent $58,780—money gone forever— on a policy with no cash surrender value. Since there’s no equity, the insurance contract pays off only when he dies.
Compare that to a popular form of permanent insurance called universal life, with higher but level annual premiums of $1739, every year to age 100 or beyond. By his 65th birthday, the man’s total premium outlay of $69,560 ($1739 x 40) will have built equity (cash surrender value) of $157,000—$87,000 more than his premium investment. That’s real money the man can cash in, perhaps to supplement his retirement, borrow against, or leave alone to grow further. Permanent insurance has a living benefit—it can pay off before one dies.
Written Life Insurance Illustrations Enable Comparison of Long-term Costs and Benefits
When shopping for life insurance, have the agent provide and explain term and permanent life illustrations. These are printed reports in a spreadsheet format that lay out the total premiums a proposed insured person can expect to pay over time for a given death benefit. A term illustration will reveal how premiums ratchet up when the stated term period expires. A permanent life insurance illustration will include guaranteed and non-guaranteed (historical) cash value projections, typically to age 100 or beyond. Permanent life illustrations enable one to calculate the net cost of insurance—which is cash value accumulation minus cumulative premium outlay at any given future age or policy year. If the net cost is a positive number, the life contract has, in effect, paid for itself, perhaps handsomely.
Consider Converting a Term Life Policy to a Permanent Plan
Term insurance usually allows for conversion, a feature that enables a policyholder to initially obtain life insurance coverage inexpensively, and then later exchange a portion or all of the term plan for a level-premium, cash value-building permanent plan. Often, the term conversion can be accomplished without evidence of insurability (i.e., a physical exam). Ask the agent or company if, when and for how long term conversion is available.
With life insurance, one usually gets what one pays for. Shop, compare, study and understand short- and long-term costs and benefits.
