In this article I want to discuss a question I get a lot, the difference between term life insurance and permanent life insurance. I’m going to speak to the major differences and how families and business owners incorporate both into their financial plans.
But first, what is life insurance?
A life insurance policy is a contract with an insurance company. In exchange for regular payments, the insurance company provides a lump-sum amount of money (death benefit) to the person or organization of your choice.
Life insurance company’s use health, lifestyle and family history questions to determine your premium payment. At its very essence, life insurance premium is determined by your life expectancy.
Term Life Insurance
Term life insurance provides protection against financial loss during a specified period of time. You can think of term life insurance like renting a home. When you rent a home, you pay rent over a specified period of time outlined in your lease. When your lease is up, you renew your contract.
There are many different ‘terms’ to choose from when it comes to a term life insurance policy. The most common policies are term-10, term-20, term-30, term-65 (lasts until age 65), term-life (lasts until you die). The longer the term, the more expensive the premium. However, the younger you start, the less expensive the premium.
As an example: $1,000,000 of 10-year term life insurance on a 35-year old male is $42 / month. The insured will pay $42 / month and if he dies within the 10-year period, his beneficiary will receive $1,000,000 tax-free. Once the 10-year period is up, if there is still a need for insurance, he will have to renew his insurance at a higher cost (due to age).
Term life insurance is the most efficient way for families to cover financial loss due to an unexpected death.
Families often consider the following when determining how much term life insurance they need:
A classic example to think about is a family with a stay at home spouse, 2 children and a mortgage. What if the breadwinner in the family passes away with no life insurance? How would the surviving spouse, who has no job, support the children and pay a mortgage?
Business owners also use term life insurance in several ways:
Permanent life insurance
Permanent life insurance is life insurance that stays in force until you pass way. You can think of permanent life insurance like owning a home, it’s an asset. The premium you are paying each year for the insurance policy is like paying your mortgage, you are building equity or ‘cash value’ inside of your policy. Permanent life insurance is far more expensive than term life insurance.
One key characteristic of permanent life insurance is a feature known as cash value. Cash value grows inside of the policy on a tax-deferred basis (like an RRSP) and can be used in the future. Cash value can either been withdrawn from a policy and will be taxed as income or borrowed from the policy tax-free. Any outstanding loan from the policy at death will be paid back using the death benefit of the policy. If the cash value is never touched, any growth will payout tax-free at death to your beneficiaries.
There are two types of permanent life insurance, universal life and whole life. Guaranteed universal life insurance is very vanilla – you have a premium and death benefit that never changes. You can deposit additional money beyond your premium inside of a universal life policy that can be invested in various investment vehicles, growing your money on a tax-deferred basis. If the money is never withdrawn, it will pay out tax-free to your beneficiaries as part of the death benefit.
Whole life insurance is insurance with a forced savings aspect. It is more expensive than universal life because part of the premium is added to an invested savings component (cash value). Each year the insurance company pays a dividend that can be used to purchase additional insurance (paid up additions). Once again, if the cash value is never touched, the death benefit and additional paid up additions are paid tax-free to your beneficiaries.
Families often use permanent life insurance for the following reasons:
Business owners often use permanent life insurance in the following ways:
I hope this guide has provided insight on the main differences between term and permanent life insurance. One is not better than the other, it all depends on what you are trying to achieve with your financial plan.
Plitvice National Park is a must see when travelling through Croatia, the waterfalls are breathtaking. We stopped in after we visited Dubrovnik and Hvar, as it was on our way up to Zagreb. From there we ventured to Budapest to continue our travels.